Regarding Judge Furman’s order dismissing “In Re: Barclays Liquidity Cross and High Frequency Trading Litigation
By Charles K. Seavey
Contrary to the mistaken holding of Judge Furman, the facts described in his Order Granting Motion to Dismiss, In Re: Barclays Liquidity Cross and High Frequency Trading Litigation (SDNY, Case 1:14-md-02589-JMF Aug. 26, 2015) (“Flash Boys”) easily pass the primary liability test in Stoneridge.
In Stoneridge, respondents Scientific-Atlanta and Motorola entered into sham business transactions with Charter for the purpose of enabling Charter to cook its books and thereby mislead its auditor and investors. Stoneridge Inv. Partners v. Scientific-Atlanta, 552 U.S. 148, 154-55 (2008).The Supreme Court held that Scientific-Atlanta and Motorola made no direct statements to investors as part of the scheme and that therefore investors’ reliance on their misconduct was too indirect to qualify for primary liability under 10b:
Here respondents were acting in concert with Charter in the ordinary course as suppliers and, as matters then evolved in the not so ordinary course, as customers. Unconventional as the arrangement was, it took place in the marketplace for goods and services, not in the investment sphere. Charter was free to do as it chose in preparing its books, conferring with its auditor, and preparing and then issuing its financial statements. In these circumstances the investors cannot be said to have relied upon any of respondents' deceptive acts in the decision to purchase or sell securities; and as the requisite reliance cannot be shown, respondents have no liability to petitioner under the implied right of action.
Stoneridge at 166-67.
The precise element that the Supreme Court said was missing in Stoneridge – publication to investors – is present in Flash Boys. Order at 8. In Flash Boys the deceptive conduct largely consisted of direct communication to investors by the Exchanges. Id at 6-9. They published or caused to be published two sets of information regarding stock transactions: (1) an advance feed published to select market participants (the “tippees”); and (2) a version of the same information published slightly later to the public. Ibid. The Exchanges led the general public to rely upon the second feed to their detriment. The public was led by the Exchanges like financial sheep to slaughter at the hands of the tippees.
Judge Furman’s treatment of Stoneridge instead revolves around a proposed rule (unsupported by Stoneridge) that anything short of making the specific trades that change the price of the mispriced security is aiding and abetting. Order at 27-28, 31. He writes that “without the trades, there would be no effect on the market at all.” Id. at 28. But that’s true of any stock fraud and says nothing. Instead the question is whether ordinary investors rely upon the communications of the Exchanges. And obviously investors rely exclusively and completely on the truthfulness of the Exchanges every time they see a stock quote and place a trade. Judge Furman’s proposed new rule is that even such direct deceptive communication is too indirect to create reliance. Order at 27-28. He declines to follow Stoneridge, which draws the line between aiding and abetting and primary liability at the point of direct deceptive communication to investors “in the investment sphere” by the defendant. Compare id at 27-28 and Stoneridge at 166-67.
Independent of Stoneridge, the Exchanges are plainly the primary violators here. With a vague blessing from the SEC, the Exchanges as SROs sell information that allows to tippees to front-run the general public. They encourage the tippees to believe, and now strenuously argue, that their “product” is perfectly legal. The tippees act rationally; they aren’t publishing anything. Their role is slightly analogous to that of Motorola and Scientific-Atlanta in Stoneridge.
The Exchanges, by contrast, are the beginning and end of the fraud. They tip the tippees on one side and lull/set up the general public on the other. They are primary violators whose conduct is an abomination; it offends any duty that they have as quasi-regulators; it completely violates the most basic concepts of perfect information and honest markets, as well as the purposes underlying the exchange acts and the creation of the SEC.