SEF Scuttling? Alleged Manipulation of the Interest Rate Swap Market – Part II – Buy-Side Funds Claims Survive Motion to Dismiss Shelling, but Not Unscathed.

This week we cover the July 28, 2017, decision on the Motion to Dismiss the Second Amended Complaint in Interest Rate Swaps Antitrust Litigation, No. 1:16-md-02704 (SDNY) (“IRS Antitrust Litigation”), an action previously introduced in our August 6, 2018, post, where one can find a full account of the alleged collusion. The Court granted Defendants’ motion for the time period of 2007-2012, but predominately denied it for the period of 2013-2016.

In brief, Plaintiffs, buy-side funds such as pension and retirement funds, along with several all-to-all trading Swap Execution Facilities (“SEFs”) including Tera and Javelin, alleged that Defendants have used their heavy hand to prevent the development of truly all-to-all platforms for trading of interest rate swaps (“IRS”), along with central clearing of IRS transactions. Defendants’ aim was to maintain a two-tiered system of trading, where the broker-dealer banks traded with one another on all-to-all inter-dealer bank (“IDB”) platforms, but their buy-side clients were still forced to purchase through the broker-dealers, with more limited pricing information than they could have obtained through an all-to-all platform. Plaintiffs allege that the Dealer Defendants accomplished this by blackballing several companies attempting to offer all-to-all trading platforms, including Javelin and Tera. Defendants’ aim was to limit buy-side firms to purchasing IRS from the major sell-side dealers, through request for quote (“RFQ”) protocols that mimicked many of the informational and pricing inefficiencies of over the phone requests for price quotations, and likewise widened bid/ask spreads for prices that the buy-side Plaintiffs would have to pay, causing those Plaintiffs’ damages. See In re Interest Rate Swaps Antitrust Litig., 261 F. Supp. 3d 430 (S.D.N.Y. 2017).

Generally speaking, the Plaintiffs’ claims for conduct prior to 2013 were dismissed, but their claims for conduct between 2013 and 2016 mostly survived Defendants’ motion. See id.

Plaintiffs’ Claim of a Sherman Act § 1 Conspiracy Among the Dealer Defendants was Dismissed for the Period of 2007-2012 Under Twombly

According to Judge Engelmayer, Plaintiffs’ claims for the period 2007-2012 plead parallel inaction which was not sufficient to survive under Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007). Plaintiffs’ claim that Dealer Defendants threatened to deny liquidity to IDBs that allowed buy-side firms to make purchases and sales on their platforms, and insisted on clearing through dealer-controlled platforms. The Court found that Plaintiffs’ claims of parallel inaction on the part of the various dealer banks however were not enough to give rise to a claim under Twombly.

The dealer banks’ actions were consistent with self-interested behavior, rather than an active conspiracy. The Dealer Defendants had no reason to change a system where they were reaping profits, and promote a system which would foster their own disintermediation. Of particular importance to the court’s determination was the fact that the central clearing infrastructure necessary to facilitate all-to-all trading was not present at this time, and as such, bilateral trade specific inquiries, into, inter alia, creditworthiness, were still needed prior to finalizing IRS deals. This made all-to-all trading all but impossible. Rather, central clearing, was only forced into existence later in 2013, when it was mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). The introduction of central clearing obviated the need for deal specific inquiries into creditworthiness. See IRS Antitrust Litigation, 261 F. Supp. 3d at 463-65.

Similarly, Plaintiffs’ claims were too speculative because the foundational clearing infrastructure needed was not present. The “alternative history of IRS trading for the first five years of the class period (2008-2012) require[d] too many leaps of imagination and guesswork for a claim of class injury to be viable.” Id. at 493.

Moreover, while Plaintiffs did allege that as part of “Project Fusion” most of the Dealer Defendants acquired a controlling stake in Tradeweb and forced it to remain a RFQ platform, rather than an all-to-all platform, Plaintiffs’ allegations as to the “Project Fusion” conspiracy likewise failed. This was because Plaintiffs plead conclusory allegations and inferences, did not plead the existence of a per se unlawful agreement, as the mere joint investment into a legitimate business does not fit into any category of agreement that is recognized as per se illegal, and did not plead facts sufficient to support an unlawful restraint of trade under a rule of reason analysis, as there were no allegations of an applicable market for Tradeweb’s product, or that Tradeweb had any power in any market, or even what the anti-competitive harms were from Tradeweb’s conduct. Id. at 465-69. For these reasons, Plaintiffs’ Sherman Act § 1 claims for this 2007-2012 time period were dismissed. Id. at 472. Such pre-2012 claims also were time-barred, as the court rejected arguments of tolling due to fraudulent concealment of Dealer Defendants majority interest in Tradeweb. Id. at 487-90.

Likewise the Buy-Side Class Plaintiffs’ state law claims for unjust enrichment for this time period were dismissed. Id. at 500-501. Further, Javelin and Tera’s claims under New York State Donnelly Act were also dismissed for this time period. Id. at 498-99.

Defendants’ Motion to Dismiss Plaintiffs’ Sherman Act § 1 Conspiracy Claim was Denied for the Period of 2013-2016 as Plaintiffs Plead a Per Se Unlawful § 1 Conspiracy; Namely a Group Boycott

According to Judge Engelmayer, Plaintiffs’ claims for the period of 2013-2016 in contrast did plead a per se unlawful Section 1 conspiracy, as Plaintiffs plead a group boycott of new all-to-all platforms by the Dealer Defendants. As alleged, this could be inferred from, among other things, the Dealer Defendants’ parallel refusals to trade on the Javeline, Tera, and TrueEx platforms, their common excuses and vocabulary for why they would not trade on these platforms, their similar bait and switch tactics to attempt to buy-out and undermine these platforms, their withholding of consent to IDB’s to use these platforms, their threats, pressure, and penalties, applied to buy-side customers who used these platforms, and their withholding, and threats of withholding, of clearing services to these platforms and the buy-side firms who used them. Id. at 472-75.

While it was true that Defendants had a natural explanation under Twombly for not supporting and supplying liquidity to these all-to-all platforms, namely their concerns about their own disintermediation, the alleged common behavior during this period was not purely explainable by self-interest. Rather, the Dealer Defendants actions as alleged, while not irrational, were so symmetrical, and so similar, so as to support the conclusion that they were acting in unison in a fashion that goes beyond simple self-interest, which would have been satisfied by refusing to do business with these platforms. Id. at 475-76. Judge Engelmayer’s decision was also supported by certain “plus-factors,” namely, the presence of a motive to starve these platforms of sufficient liquidity to be viable, a high degree of communications among the Dealer Defendants, and certain suspicious behaviors by the Dealer Defendants, including the alleged statement by a smaller IDB that it could not do business with an all-to-all trading platform because the Dealers “would not allow it.” Id. at 475-77.

Viewed as a whole Plaintiffs’ allegations were sufficient to plead a per se group boycott conspiracy under Sherman Act § 1. See Id. In coming to this conclusion, Judge Engelmayer rejected arguments of impermissible group pleading, and lack of uniformity of action by the Dealer Defendants. Id. at 478-79. He likewise rejected arguments that certain “market realities,” as evidenced by certain secondary sources, made this argument implausible. These “market realities” included (1) that buy-side support for all-to-all trading was limited because most IRS are “bespoke,” specially tailored contracts in which there is insufficient liquidity for trading on all-to-all platforms; (2) that at least for one all-to-all platform, TrueEx, there was support from many IRS dealers and a high amount of trading volume; and (3) that several of the all-to-all trading platforms failed due to reasons outside of a group boycott. Judge Engelmayer noted that while these “market realities” could be probative as to the merits of Plaintiffs’ claims if explored more in discovery, he was constrained not to second-guess Plaintiffs’ well-pled § 1 claims at the pleading stage on the basis of a few secondary sources. Id. at 479-81.

That being said, the Court did go on to caution that Plaintiffs’ claims would be limited to proceeding on claims for “plain vanilla” IRS, as claims for bespoke IRS were too speculative. Bespoke IRS, with their idiosyncratic terms that must be negotiated prior to closing, have more intermittent liquidity, and lack general “commodity-like” uniformity that make them amenable to trading on an all-to-all trading platform. While class counsel argued that such all-to-all trading platforms would foster greater price transparency and competition for all IRS, including bespoke IRS, he all but conceded that the class was intended only to be limited to purchasers of “plain vanilla” IRS. See id. 494-95.

The court did however grant some of the individual motions to dismiss some of the Defendants for failure to allege facts sufficient to tie them to the conspiracy, including those of HSBC, ICAP, a London-based IDB, and Tradeweb, but the Court rejected similar arguments from BNPP and UBS. Id. at 482-87. Tera and Javelin’s claims under the Donnelly Act and for unjust enrichment were likewise dismissed against HSCB, ICAP and Tradeweb. Tera and Javelin’s claims for tortious interference were also dismissed in their entirety. See id. at 497-501.

Defendants’ Motion to Dismiss Plaintiffs’ Sherman Act § 1 Conspiracy Claim was Denied as Class Plaintiffs did Allege Facts that Support the Inference that they were Efficient Enforcers

Further, the court held that Plaintiffs did allege that they suffered a direct injury and were efficient enforcers. The prevention of all-to-all exchange trading on these platforms left buy-side Plaintiffs with no alternative but to continue to make trades at wider bid/ask spreads. “As alleged this scheme proximately and predictably harmed buy-side investors who were denied the superior prices of an allegedly tighter-priced trading platform.” Id. at 491 citing Blue Shield of Virginia v. McCready, 457 U.S. 465, 480-84 (1982). The court goes on to distinguish the Court’s opinion in In re Aluminum Warehousing Antitrust Litig., No. 13-MD-2481 KBF, 2014 WL 4277510 (S.D.N.Y. Aug. 29, 2014) and In re Aluminum Warehousing Antitrust Litig., 833 F.3d 151, 161-163 (2d Cir. 2016), covered in more detail in our October 17, 2018 post, on the grounds that this action as alleged involves manipulation of a single market, rather than multiple markets.

While Defendants claimed that Javelin and Tera, the all-to-all trading platforms, were more efficient enforcers, the Court noted that “[i]nferiority to other potential plaintiffs can be relevant, but is not dispositive.” Id. at 493 citing In re DDAVP Direct Purchaser Antitrust Litig., 585 F.3d 677, 689 (2d Cir. 2009). Moreover, effective enforcement of the antitrust laws would be enhanced by collaboration between the buy-side Plaintiffs and Javelin and Tera, and that given that those SEF all-to-all trading platforms may not be able to fund discovery on their own, partnership with the class, and their resources, would help make sure that the antitrust claims were vigorously prosecuted. As such, the court rejected arguments that the class Plaintiffs were not efficient enforcers. The court also rejected that the potential for tension and negative correlation between the damages of buy-side Plaintiffs, and the SEFs, Tera and Javelin, are not fatal to the Plaintiffs’ claims. Id. at 495.

Defendants’ Motion to Dismiss Plaintiffs’ Sherman Act § 1 Conspiracy Claim was denied as that claim was not Barred by Dodd-Frank

Finally, Defendants’ argument that applying the analysis in Credit Suisse Securities (USA) LLC v. Billing, 551 U.S. 264 (2007), Dodd-Frank precludes application of the antitrust laws, including Sherman Act § 1. The court rejected this, noting that Dodd-Frank, particularly 12 U.S.C. § 5303, includes an “antitrust savings clause” prohibiting the inference that Dodd-Frank precludes application of the antitrust laws. See IRS Antitrust Litigation, 261 F. Supp. 3d at 495-97. Judge Engelmayer, in part relying on the analysis in In re Credit Default Swaps Antitrust Litig., No. 13MD2476 DLC, 2014 WL 4379112, at *16-17 (S.D.N.Y. Sept. 4, 2014), further rejected Dealer Defendants’ reliance on 7 U.S.C. § 6s(j)(6); and 15 U.S.C. § 78o-10(j)(6), as an exception to the antitrust savings clause, as the Dealer Defendants’ SEF boycott, as alleged, would not be “necessary or appropriate” to achieve the purposes of Dodd-Frank, as required by those cited provisions, and, more importantly, because those provisions are not exceptions to the antitrust savings provisions, but are rather provisions that “impose additional duties on swap dealers.” IRS Antitrust Litigation, 261 F. Supp. 3d at 497-98 (emphasis in original).

This post was written by Lee J. Rubin.

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