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Article: Stock Exchanges Call for Dismissal of HFT Lawsuit

17 December 2014 | Derivatives Law Feed
 

Background

Filing a motion to dismisson November 3, 2014, major stock exchanges fired back at a class action lawsuit against them for allegedly providing high-frequency traders (“HFTs”) with material, non-public information and subsequently allowing these traders to engage in predatory trading practices. This lawsuit flows from the wake of allegations made in Michael Lewis’ book “Flash Boys: A Wall Street Revolt” published earlier this year. The current lawsuit provides the court with several questions that could hold big implications for future suits against exchanges in particular. Not dismissing this lawsuit could provide, for better or worse, a roadmap for litigants to (a) bypass SEC review and head straight to district court, and (b) plead general as opposed to specific violations of Securities Exchange Act Section 10(b) and SEC Rule 10b-5.

History of the Case

A brief timeline of this case is as follows:

Date

Action

April 28, 2014

Plaintiffs (City of Providence, et al.) file original complaint against numerous defendants (broker-dealers, exchanges, and HFTs)

June 25, 2014

New York Attorney General files complaint against Barclays Capital and Barclays PLC alleging similar facts and violations

September 2, 2014

Plaintiffs (City of Providence, et al.) file consolidated amended complaint dropping numerous exchange defendants and all HFT and broker-dealer defendants except for Barclays

November 3, 2014

Defendants (Exchanges) file motion to dismiss

November 3, 2014

Defendant (Barclays) files motion to dismiss

November 24, 2014

Plaintiffs file second consolidated amended complaint

As all HFTs and all but one broker-dealer were voluntarily dismissed from the case in the plaintiffs’ consolidated amended complaint filed on September 2, 2014, this post focuses on the exchange defendants’ motion to dismiss and the arguments presented in that motion.

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A Look at Some of the Arguments

The Exchanges filed a motion to dismiss that argues the lawsuit should be dismissed for three major reasons:

       (1)  

Lack of subject matter jurisdiction

       (2)  

Absolute immunity afforded to self-regulatory organizations (“SROs”) like exchanges

       (3)  

Plaintiffs’ failure to state a cause of action

Lack of Subject Matter Jurisdiction

The Exchanges’ first argument is that the Court lacks subject matter jurisdiction and therefore is not the appropriate place to adjudicate the claims. The argument goes as follows: the Securities Exchange Act of 1934 (“Exchange Act”) provides a two-tiered review procedure that applies to any allegation that the Exchanges violated the Exchange Act or Regulation NMS.  First, the allegation must be presented to the SEC. Second, the aggrieved party may seek further review only of a final order of the SEC and only in a federal court of appeals.  The Exchanges argue that the Plaintiffs are unacceptably trying to circumvent the review procedure by proceeding directly to district court.

Absolute Immunity afforded to SROs

The second argument presented by the Exchanges in their motion to dismiss is that an SRO is entitled to absolute immunity from private damage lawsuits in connection with their regulatory responsibilities. To find absolute immunity, the court must ask whether “the specific acts and forbearances [challenged by the plaintiff] were incident to the exercise of regulatory power.” To show that they qualify for such immunity, the Exchanges analogize this situation to another case in which plaintiffs’ alleged wide-ranging manipulative, self-dealing, deceptive, and misleading conduct against an SRO for allowing certain market participants advanced access to trading information.  The plaintiffs in that earlier case alleged that the SRO had abandoned its regulatory role to maintain a fair and orderly market.  That case was dismissed because the SRO had a core regulatory responsibility to maintain a fair and orderly market, and exchanges have absolute immunity with regard to core regulatory functions. Similarly, the Exchanges argue that the Plaintiffs allege a violation of regulatory duties with respect to dissemination of market data, and therefore the case should be dismissed as this is a core regulatory duty.

No Cause of Action

The third argument used by the Exchanges in this case is that the Plaintiffs have failed to state a proper cause of action because they (1) enjoy no private right of action under Section 6(b) of the Exchange Act, and (2) have failed to allege sufficient facts to establish their standing to sue under Section 10(b) and 10b-5.

First, the exchanges argue that Congress created a statutory scheme that provides the SEC alone with the power to prosecute an SRO for any alleged violation of Section 6(b) of the Exchange Act. The Exchanges argue that the “extensive system of administrative remedies” makes it improbable that Congress forgot to add a private right of action.  Simply put, the exchanges argue that no matter what the Plaintiff alleges or proves, under Section 6(b), there is no private right of action and therefore the Plaintiffs cannot recover.

Second, the Exchanges argue that the Plaintiffs fail to allege sufficient facts to establish their standing to sue under Section 10(b) and 10b-5. Most persuasive is the Exchanges’ contention that the Plaintiffs have not established standing under the guidelines of the well-established Blue Chip Stamps case that describes the information that is essential to establishing standing in such cases:  information such as specific dates of purchases, number of shares acquired, and price of shares. Instead, the Exchanges contend, the Plaintiffs here allege vague conduct that amounts at most to “aiding and abetting, which is not actionable.”

Looking Ahead

If the court accepts either of the first two arguments related to lack of subject matter jurisdiction and absolute immunity it would further cement the belief that an Exchange cannot be sued in district court for most actions it takes. This complaint and all similar complaints would be required to go through the SEC’s adjudication process, which would be much more difficult for plaintiffs.

An argument touched on briefly in the motion to dismiss that will certainly play a large role in any subsequent SEC review is the fact that the SEC has approved most of these actions by the Exchanges. For example, when an exchange issues a new rule, it is subject to approval by the SEC. A complaint that alleges preferential access to market data and unfair co-location services has a huge hurdle to jump if the SEC has already given its blessing to those actions, especially if the first review of the complaint lies with the SEC itself.




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The one remaining broker-dealer is Barclays, which filed a separate motion to dismiss on November 3, 2014.  The allegations surrounding the complaint are targeted towards the relationship between its broker-dealer and dark pool. Presumably, the fact that Barclays operates a dark pool along with its broker-dealer functions, is the reason it remains in this case. Additionally, Plaintiffs here can follow the lead of the NYAG investigation and theory against Barclays to better their own chances at proving their case. 

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Authored by: Douglas Cahanin, Founder of Derivatives Law Blog, Associate at Ziliak Law, and Counsel at Eris Exchange, LLC
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