Australian Flash Boy in contempt of court

As anyone who has read Michael Lewis’ latest book, Flash Boys, will know there is a lot of money to be made and lost through high frequency trading (HFT). Whilst the Australian securities market is structured and regulated quite differently from the US market described by Lewis, there is no doubt that Australia has had its share of ‘colourful’ Flash Boys whose conduct has been challenged in the courts. One such individual is Mr Matthew Hurd, who was found (in late 2012) by the Federal Court of Australia (Justice Gordon) to have “set out on a covert course of conduct that was nothing more than a flagrant and deplorable attempt to appropriate benefits for himself which were properly those of his employer”. Mr Hurd’s saga has continued. On 28 May 2014 Justice Tracey of the Federal Court of Australia found that Mr Hurd and various corporate entities associated with Mr Hurd were in contempt of court because they had breached various court orders.

The story began in 2005 when Mr Hurd became a director, an employee and the company secretary of Zomojo, an Australian company involved in HFT, primarily on the Korean Stock Exchange, using proprietary technology it developed in house. Mr Hurd was the lead technologist, with the other founders providing start-up capital. At the outset Mr Hurd identified as Zomojo’s principal business risk “important staff leaving with enough IP in their heads to competitively hurt the venture”. Whilst employed by Zomojo, Mr Hurd established Zeptonics and a number of associated entities, the purpose of which was to compete against Zomojo. He then left Zomojo and devoted his efforts to Zeptonics and a number of associated entities. The court found that Mr Hurd breached his contractual, fiduciary and statutory duties to Zomojo, and that Zeptonics and a number of other corporate entities associated with Mr Hurd had assisted and participated in Mr Hurd’s misuse of Zomojo’s confidential information.

Mr Hurd, Zeptonics and the other corporate respondents were ordered, amongst other things, to:

  1. assign their rights in various products they had developed to Zomojo, and deliver up to Zomojo all tangible parts, and prototypes, of those products in their possession;
  2. cease using or accessing the relevant products (and cease assisting others to use or access them);
  3. swear and file affidavits deposing to the profits derived from commercialisation of the relevant products.

In the most recent decision, the court found that these orders had been breached. The next step will be a hearing to determine penalties. (If Justice Tracey decides the penalty phase, he will be particularly conscious of very recent criticism by the Full Federal Court of one of his decisions in 2010 to impose quite serious penalties, including a sentence of imprisonment, in another contempt of court case involving IP infringement and UGG boots).

One of the interesting aspects of this decision was its exploration of the effect of the court’s orders on licensing arrangements entered into by Zeptonics with its customers. As IP lawyers, we regularly draft and negotiate clauses dealing with the rights of the parties to the contract if a third party claims that the use of a licensed product infringes that third party’s rights. But we don’t often see how those clauses play out.

It was a term of one of the licensing arrangements that if the use of the relevant products were to be prohibited “by a temporary injunction or legally binding decision” for any reason Zeptonics had the right, at its discretion, to terminate the agreement. Zeptonics did not terminate the agreement after the court’s orders were made, and Justice Tracey found that by failing to exercise its right to terminate, Zeptonics breached the order obliging Zeptonics to cease assisting others to use or access the products.

In contrast, the agreements between Zeptonics and two other Korean customers did not confer on Zeptonics such a termination right. Zomojo argued that Zeptonics could have implemented technical measures to disable access to the relevant systems used by those customers. However, Justice Tracey found there was no evidence that Zeptonics could lawfully have taken steps to disable access by those customers, and held that there was no breach of the order in respect of those customers.

Breaches were also established in relation to failures to adequately disclose profit (and loss) figures in affidavits filed on behalf of the relevant companies. It seems that this case is one of those instances where it is very challenging to obtain a satisfactory financial remedy due to the lack of co-operation by the respondent in providing accurate and comprehensive accounting records. In general terms such failures can either be attributed to a deliberate attempt to conceal incriminatory evidence or simply to poor record-keeping practices. Whatever the reason, the consequence for the successful innocent party is that it must spend its own “good” money to pursue an uncertain financial outcome. In this instance, given the strength of the court’s findings against Mr Hurd, pulling back from enforcement of the court’s orders would be a bitter pill for Zomojo to swallow.