Hello sports fans, and welcome back—I know you’ve all been standing by for a second slice of the strange and scintillating story of shenanigans in the snarled sphere of HFT. In this supplemental stab at spelling out the slightly circuitous state of the stock exchange nation, we will cover the Exchange Defendant’s renewed motion to dismiss, Plaintiff’s opposition to that motion, and, finally, Defendant’s reply brief.
And if you’re curious as to where the story currently stands, I encourage you to spend a few seconds skimming our first installment — that post contains background to the high frequency trading market, as well as an overview of past motion practice and the remaining Section 10(b) and Rule 10b-5 claims contained in the Second Consolidated Amended Complaint (SCAC), to which this renewed motion to dismiss applies.
Here We Go Again: The Exchange Defendant’s Renewed Motion To Dismiss
The December 2017 decision from the Second Circuit held that the Exchanges were not entitled to absolute immunity with respect to the securities fraud claims, thus vacating the lower court’s dismissal. Defendant’s motion to dismiss the SCAC was accordingly limited to grounds for dismissal not yet addressed—and much pithier than earlier briefings, as a result.
Defendant’s motion presents in two parts: first is the straightforward argument that the SCAC fails to plead either Article III standing, or to state a claim upon which relief can be granted; second, Defendants argue that Plaintiff’s remaining claim, brought under Section 10(b) of the Exchange Act and Rule 10b-5, are in fact precluded by the Exchange Act insofar as the claim obstructs the SEC’s comprehensive regulatory structure.
According to Defendants, to successfully plead Article III standing, Plaintiffs are required to allege that they have suffered an injury-in-fact, and that such an injury was directly traceable to Defendant’s challenged conduct. Because Plaintiffs have not specified “even basic transaction details [or] factual allegations that anyone was injured, much less that they were among the injured,” they simply have not pleaded Article III standing, and the claim should be dismissed under Rule 12(b)(1).
Defendant’s second standing argument is premised on the purchaser-seller statutory standing rule, which “limits the class of plaintiffs to those who have at least dealt in the security to which the . . . representation or omission relates.” This argument focuses on the same lack of specificity as covered in the Article III standing argument—namely, Defendants believe that, in order to meet standing requirements, Plaintiffs are required to identify the specific securities that are the subject of manipulation with a high degree of specificity. Moreover, Defendants assert that the “in connection with” requirement of Rule 10b-5 cannot save Plaintiffs claim, as it is separate and additional to the “purchaser or seller” standing rule.
- Failure to State a Claim Upon Which Relief Can Be Granted
Arguing under Rule 12(b)(6), Defendants further claim that the SCAC does not adequately plead reliance, loss causation, scienter, or the falsity of any alleged misstatement. A plaintiff may establish reliance through either direct reliance or through one of two recognized presumptions of reliance: a “fraud-on-the-market” presumption allows reliance on public statements, and the Affiliated Ute presumption, which arises where there is an omission of a material fact by one with a duty to disclose. Defendants posit that the reliance Plaintiffs pled was limited to an “integrity of the market in the securities listed and traded on the public exchanges”—and that this theory does not qualify as actual reliance, or fall into either of the identified presumptions of reliance.
Specifically, there is no “fraud on the market” reliance because “Plaintiffs have failed to plead the existence of an efficient market for a specific security,” and do not point to statements made by the Exchange Defendants that could have affected the price at which Plaintiffs traded. Affiliated Ute is similarly unavailing, according to the Defendants, because it simply does not apply to market manipulation claims, and, further, because the presumption only applies where there are actionable omissions in the face of fiduciary duties owed—and the Exchange Defendants owed no fiduciary duties to the investors. Moreover, defendants insist, Plaintiff’s “integrity of the market” theory was rejected by the Second Circuit in the 2013 Fezzani v. Bear, Stearns & Co. decision.
Loss causation—a specific economic harm resulting from a defendant’s conduct—requires that Plaintiffs must allege not only that they bought or sold specific securities at manipulated prices, but also that the prices of those securities would have been lower or higher, respectively, absent such manipulative conduct. If you’re sensing a theme in Defendant’s arguments here, well, let’s just say you’re not alone.
Defendants turn next to scienter—particularly important in manipulation claim, they point out, as scienter is oftentimes the only factor distinguishing legitimate trading from improper manipulation. The PLRSA requires that the facts alleged give rise to a strong inference that defendants acted with the required state of mind; this can be proved through facts showing either (a) that defendants had both motive and opportunity to commit fraud, or (b) strong circumstantial evidence of conscious misbehavior or recklessness. As Plaintiffs rely on circumstantial evidence, they must demonstrate conscious recklessness, and, Defendants argue, the conduct they allege is within the core functions of the Exchanges and one thus cannot infer an intent to defraud—particularly because the products and services concerned were publicly disclosed.
Finally (for the 12(b)(6) section, at least), Defendants argue that Plaintiffs have not pled the falsity of any alleged misstatement with sufficient particularity. First, Plaintiffs have waived any attempt to base claims on alleged misstatements, rather than manipulation, when they failed to respond to challenges to that theory in the earlier motion to dismiss. Second, Defendant again fall back on lack of specificity in the SCAC: Plaintiffs identified only generic statements about market integrity, any do not show how any challenged statement was in fact false or misleading.
Defendant’s other main argument for dismissal deals with the perceived conflict between Plaintiff’s claims and the comprehensive regulatory structure provided by the Exchange Act. Private lawsuits, Defendants argue, undermine Congress’ intent that the SEC is the expert in the field and the entity making rules regarding the markets. Relying on Credit Suisse Secs. (USA) LLC v. Billing, Defendants lay out the four-factor framework to be used in determining whether or not the Exchange Act’s regulatory scheme precludes private claims:
(1) the existence of regulatory authority under the securities law to supervise the activities in question;
(2) Evidence that the responsible regulatory entities exercise that authority;
(3) The ‘risk’ that allowing the claims to proceed would produce conflicting guidance, requirements, duties, privileges, or standards of conduct; and
(4) Whether the conduct at issue lies squarely within an area of financial market activity that the securities law seeks to regulate.
Based on these four factors, Defendants believe that Plaintiffs claims should be precluded. With respect to factor one, the SEC clearly possess the regulatory authority to supervise the conduct about which Plaintiffs complain: the Exchanges are in fact required to file proposed rule changes before making any of the offerings covered in the SCAC—the proprietary feeds, the co-location services, and the complex order types—and the SEC must approve these rules before they are promulgated. As to the second factor, it is clear that the SEC does in fact exercise its regulatory authority on these topics. For example, the SEC has instituted enforcement proceedings concerning proprietary data feeds not in compliance with SEC rules. The third factor also favors preclusion, according to Defendants, because there is actual conflict between Plaintiff’s claims and the Exchange Act’s regulatory structure. Specifically, the SEC has approved all of the challenged services, warts and all, and concluded that they are consistent with the SEC rules. They have thus exercised their expertise and authority, and Plaintiff’s challenge to the same approved practices are an explicit conflict. Finally (for real…for this section), the fourth factor also favors preclusion because all of the challenged products and services “lie squarely within an area of financial market activity that securities law seeks to regulate”: all of these products and services relate to the dissemination of information, and that is firmly within the remit of the SEC.
Excuse Me, I Have Something To Say: The Plaintiff’s Oppose This Motion
Making full use of the case-saving Second Circuit decision, the preliminary statement of Plaintiff’s opposition quotes heavily from that document, taking particular note of the following excerpt:
[The SCAC] sufficiently pled that the exchanges created a fraudulent scheme that benefitted HFT firms and the exchanges, sold the products and services at rates that only the HFT firms could afford, and failed to fully disclose to the investing public how those products and services could be used on their trading platforms.
They also take the time to point out that the Second Circuit had further held that the SCAC “sufficiently alleges conduct that can be fairly viewed as manipulative or deceptive within the meaning of the Exchange Act,” and that Defendants had committed “primary” violations of Section 10(b) and Rule 10-5.
In response to Defendant’s arguments against standing, Plaintiffs focus on the historically broad interpretation of the “purchaser or seller” standard set in Blue Chip. Specifically, they point out that the court has previously held that a sale of a security, plus a fraud used “in connection with it,” is sufficient for redress under Section 10(b). Plaintiffs further note that “neither the SEC nor the Supreme Court has ever held that there must be a misrepresentation about the value of a particular security in order to run afoul of the Exchange Act,” and go on to identify several cases in which courts have “espoused a broad interpretation of the “in connection with” phrase.
In addition to this broad interpretation, Plaintiffs rely on In re Blech Sec. Litig. and Sharette v. Credit Suisse Int’l for the argument that “allegations of the nature, purpose, and effect of the fraudulent conduct and the roles of the defendants are sufficient for alleging participation” because, very practically, the exact mechanism of the fraudulent scheme is unlikely to be known to the Plaintiffs.
- Failure to State a Claim Upon Which Relief Can Be Granted
On the topic of scienter, Plaintiffs responsive argument focused on the duty of the court to “assess all allegations holistically” to answer the question: “When the allegations are accepted as true and taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference?” They further argue that the SCAC successfully pleads scienter under the “motive and opportunity” theory because they are able to show—through the substantial kickback payments received by the Exchanges for providing the HFT firms access to material trading data via enhanced feeds and access to trading floors, and for implementing complex new order types—that Defendants benefited in a concrete manner from the purported fraud. They note other cases in which similar profits were held sufficient under a motive and opportunity theory, and point again to the Second Circuit’s decision in this case, where it held that the Plaintiffs had sufficiently pled that Defendants had created a fraudulent scheme benefiting the exchanges and the HTF firms.
Under the indirect theories of scienter, Plaintiffs also argue that the allegations contained in the SCAC collectively supply sufficient circumstantial evidence from which one could infer recklessness. Even if the specific manipulative intent was not shared as between the HFT firms and the Exchange Defendants, the Court could still infer that the Defendants knew, or were reckless in not knowing, that their actions catered to the HFT firms at the expense of individual and institutional traders. Plaintiffs further point to the Defendant’s active concealment of their schemes—namely, the functionality and use of their complex order types—despite the fact that the “guaranteed economics” of those schemes would come at the expense of Plaintiffs.
With respect to reliance, Plaintiff’s insist that the allegations of the SCAC are sufficient both because the Affiliated Ute presumption applies, and because the complaint pled reliance on the integrity of the public markets. First, Plaintiffs undercut Defendants assertion that Affiliated Ute does not apply simply because the exchanges owned no fiduciary duties with a citation to In re IPO, which held that “where a defendant has engaged in conduct that amounts to market manipulation under Rule 10b-5 (a) or (c), that misconduct creates an independent duty to disclose.” On the integrity of the market theory, Plaintiff points to ATSI and In re Blech, both of which permitted a plaintiff to plead reliance by alleging than an injury was caused by reliance on “an assumption of an efficient market free of manipulation.” Plaintiffs make use of a footnote to differentiate their application of the case with the Court’s earlier decision concerning the Barclays defendants: Affiliated Ute did not apply there because Plaintiffs did not adequately plead that Barclays had committed manipulative acts, and because what claims were made against Barclays were based on misrepresentations, not the omissions that Affiliated Ute is concerned with. In contrast, Plaintiffs claims against the Exchange Defendants are not based on misrepresentations, and the Second Circuit has already found that Plaintiffs adequately alleged market manipulation.
On loss causation, Plaintiffs point out that, at the pleading stage, it is only necessary that they provide defendants with notice of what the relevant economic loss might be, or what the causal connection between the loss and their misconduct their might be. Moreover, manipulation cases are “simply different” from regular securities fraud cases, and the relevant standard does not require specifics of what price was paid for what security.
Addressing Defendants Article III standing argument, Plaintiffs first note that, because the issue was not raised in Defendant’s earlier motion, it should not be raised now. Even if it is permitted, Plaintiffs argue that the bar for alleging an injury sufficient to meet Article III’s requirements is a low one, and one that the SCAC easily surpasses. It is enough, Plaintiffs note, quoting Harry v. Total Gas & Power N. Am. Inc., that the alleged manipulation is “within the realm of possibility.”
The final section of Plaintiffs brief addresses Defendant’s preclusion arguments. First protesting that the concept of preclusion is merely a rehash of their original motion to dismiss, but under a different framework. Namely, Defendants assert that private lawsuits would conflict with congressional intent that the SEC make the rules regulating the market, but the Second Circuit addressed this contention:
Plaintiff’s claims are not a challenge to the SEC’s general authority or an attack on the structure of the national securities market. Instead, they are properly characterized as allegations of securities fraud against the exchanges that belong to that ordinary set of suits in equity . . . .
Plaintiffs further argue that the preclusion defense, like the Article III standing claim, is barred at this stage in the proceedings. Under FRCP 12(g)(2), a party is foreclosed from making successive, pre-answer 12(b) motions that include new defenses.
Moving on the Defendant’s application of the four Credit Suisse factors: Plaintiff’s first argument is that the test simply does not apply. The Supreme Court identified these factors, Plaintiffs argue, as considerations relevant to the determination of whether “the securities laws are clearly incompatible with the application of the antitrust laws.” Because this case does not arise under antitrust law, and because no other case has attempted to apply the factors to cases in which an Exchange act claim was precluded by the Act’s own regulatory structure, the test is simply not applicable under these circumstances. And even if the preclusion defense is properly presented in this case, it is, or so Plaintiffs argue, not ripe for decision at this point—there are questions of fact that remain.
The Last Word: The Exchange Defendant’s Reply Memorandum
Defendant’s reply memorandum closely tracks the same three arguments presented in its opening brief. First looking at standing, continue to insist that the SCAC does not adequately plead Article III standing because it “contains no factual allegations sufficient to show anything about the impact” of the challenged products and services, and thus fails to show how any trade of theirs was negatively impacted, or how they relief sought would address their injury. With respect to statutory standing, Defendants view plaintiff’s arguments as ignoring the purchaser/seller standing requirement in favor of assertions that the “in connection with” clause be read broadly—and argument with fails, according to Defendants, because the “in connection with” standard is separate from the purchaser/seller requirement.
The next section of Defendant’s reply attacks Plaintiffs arguments on reliance, loss causation, and scienter. Reliance has not been adequately pled, Defendants argue, because both the Affiliated Ute presumption and the “integrity of the market” theory were rejected in the court’s initial motion to dismiss decision as it related to Barclays, and that Plaintiff’s attempt to distinguish the two were unavailing. With respect to loss causation, Defendant’s decry Plaintiff’s “attempt to reduce their loss causation burden to a triviality,” and insist that “under any reasonable understanding of loss causation, Plaintiff have to offer more than the general allegations they present here.” For scienter, Defendants point to Second Circuit precedent making clear that generalized allegations of motives possessed by all corporations—namely, increasing profitability—are insufficient to plead scienter.
Finally, on claim preclusion, Defendants react strongly to Plaintiff’s suggestion that the argument is merely a prior argument recast: “Although some aspects of this argument [. . .] overlap with arguments the exchanges have made before, that does not make the arguments the same.” They further argue that, contrary to Plaintiff’s analysis, the Credit Suisse factors not only apply to when the Exchange Act precludes a claim brought under federal law, but that an application in that context makes even more sense than its present application to antitrust cases.
For those who have read to the bitter end: congratulations! This does conclude our HFT write-ups for the time being, but when the motion to dismiss decision is issued, you know where to come for the liveliest—or at least lengthiest—summaries in the blogosphere.
This post was written by Alexandra M.C. Douglas.