We’re back for another installment of the most-fun-to-name series of posts the Manipulation Monitor has to offer. Last time around, we reviewed Defendant’s valiant efforts to rid the world – or, at least, the Northern District of Illinois – of the scourge of VIX-related claims. Plaintiffs have some comments, of course, so we’re back again with VIX-the-fifth. Post the first through post the fourth are linked below – recommended reading before moving on to part two of this post:
Post the First: The VIX is Fixed?! A Preview of the Tricks
Post the Second: The VIX is Fixed?! A Complaint is Remixed
Post the Second: The VIX is Fixed?! Defendants Request this Suit be Nixed
Post the Fourth: The VIX is Fixed?! Plaintiffs Would Like Some Discovery Real Quick
Now that you’re caught up, or at least content to boogie on without background (way to live on the wild side, you crazy antitrust addict you!), let’s look at the opposition:
But Did It Ever Really Happen?
Plaintiffs begin by attacking Defendant’s final argument: that plaintiffs failed adequately to allege that flaws in the VIX franchise were ever exploited. To counter this proposition—which they note Defendants addressed only halfheartedly—Plaintiffs identify four key areas in which their Complaint demonstrates manipulation:
- Aggregation: “there is nothing wrong,” Plaintiffs argue, with providing aggregate analyses that highlight data patterns demonstrating manipulation; indeed, the practice avoids charges that only anomalous, “outlier” data points are being presented.
- Griffin & Shams: Plaintiffs next point out that, while they refer to the work done by these eminent academics, all the analyses outlined in their complaint were designed and conducted by Plaintiffs (or, presumably, Plaintiffs’ experts), using data obtained by the plaintiffs, and goes beyond the work of Griffin & Shams to included new methods of analysis.
- Griffin & Shams, Again: Plaintiffs also counter Defendants’ attacks on the academic paper, accusing defendants of “engaging in sleight of hand” by attacking only the academic paper rather than the analyses carried out by Plaintiffs. Moreover, to the extent that Defendants argue that the academics failed to “fully rule out all potential explanations,” Plaintiffs point out that that is simply not the pleading burden.
- Witnesses: To defendants’ claim that it is “striking” that Plaintiffs have failed to present a corroborating witness, Plaintiffs again note that at the pleading stage, before discovery, a smoking gun is unnecessary where statistical analysis can give rise to plausible claims.
Trust the Process (this used to be good advice)
Plaintiffs begin this section by outlining the requisite standard for pleading their claims under Rule 10b 5—something Defendants apparently failed to do—and quote recent Second Circuit authority for the principal that “the gravamen of a manipulation claim is the deception of investors into believing that prices at which they purchase and sell securities are determined but the natural interplay of supply and demand, not rigged by manipulators.”
Breaking this standard into its component parts, Plaintiffs first note that pleading deceptive or manipulative conduct for a market manipulation claim only requires them to allege, “to the extent possible, what manipulative acts were performed, which defendants performed them, when the manipulative acts were performed, and what effect the scheme had on the market for the securities at issue.” The what/who/when questions, Plaintiffs address by way of reference to the original complaint, and similarly summarize the effect on the market resulting from the rigged SOQ process. They further note that similar claims were found sufficient in other 10b-5 market manipulation claims, where exchanges engaged in manipulative conduct resulting in purchased by investors deceived into believing that the prices at which the relevant securities were bought and sold were determined by the market. Nor is it plausible to recast Plaintiffs Rule 10b-5(a) and (c) claims as 10b-5(b) misrepresentation and omission claims, Plaintiffs argue: the case law relied on by Defendants for that argument address only fact patterns where the sole fraudulent conduct at issue was misleading statements or omissions, rather than a situation such as Plaintiffs’ complaint describes, where a larger scheme that encompasses such conduct or statements.
CBOE’s argument that it cannot be liable because Plaintiffs do not allege that that entity personally engaged in manipulative trading is also erroneous, Plaintiffs insist, neither 10b-5(a) or (c) require such engagement for liability. Instead, all that is required is “any devise, scheme or artifice,” or “any act, practice, or course of business” used to perpetrate a fraud. Moreover, the CBOE was not “aiding and abetting” the fraud; Defendants ignore Plaintiffs allegations that CBOE was by way of its creation, maintenance, marketing, and expanding of the VIX franchise, a primary act in its own right.
Plaintiff’s next argument addresses scienter. This is a factor to be address collectively, Plaintiffs argue, considering “all of the facts alleged,” and whether they together “give rise to a strong inference of scienter,” not whether any individual allegation meets the requisite standard. To that end, Plaintiffs point out that the complaint directly alleges scienter, and that such allegation is supported by plentiful facts—such as CBOE’s admission that it oversaw every settlement, had complete access to all relevant data, and actively reviewed said data for potential VIX settlement manipulation. Where Plaintiffs access to more limited public data showed numerous signed of manipulation, CBOE’s more granular data gave it even more knowledge. To the extent that CBOE argues that scienter cannot be inferred based on a theory that “any competent observer would detect manipulation,” given that Plaintiffs allege that they were themselves in the dark until recently, it simply cannot stand: CBOE is not an outside investor, but “the ultimate insider act[ing] knowingly or recklessly.” Moreover, the allegations concerning CBOE’s financial motivations are not “generic,” and cannot be compared to the “generalized motives common to all corporate executives to protect their own interests”: the VIX franchise accounted for nearly half of the CBOE’s total revenues, and the importance of the franchise has repeatedly been acknowledged by the CBOE itself. And along the same lines, Plaintiff claim, Defendants’ claim that the importance of VIX would have led the CBOE to cure any problems discovered is both inappropriate to accept at the pleading stage, and without any justification showing that the SOQ process could be cured without diminishing the value of the “crown jewel” franchise.
Next, Plaintiffs address Defendants argument that they failed to sufficiently allege reliance, because Plaintiffs asserted that they relied on the integrity of the VIX SOQ process, rather than alleging reliance on a particular misstatement or omission. Because this is not a misrepresentation case, Plaintiffs explain, all that is required is that they meet the market manipulation case standard: an alleged reliance on the “assumption of an efficient market free of manipulation.” Because they satisfy this pleading requirement, Plaintiffs explain, the allegations adequately plead reliance. They also observe that pleading reliance in a manipulation case does not prevent them from also availing themselves of fraud-on-the-market presumption, noting that courts have uniformly held such presumption to be appropriate. Plaintiffs also explain that they meet the Affiliated Ute presumption, a standard associated with cases applying to failure to disclose, and that under such standard CBOE, as a party aware of the manipulation, had a duty to disclose.
Turning to causation and standing arguments, Plaintiffs rebut the CBOE’s assertion that Securities Exchange Act claims are not well pled by claiming that FRCP 8(a)(2) governs allegations of loss causation, and that the applicable standard thus only requires Plaintiffs to “provide [the] defendant[s] with some indication of the loss and the causal connection that the plaintiff has in mind.” Article III standing poses a similarly low threshold, according to plaintiffs, and requires only a “reasonable causality chain” to link Plaintiffs’ injury to Defendants’ actions. Plaintiff alleges that class members were forced to pay more as buyers, and accept less, as sellers, for VIX products than they would have in a fair market, and the complaint includes detailed allegations of the types of instruments causing harm in which each Plaintiff transacted. Together with their analysis demonstrating abnormal movement in market prices on settlement days, Plaintiffs insist that their allegations are both sufficient at the pleading stage, and substantially similar to allegations upheld in recent Rule 10b-5(a) and (c) cases. The causal connection prong, moreover, does not require a causal connection with a specific statement – Plaintiffs point to Defendants insistence on this point as yet another way they are attempting to force the square peg of market manipulation claims into the round hole of misrepresentation cases. Similarly, Plaintiffs ague that they are not obligated at the pleading stage to tie specific transactions to specific episodes of manipulation and amounts. In support, they cite to a 2016 case involving the ISDAfx benchmark which sets forth that, “at this stage, the appropriate question is whether the alleged manipulation…plausible caused each Plaintiff to suffer some loss under the terms of some derivative at some point.”
On the immunity prong, Plaintiffs counter Defendant’s assertions with the observation that immunity is only granted in “rare and exceptional” circumstances. The burden is on CBOE to demonstrate that self-regulatory organization immunity is appropriate, and it is a high bar: the conduct must be of a regulatory nature such that CBOE was effectively “standing in the shoes of the SEC.” The immunity cannot apply, Plaintiffs posit, where the self-regulated organization is acting in its own market as a regulated entity, not as a regulator—and this is where Defendants apparently fail. In creating, marketing, and selling the VIX derivative products, CBOE was not, according to Plaintiffs, acting as a regulator: it was behaving in every respect as a commercial actor, and the profits it earned while doing so show its role clearly. Plaintiffs highlight several cases on this point, including a comparison to In re Facebook, Inc., IPO Securities & Derivative Litigation, which permitted negligence claims related to the design, testing, and marketing of NASDAQ’s technology on the grounds that they were “undertaken to increase trading volume” – presumably, much like CBOE’s proprietary VIX products – and thus non-regulatory. Plaintiffs also pushed back strongly against Defendant’s assertion that the complaint’s inclusion of regulatory allegation was a “virtual concession” as to the applicability of regulatory immunity. Plaintiffs don’t see it that way. Instead, they argue that the Rule 10b-5 claims are not based on any of the regulatory-related allegations and are present only to serve Plaintiffs’ separate CEA claims. This is very different, Plaintiffs insist, from In re NYSE Specialist Securities Litigation, relied on by Defendants, because Plaintiffs in that case expressly based their securities claim – as opposed to the CEA claim here – on various categories of wrong doing described by Plaintiffs themselves as regulatory failures. Further, the Facebook litigation found that overlapping evidence between claims did not mean that all claims were immunized; accordingly, Plaintiffs CBOE “cannot cloak the entire VIX franchise with immunity merely because the CBOE might have stopped the manipulation with better policing.”
Further addressing questions of immunity and preemption, Plaintiffs next tackle Defendant’s position that, because certain of the CBOE’s rules regarding VIX products were reviewed or approved by the SEC or CFTC, Plaintiffs’ securities claims are barred by immunity. To counter this assertion, Plaintiffs point to the Second Circuit’s decision in City of Providence, where the court declined to grant immunity in respect of the exchange’s offering of proprietary data feeds and co-location services firms, notwithstanding the SEC’s repeated approval of those practices. Indeed, the SEC apparently felt strongly enough about the issue to submit an amicus brief echoing that its “mere approval” of a practice does not give rise to immunity. Defendants also argues that these approvals result in the preemption of Plaintiffs’ Rule 10b-5 claims by the Securities Act. Again, Plaintiffs see things a little differently, explaining that the case Defendants cite in support of this notion addresses preclusion of antitrust claims by potential conflicting securities laws, and further observing that the case has not, in eleven years, been imported to the Rule 10b-5 arena.
Finally (for this section, anyway), Plaintiffs find time to tackle timeliness troubles. Because their Rule 10b 5 claims do not arise from “independently actionable false statements,” Plaintiffs argue that are not limited by the fact that the SOQ process and the defective VIX index were originally designed more than five years ago. The claims are continuous – or, by the data, continuous through as recently as February 2018 – and the repose period has not yet run. And irrespective of the accuracy of that argument, Plaintiffs also point out that the question of repose is fundamentally factual, and thus cannot be decided on a motion to dismiss.
A Sufficient Degree of Plausibility is as easy as C-E-A
Shifting gears now to focus on the Commodities Exchange Act claims, Defendants’ first argument is that Section 5 of the CEA does not contain a private right of action. In response, however, Plaintiffs note that Section 22—conveniently titled “Private Rights of Action”—does contain such rights, including for Section 5 obligations.
Up next is the question of particularity: again, a lack of specific, manipulated quotes. Again, Plaintiffs work to distinguish Defendants’ case cites, including the slightly weaker argument that allegations in other cases that were upheld “where the complaints happened to be able to ‘name names,’ that does not mean those cases establish identifying quotes as a pleading prerequisite in a completely different fact pattern.” More convincingly, Plaintiffs also posit that, even if Defendants were correct that a specific quote might be required at the pleading state, such burden would likely—and has been regularly—lightened by the courts “where, as here, the information is exclusively in the defendants’ control.” Plaintiffs arguments in favor of their plausible pleading of causation follow a similar logical path: such detail is not reasonably required at the pleading stage, and all that needs to be provided is some indication of loss and the causal connection.
Plaintiffs further assert that they plausibly pled that CBOE acted in bad faith. Under the Seventh Circuit’s decision in Bosco, “bad faith” under the CEA has a unique meaning, one akin to “negligence.” Only where the exchange has full discretion is more than “mere negligence” required. The negligence standard applies in this case, Plaintiffs assert, because the claims are about the CBOE’s mandatory obligations regarding rules that the exchange “should know” were being flouted.
Beyond bad faith, Plaintiffs also address CBOE’s contention that an ulterior motive is necessary part of the pleading requirements. Spoiler alert: disagreement. Plaintiffs distinguish the Sam Wong & Sons case relied on by Defendants by noting that the case itself recognized the “common-sense fact” that, “if the action was not reasonable on its own terms, motivation is irrelevant.” Citing Bosco, Plaintiffs go on to note that the Seven circuit expressly held that, even when “more” than negligence is required, “more” can be satisfied by showing “either that the exchange acted unreasonably or that it had improper motivation.” Seems pretty clear that an ulterior motive, while critical for The Enchantress and her supervillain friends in the Marvel universe, is just not a necessity under the CEA. Despite their argument for irrelevancy, Plaintiffs still argue that such ulterior motive is plain here based on selfish financial gain. Perhaps CBOE is channeling Thanos after all?
Negligent or Not?
As Plaintiffs address the plausibility and proper assertion of their negligence claims in less than two pages, I will endeavor to do so here in less than two sentences. To briefly summarize, then: Plaintiffs withdraw their negligence claims respect to the VIX Options and SPX Options. VIX Futures, on the other hand, are not preempted by the CEA – because the CBOE “stepped outside its regulatory shoes”—and the CBOE’s argument that nothing it did was wrong or has been shown to cause damage is incorrect, because CBOE’s course of conduct regarding the VIX franchise creates a duty of care.
And that’s it, dear readers, for this month’s bloggy installment. As always, stay tuned for updates on the outcome of this motion to dismiss and, while you’re waiting, I recommend you peruse my other ramblings on related cases – SOS to GSEs is shaping up to be a fun series, and you can check out the first installment right here: SOS to GSEs: Your Bonds Are a Beautiful Mess.
This post was written by Alexandra M.C. Douglas.