Second Circuit Stays Hot News Injunction–Barclays v. theflyonthewall

By Eric Goldman

Barclays Capital Inc. v. Theflyonthewall.com, Inc., 10-1372-cv (2d Cir. May 19, 2010)

This case is my choice for the most interesting Cyberlaw development of 2010 (so far). Unfortunately, I ran out of time to blog it when the district court opinion came out in March; the opinion was 89 pages, and I must confess that I let my quest for a perfect blog post become the enemy of a good blog post. Some commentary on the district court ruling: Wendy Davis, Sam Bayard (with a detailed First Amendment analysis), Jeff Neuburger. Fortunately, yesterday we got an important new development in the case, which gives me an excuse to recap the case and talk about its implications.

The case involves an anachronistic business model deployed by brokerage houses. Brokerage house analysts develop and publish stock recommendations. The recommendations are provided first to brokerage clients, who in theory get a chance to act on the new information before that information is generally incorporated into the stock price. Eventually these recommendations are published to the media or otherwise reach the general public.

This is where the business model get weird. The brokerage houses don’t directly charge clients for this early access to this information that may move the stock price. Instead, there is an unwritten expectation that the clients who receive the recommendations early will place their stock trades with the brokerage house providing the information, generating commission revenue for the brokerage firm. Clients who take a firm’s recommendations and then consistently transact with other (presumably cheaper) brokerage firms should eventually find themselves kicked off the distribution list for future recommendations.

Consider this business model from a game theory standpoint. It’s a multi-iteration game that keeps the brokerage clients from “cheating” (taking the business elsewhere) on any one interaction by promising profits from future interactions so long as they cooperate (place the order with the brokerage house making the recommendation). But the entire model is premised on the brokerage house delivering valuable information that makes clients money, which in turn requires that the clients get the information before the marketplace has incorporated the information into the stock price. And because “information wants to be free” in the ways discussed in John Perry Barlow’s seminal article, there is a significant risk that the information will “leak out” quickly, get absorbed into the stock price, and eliminate the brokerage house’s quid that is designed to elicit its clients’ quo.

Theflyonthewall is a publication that gathers brokerage house recommendations from a variety of sources and republishes them in a subscription newsletter. The quicker theflyonthewall gets a recommendation to its readers, the more likely that the readers can act before the information has already been incorporated into the stock price. In that sense, then, theflyonthewall strikes directly at the heart of the brokerage house’s archaic business model. Instead of having to keep transacting with the brokerage houses to keep the information coming, theflyonthewall readers can get some of the same economic benefits and retain the freedom to transact with whomever they want.

Although theflyonthewall disaggregates the brokerage house’s business model in a potentially fatal way, it’s not like the brokerage houses are defenseless. They could make a number of changes to their business models that would fix the problems. Most obviously, they could charge a subscription fee for access to their stock recommendations directly, rather than being compensated indirectly through the resulting stock trade orders. They could also enter into exclusive dealing contracts with trading clients, i.e., anyone getting the reports MUST trade with the brokerage houses. I’m sure other business model changes are feasible.

Instead, the brokerage houses like the situation exactly as it used to work, without having the worry about accelerated information velocity provided by aggregators like theflyonthewall. So, instead of taking a hard look at their business models, the brokerage houses sued theflyonthewall for, among other things, hot news misappropriation. The Second Circuit revitalized the hot news misappropriation doctrine in its 1997 NBA v. Motorola ruling, which articulated a 5 element prima facie case:

(i) a plaintiff generates or gathers information at a cost; (ii) the information is time-sensitive; (iii) a defendant’s use of the information constitutes free riding on the plaintiff’s efforts; (iv) the defendant is in direct competition with a product or service offered by the plaintiffs; and (v) the ability of other parties to free-ride on the efforts of the plaintiff or others would so reduce the incentive to produce the product or service that its existence or quality would be substantially threatened.

I am not a fan of the hot news misappropriation doctrine. The last thing we need is another amorphous legal doctrine to protect intangible assets, and usually hot news misappropriation is a tool plaintiffs use to suppress competition rather than innovating to fix gaping holes in their business practices. However, if we choose to legally recognize the hot news misappropriation doctrine, this case seemed to be a fairly straightforward application of the doctrine.

A hot news claim requires there to be “hot news”–a narrow category of non-copyrightable information that derives value from its time-sensitivity. I can think of only three categories of information that will reliably meet this requirement: real-time sport scores (fans care about a game’s score RIGHT NOW; in 3 days, it’s a distant memory), real-time weather information (information about today’s weather is far more valuable than information from 3 days ago), and certain types of financial information that feed into stock prices. Here, theflyonthewall was trading in the latter category of information that clearly had time-sensitivity–by the time the brokerage house recommendation was incorporated into the stock price, the information was essentially worthless.

Furthermore, unlike the NBA v. Motorola case, theflyonthewall’s republication of the hot news does threaten its production. If the brokerage houses don’t change their business model, theflyonthewall and other aggregators will eliminate the differential value that the stock recommendations can provide to clients, which undercuts a main point of producing the recommendations in the first place.

One more interesting fact about the hot news claim. During the pending legal proceedings in this case, theflyonthewall turned around and sued a third party aggregator for ripping off theflyonthewall–alleging, among other things, that the third party aggregator was committing hot news misappropriation of theflyonthewall’s publications. This was an obviously duplicitous position, and as a result, the legal positions in theflyonthewall’s enforcement action were liberally quoted against it in this lawsuit. A tip to all aggregators that should be common sense but apparently isn’t: be very careful about bringing enforcement actions against other aggregators. You might just be helping to build precedent that will undercut your legal positions when the enforcement action comes against you. When I work with aggregators, I tell them that there’s almost no circumstance when it will make sense for us to go after other aggregators that rip us off. Instead, I advise aggregators to build ex ante technology controls to restrict re-aggregation rather than relying on ex post legal proceedings.

So if there are going to be hot news cases, this case looks about as good as it gets for the plaintiff. As a result, I didn’t see this ruling as particularly troubling for other aggregators, in part because most of them will not meet the elements nearly as well as theflyonthewall did. As a good example, Tom O’Toole recently reported on a lawsuit against Goldman Sachs that included a hot news claim. Putting aside the irony of a brokerage house being on the defense side of a hot news claim, the type of data at issue there looks nowhere as close to “hot” news as the data in theflyonthewall case.

After finding a hot news misappropriation, the district court then did something a little goofy. It issued an injunction that required theflyonthewall to delay publication of any stock recommendations it came across until 10 am (if the recommendation was issued before the stock exchanges open) or 2 hours after the brokerage house’s release, with an exception for theflyonthewall’s independently developed reporting on a big news event. Note that the time delay applies even if the recommendations have already been extensively republished elsewhere, such as being picked up by major newswires, so the injunction puts theflyonthewall at a noticeable competitive disadvantage compared to other aggregators/news publishers who are freely publishing the same information without the court-ordered embargo.

Furthermore, the court said that theflyonthewall could request dissolution/modification of the injunction in a year “in the event that it can demonstrate that the Firms have not taken reasonable steps to restrain the systematic, unauthorized misappropriation of their Recommendations, for instance, through the initiation of litigation against any parties with whom negotiation proves unsuccessful.” Say what? The court apparently took a carrot and stick approach to the brokerage houses—the plaintiffs get an injunction against theflyonthewall, but they get to keep it only if they take down lots of other news publishers and aggregators. Now, the brokerage houses might just be willing to do that, but do we really want them doing that? From my perspective, it sounds like a lot of extra litigation to prop up a broken business model.

Yesterday, in a noteworthy development that shows this issue is not going away, the Second Circuit put the kibosh on the injunction. The court’s order says:

it is hereby ORDERED that the motion for a stay is GRANTED, and Appellant shall not be required to post a bond. It is further ORDERED that the motion to expedite the appeal is GRANTED.

The court then issued two related orders with deadlines for briefing and oral argument, but those orders had inconsistent schedules. I assume the court will issue a corrected order that lays out the schedule it actually meant to say. Either way, it doesn’t look like this case will languish in the Second Circuit as so many other Internet cases have done (e.g., the Register.com v. Verio case emerging three years after the appeal).

The Second Circuit orders provide no substantive insight into the appellate court’s thinking, but the fact they stayed the injunction is a pretty strong hint that they are unhappy with something in the district court’s opinion–perhaps its assessment of hot news, or more likely some aspect of the injunction.

Either way, it would be hard to overstate the importance of the Second Circuit proceedings. I’ve recently been to a few angst-ridden “Future of Journalism” conferences where this case is highlighted as one possible way that news originators can get some legal and financial leverage over Google News and other news aggregators. I’ve been generally uncomfortable with those discussions on a number of fronts–most importantly because the news originators unduly denigrate the significant value created by curation, even though many traditional publishers do a fair amount of curation themselves. If the Second Circuit guts the district court’s opinion, I assume the pro-hot news forces will go searching for some other menacing doctrine (or worse, crank up the lobbying machine for statutory relief). Or, if the Second Circuit endorses a broad reading of hot news, expect to see a lot more hot news lawsuits.

With the Second Circuit’s lax standards for submission of amicus briefs, I expect a lot of amicus briefs will be filed in this case. Public Citizen has already announced its intent to file an amicus brief.

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