Introduction

The Securities and Exchange Commission (SEC) announced in its Fall 2021 regulatory agenda that the agency is considering asking for public comment on the role of index providers and the implications for the asset management industry (see Reginfo.gov, SEC Agency Rule List at RIN 3235-AM95). This follows a recommendation by the agency’s Asset Management Advisory Committee that the Commission consider taking action to limit index licensing fees (see sec.gov, AMAC Report and Recommendations dated 1 November 2021).

Whatever action the SEC may take to regulate index licensing practices, it is interesting to consider a fundamental underlying question: Why is an index license required at all? The easiest answer is that most major financial firms are already subject to data provider agreements that expressly require separate index licenses for structuring financial products and managing portfolios. Another is that a license is often needed to use the provider trademarks associated with the index.

In theory, these contract and trademark concerns can be circumvented by careful branding and data collection practices. Reliable index data is available from public news sources that do not impose contractual restrictions and a trademark license is not required for purely descriptive references to index marks so long as the references are not misleading (Dow Jones & Co., Inc. v. International Securities Exchange, 451 F.3d 295 (2d Cir. 2006) (“ISE”) (exchange’s descriptive use of SPDR mark in listing and trading options on index-linked exchange traded funds did not violate trademark rights).

Contract and trademark, however, are not the only legal risks associated with unlicensed use of indexes. Index providers have successfully blocked or impeded unlicensed use of their indexes by asserting claims of copyright infringement and common law misappropriation. Neither protection covers all index uses, but their combined effect has been compelling. The case law in this area is obscure and fluid, but familiarity with the key precedents and concepts can be useful in negotiating and interpreting index data and license agreements.

Federal Copyright

A typical index is a compilation of information and data concerning its constituent securities. To qualify for copyright protection under U.S. law, a compilation must be “formed by the collection and assembling of preexisting materials or of data that are selected, coordinated and arranged in such a way that the resulting work as a whole constitutes an original work of authorship” (17 U.S.C.§ 101). The work of authorship must involve creativity, but the creativity threshold for a compilation is extremely low. Feist Publications, Inc. v. Rural Telephone Srvc. Co., 499 U.S. 340 (199l) (alphabetical arrangement of telephone directory not sufficiently creative to merit copyright compilation protection); compare Key Publications, Inc. v. Chinatown Today Publishing Enterprises, Inc., 945 F.2d 509 (2d Cir. 1991) (business directory with categorical arrangement is copyright protected).

Most market indexes readily meet the compilation creativity threshold. The Dow Jones Industrial Average, for example, is based on a constituent selection process that is described by its publisher in terms that emphasize judgment and creativity:

• While stock selection is not governed by quantitative rules, a stock typically is added [to the index] only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors.
• Maintaining adequate sector representation within the index is also a consideration in the selection process for the Dow Jones Industrial Average.
• (Excerpts from S&P Dow Jones Indices, Dow Jones Averages Methodology (December 2021), available at spglobal.com.)

Yet, even indexes based on more objective selection criteria can meet the creativity standard for compilations. For example, selection based primarily on capitalization may seem purely mechanical, but the S&P 500 and similar indexes tend to apply weighting and selection adjustment techniques that require creative skill and good judgment.

There are, however, significant limitations on copyright protection for market indexes. For example, in Dow Jones & Company Inc. v. Board of Trade of the City of Chicago, 546 F.Supp. 113 (S.D.N.Y. 1982) (“Dow”), the court held that the Dow Jones index constituent list was a protected compilation, but it also found that such protection did not apply to every element of the index:

• Forbidding copying of [the index constituent list] will not insulate the underlying idea that monitoring 30 blue-chip stocks might provide a valuable, continuous indicator of stock market performance. Only the expression of that idea, embodied in the particular stocks selected by Dow, is protected from slavish copying. (Dow at 118)

The distinction between free-flowing “ideas” and copyright-protected “expression” is also reflected in the Dow court’s recognition that the Dow Jones average — i.e., the weighted average of the index’s constituent stock values — is not protected under copyright laws (Dow at footnote 8). Although the average is arguably the numerical embodiment of the idea expressed by the index, courts have consistently held that there is no protection where the idea and its expression are effectively merged. See, e.g., New York Mercantile Exchange v. Intercontinental Exchange, 497 F.3d 109 (2d Cir. 2007) (exchange could not assert copyright protection in the settlement prices it produced to value open futures contracts). Notably, Dow Jones in this case conceded that its copyright claim involved its constituent lists only and not the index averages (Dow at 117; see also Chicago Board Options Exchange. Inc. v. International Securities Exchange, 2012 IL App (1st) 102228 (2012) (“CBOE”) (index values are market facts and may be freely used once published)).

An additional limitation on an index copyright claim is the “fair use” defense, which includes a balancing of factors outlined in the Copyright Act (17 U.S.C. § 107). In Dow, the court noted that the evidence concerning the “central” fair use factor — that is, the effect of the use on the potential market value of the index lists — did not support Dow Jones’s copyright claim (Dow at 121).

In summary, there is precedent indicating that the creation, sale, and marketing of financial products with valuations linked to third-party index averages would not by itself require copyright license, but other uses that rely on copying the index constituent lists might.

Common Law Misappropriation

Index providers have had some success blocking unlicensed use of the index averages by invoking the common law misappropriation tort. For example, in Standard & Poor’s Corporation, Inc. v. Commodity Exchange, Inc., 683 F.2d 704 (2d Cir. 1982) (“S&P”), a Second Circuit panel applied misappropriation principles to uphold an injunction against the Commodity Exchange’s attempt to market futures contracts that were to settle at prices determined by the then-current value of the S&P 500 Index. Although the court did not reach the merits of the dispute, it noted that S&P’s claim of misappropriation “present[ed] sufficiently serious questions going to the merits to make them a fair ground for litigation” (S&P at 117).

The doctrine of misappropriation as applied in S&P and elsewhere traces to the Supreme Court’s decision in International News Service v. Associated Press, 248 U.S. 215 (1918) (“INS”), where the court determined that one news agency should not be permitted to copy and distribute the reports of a competitor agency. Recognizing that “the value of news is the spreading of it while it is fresh,” the court concluded that:

• [D]efendant, by its very act, admits that it is taking material that has been acquired by complainant as the result of organization and the expenditure of labor, skill, and money, … and that defendant is endeavoring to reap where it has not sown. [A] court of equity ought not hesitate long in characterizing it as unfair competition in business. (INS at 239-240)

Following S&P, the INS principles were again applied when an Illinois state court found that the Dow Jones averages were subject to protection against misappropriation. That case, The Board of Trade of the City of Chicago v. Dow Jones & Company, Inc., 98 Ill. 2d 109 (1983) (“Board of Trade”), arose after the Chicago Board of Trade sought a Commodity Futures Trading Commission designation as a market for stock index futures contracts based on the value of the Dow Jones Industrial Average (“DJIA”). Although Dow Jones was not then in the business of licensing its indexes for use in settling futures contracts, the court found that the lack of actual competitive injury did not justify the unlicensed use of the index average by the exchange, stating:

• The publication of the indexes involves valuable assets of defendant, its good will and its reputation for integrity and accuracy. Despite the fact that plaintiff’s proposed use is not in competition with the use that defendant presently makes of them, defendant is entitled to protection against their misappropriation. (Board of Trade at 121-122)

More recently, in CBOE (supra) the Illinois Appellate Court treated Board of Trade as controlling authority for the continued application of the misappropriation doctrine to index averages.

These index misappropriation cases (S&P, Board of Trade, and CBOE) offer index providers an important legal tool — not available in copyright — to impede unlicensed use of their index averages in connection with the performance of financial products. There is little in these cases to suggest that the same reasoning may not apply to other index elements (e.g., constituent lists, weightings, or data), although federal courts in New York have declined to extend misappropriation protection to unlicensed secondary market trading of index-linked products. See, e.g., ISE; see also, The Nasdaq Stock Market Inc. v. Archipelago Holdings, LLC, 336 F. Supp. 294 (S.D.N.Y. 2004)) (dismissing Nasdaq’s claim that the Archipelago Exchange was misappropriating Nasdaq’s rights by engaging in unlicensed trading of shares in the Nasdaq “QQQ” ETF).

Misappropriation and Copyright Preemption

Misappropriation is subject to significant copyright preemption concerns that predate the early index decisions in S&P (1982) and Board of Trade (1983). When Congress amended the Copyright Act in 1976, it provided for the preemption of state law claims that are “equivalent to any of the exclusive rights within the general scope of copyright . . . and come within the subject matter of copyright” (17 U.S. Code § 301(a)). The legislative history of the Act includes commentary to the effect that some forms of misappropriation survive preemption:

• [A] cause of action labeled as “misappropriation” is not preempted if it is in fact based neither on a right within the general scope of copyright … nor on a right equivalent thereto. For example, state law should have the flexibility to afford a remedy (under traditional principles of equity) against a consistent pattern of unauthorized appropriation by a competitor of the facts (i.e., not the literary expression) constituting “hot” news, whether in the traditional mold of INS or in the newer form of data updates from scientific, business, or financial data bases.

H.R.Rep. No. 94-1476, 94th Cong., 2d Session, 132.

Applying the statutory preemption principles in cases involving claims of misappropriation of information or data, the Second Circuit has repeatedly concluded that claims under New York’s misappropriation doctrine are preempted, with the sole exception of INS-like “hot news” claims. See, e.g., National Basketball Association v. Motorola Inc., 105 F.3d 841 (2d Cir. 1997) (Motorola’s transmission of updated NBA scores gathered from television and radio broadcasts did not constitute a misappropriation of hot news; New York law supporting other misappropriation theories was effectively preempted by the Act), citing Financial Information, Inc. v. Moody’s Investors Service, Inc., 808 F.2d 204 (2d Cir. 1986), cert. denied, 484 U.S. 820, 108 S.Ct. 79 (1987) (“FII”) (publisher of printed cards containing municipal bond issuance information failed to prove the quantity of copying [or] the immediacy of distribution necessary to sustain a hot news claim); see also Barclays Capital v. Theflyonthewall.com, Inc., 650 F.3d 876 (2d Cir. 2011) (claim regarding unauthorized use and distribution of broker research recommendations did not meet the exceptions for a ‘hot news’ misappropriation and is preempted).

The early index cases do not expressly address the preemption issue, but arguably those misappropriation claims would not survive the Second Circuit’s more recent preemption analysis. Neither S&P nor Board of Trade appears to involve an INS-style claim, and neither opinion contains any analysis of the time-sensitivity element that is central to a viable hot news claim. Instead, both cases appear to rely on a broad theory of misappropriation that focuses on the fundamental unfairness of allowing a competitor to enrich itself by exploiting the time and effort of others – precisely the approach the Second Circuit has repeatedly declined to follow (see, e.g., FII at 209 (asserting general rule of preemption for misappropriation claims based on “commercial immorality”)).

In contrast, the Illinois court in CBOE considered the issue in some detail and found that index misappropriation survived preemption, stating:

• This conclusion is consistent with our supreme court’s holding in Board of Trade, by which we are bound. … It is true that the Board of Trade decision did not address the preemption issue, though it was decided after the 1976 amendments to the Copyright Act, but its conspicuous silence on the issue necessarily means, by logical deduction, that a misappropriation claim of the type advanced by plaintiffs is not preempted. (CBOE, at Para. 31.)

The opinion also stated that the Second Circuit in ISE “clearly held that copyright law does not preempt misappropriation claims of the type at issue here” (CBOE, at Para. 32).

The court in CBOE may have been compelled to adhere to the binding precedent set by its superior court, but its preemption analysis rests on a couple of questionable points. In addition to taking the unusual liberty of reading the higher court’s silence on preemption as akin to a judicial holding, it is difficult to find anything in the written opinion to support the assertion that the Second Circuit in ISE “clearly” made any holding at all regarding preemption. Much to the contrary, the Second Circuit in ISE repeatedly side-stepped the copyright issues, expressly assumed arguendo that the providers held exclusive proprietary rights in their indexes, and then held that any such rights were relinquished as to the resale of licensed indexed-linked ETFs via options (ISE at 302-303 and fn. 8-9).

In any case, it is difficult to square the Illinois court’s preemption analysis with that of the Second Circuit. What is clear is that the Second Circuit takes a somewhat more restrictive view as to which types of misappropriation survive preemption following the 1976 Copyright Act amendments. While the CBOE court relied on Illinois law and precedent and precedent from other circuits to support the idea that “misappropriation claims other than ‘hot news’ claims have survived as well” (CBOE, at Para. 28), the Second Circuit cases applying the statutory preemption principles to New York’s misappropriation law have to date followed FII in declining to extend the preemption exemption to anything other than classic hot news claims (FII, at 208). The conflicting approaches undoubtedly arise in part from apparent differences between the New York and Illinois misappropriation doctrines, but there is still a significant question as to whether a court applying the current Second Circuit preemption analysis would come to the same result as any of the index misappropriation cases.

Conclusion

The U.S. Copyright Law and state law misappropriation doctrines continue to provide important legal tools for index providers to prohibit unlicensed use of index constituent lists and values in financial products. In combination, these protections may also extend to other common elements of market indexes, such as weightings and calculation methodologies. However, the available authority indicates that copyright protection for indexes may extend to the index constituent lists but not index averages, and copyright preemption principles may limit misappropriation protection for indexes to a very narrow class of “hot news” uses.

Authored February 2022 by Lou Trotta.

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