Judge Furman of the SDNY Dismisses Claims Against Major Exchanges and Barclays, Holding That Facilitating HFT Does Not Constitute Actionable Market Manipulation
Judge Jesse Furman of the United States District Court for the Southern District of New York on Wednesday dismissed all claims in five consolidated suits against several U.S. stock exchanges and a dark pool operator. The suits alleged violations of federal and state law arising out of defendants’ facilitation of high-frequency trading (“HFT”). The Decision1 is the latest in a string of defeats for plaintiffs who have brought suit in the wake of the publication of Michael Lewis’s book Flash Boys, which portrayed high-frequency trading as a rigged game that enriched Wall Street trading firms at the expense of institutional and retail investors. While the plaintiffs can appeal and one of the plaintiffs may seek leave to amend its complaint, the decision represents a substantial diminution of the risk stock exchanges and dark pool operators face from private litigants for enabling HFT.
The Court described HFT as generally referring “to the practice of using computer-driven algorithims to rapidly move in and out stock positions, making money by arbitraging small differences in stock prices —often across different exchanges ….”2 Because HFT traders place a premium on the ability to react quickly to information regarding the stock market, they benefit from and are willing to pay for products and services, such as co-location and proprietary data feeds, that enable the HFT traders to process and respond to market information more quickly than non-HFT traders.3 The court noted that it was hard to disagree with plaintiffs’ assertion that stock exchanges have an incentive to attract as much trading activity as possible, which allegedly drives them to offer the products and services that HFT traders require to execute on their strategies.4
Plaintiffs allege that defendants violated federal and state law by providing HFT firms with the tools they require to engage in HFT trading, without adequately disclosing such practices to ordinary investors. In four of the five consolidated suits, plaintiffs assert that major U.S. stock exchanges, including NASDAQ Stock Market LLC (“NASDAQ”), New York Stock Exchange, LLC (“NYSE”), Chicago Stock Exchange, Inc. and BATS Global Markets, Inc. (the “Exchanges”) engaged in market manipulation in violation of Section 10(b) of the Securities Exchange Act, and also violated Section 6(b) of the Act, which requires the Exchanges to adopt rules that prevent fraudulent and market manipulation. Plaintiffs allege the Exchanges engaged in a market-manipulation scheme by providing HFT firms with proprietary data feeds, offering them co-location and creating hundreds of complex order types, tools they allege HFT traders exploited to rig trading in their favor. These four suits also alleged that Barclays PLC and Barclays Capital Inc. (“Barclays”) violated Section 10(b) by misrepresenting its dark pool as a safe place to trade, even though it operated the pool in a manner that permitted HFT firms to exploit ordinary investors. The plaintiff in the fifth suit claims that Barclays’ disclosures to ordinary investors about its dark pool also violated California state law.
At the outset of its opinion, the court rejected the Exchanges’ argument that the court lacked subject matter jurisdiction over the claims against them, finding that plaintiffs allege the Exchanges “operated their business in a manner that ran afoul of federal securities laws, violations of which are typically redressable in federal district court.”5 The court agreed, however, with the Exchanges’ argument that plaintiffs’ claims against them are barred by the doctrine of absolute immunity insofar as they concern their provision of proprietary data feeds and their creation of complex order types. These practices (but not the provision of co-location services), the court held, fall within the scope of the quasi-governmental powers delegated to the Exchanges by the Securities and Exchange Commission (the “SEC”). Because the SEC would be accorded immunity from private damages suits in connection with the discharge of their regulatory responsibilities, the Exchanges are entitled to the same immunity in connection with their exercise of delegated regulatory powers.6
Even if the Exchanges were not immune from suit, the court held that plaintiffs fail to state any claims against the Exchanges for violation of Section 10(b) of the Exchange Act. First, “[t]he provision of co-location services and proprietary data feeds does not qualify as manipulative …,” because it did not involve a misrepresentation or failure to disclose material information regarding those practices.7 Second, the Exchanges cannot be held liable for merely enabling HFT firms to manipulate market prices. As the Supreme Court held in Central Bank of Denver N.A. v. First Interstate Bank of Denver N.A., 511 U.S. 164 (1994), federal law does not recognize liability for aiding and abetting market manipulation; only primary actors in a manipulation scheme can be held liable in a private action. The court also held that plaintiffs fail to state any claim under Section 6(b) of the Exchange Act on the ground that there is no private right of action under that provision.8
As with all of the claims against the Exchanges, and based on the same logic, Judge Furman also dismissed the federal and state claims against Barclays. Plaintiffs allege that Barclays misled customers into believing that its private exchange, or “dark pool,” protected ordinary investors from HFT firms when, allegedly, it gave HFT firms an advantage over other participants. Even if presumed true, Judge Furman held the allegations against Barclays would not support a claim of market manipulation because plaintiffs fail to identify any manipulative acts; fail to allege that Barclays did anything other than aid and abet HFT firms; and fail to allege that plaintiffs reasonably relied to their detriment on Barclays’ actions, since they are not alleged to have impacted the prices at which plaintiffs decided to trade (as opposed to the market generally for securities traded on Barclays’ exchange).9 The court also held that the plaintiff that alleged violations of California law fails adequately to state any viable claims for concealment, violation of California’s False Advertising Law or violation of California’s Unfair Competition Law.10 However, the court granted that plaintiff leave to file an amended complaint.11
Although Judge Furman did not necessarily disagree with plaintiffs’ position that certain structural features of modern securities exchanges, such as proprietary data feeds and co-location, may be inequitable, and acknowledged that there may be a need for regulatory reform,12 the court did not find that defendants’ actions constituted violations of the federal securities laws. In finding that stock exchanges and dark pool operators are not liable even if the HFT services they sell give HFT firms an advantage over other investors, the court’s ruling has further diminished the litigation risk for exchanges and dark pool operators who facilitate high-frequency trading.
Judge Furman’s decision is just the latest defeat for plaintiffs’ firms hoping to put high-frequency trading on trial in the wake of Flash Boys. In May, the United States District Court for the Southern District of New York dismissed with prejudice three putative class action suits brought on behalf of customers that had entered into contracts for the receipt of electronic market data services from the major U.S. securities exchanges, including BATS Exchange, Inc., NYSE, and NASDAQ. Harold R. Lanier v. BATS Exchange, Inc., et al., No. 14-cv-3745 (14-cv-3865, 14-cv-3866), Docket No. 109 (S.D.N.Y. April 28, 2015). Taking a somewhat different approach to subject matter jurisdiction than Judge Furman has taken, the court in the Laniercases held that because the SEC heavily regulates and approved the conduct at issue, the court did not have subject matter jurisdiction to decide plaintiff’s state-law claims. Even if the court had jurisdiction over the claims, the court held that it would still dismiss them, because the plaintiff failed to state any claims under state law for breach of contract, unjust enrichment or constructive trust.
With the most prominent suits challenging HFT having been dismissed (albeit with one plaintiff in the cases pending before Judge Furman having been granted leave to amend its complaint and the Lanierplaintiffs having noticed their intent to appeal), the primary remaining case directly challenging HFT practices is the suit by the New York Attorney General (the “AG”) against Barclays. In that case, the AG alleges Barclays misrepresented its “dark pool” as a safe-haven from HFT when it was, allegedly, the opposite. In February, New York Supreme Court Justice Shirley Kornreich declined to dismiss the suit. However, she made clear she was skeptical that HFT was inherently problematic and speculated it may even benefit market health.13
HFT traders may still face some risk of liability from private litigants or regulators, and regulators could still change course and curtail certain HFT practices, but in light of the decisions rendered recently in the In re Barclays Liquidity Cross And High Frequency Trading Litigation and the Lanier suits, the litigation risk to those that facilitate high-frequency trading is fading fast.