Opinion

Alison Frankel

The dubious new high-frequency trading case against the Merc

Alison Frankel
Apr 14, 2014 19:02 UTC

For all of the outrage kicked up by Michael Lewis’s depiction of fundamentally rigged securities exchanges in his book “Flash Boys,” there’s a giant obstacle standing in the way of punishing high-frequency traders or the exchanges that facilitate them: the blessing of federal regulators. As Dealbook’s Peter Henning wrote in his White Collar Crime Watch column on why high-frequency trading is unlikely to result in criminal charges, securities exchanges openly sell access to high-speed data feeds and to physical proximity that increases trading speed by milliseconds. Exchanges are, in the words of Andrew Ross Sorkin, “the real black hats” of high-frequency trading, since they unabashedly profit from differentiating access to trading information.

That may be true, but exchanges do so with the full knowledge of the Securities and Exchange Commission and the Commodity Futures Trading Commission. Georgetown professor James Angel, who specializes in the structure and regulation of financial markets, told me Monday that as long as securities exchanges don’t discriminate in the sale of high-speed access, they’re acting within their regulatory bounds. He compared the system to airlines selling different tiers of service: It’s perfectly fine to sell first-class seats to high-frequency traders as long as people in coach had the same opportunity to sit up front and opted instead for the cheap seats.

I had called Angel to ask his opinion of a new class action against the Chicago Mercantile Exchange. Filed Friday in federal district court in Chicago, the suit claims that the Merc’s parent, CME Group, has defrauded the derivatives market by representing that it’s providing real-time market information when, in fact, it has entered into “clandestine” contracts to provide order information to high-frequency traders before anyone else. Angel’s take? “This is a bogus case,” he said after reading the suit. “This is clearly about somebody who bought a coach ticket and is now complaining that they didn’t get first class service.”

The class action’s theory is new: that the Merc deceived ordinary traders and the market at large by selling upgraded access to high-frequency traders. The problem, according to Angel, is that the new theory is based on old facts that have already been examined and re-examined by the SEC and CFTC.

The complaint doesn’t include any specifics about the supposedly improper dealings between the Merc and high-frequency traders, except to say that they date back to 2007. It’s not clear, in other words, whether the class is claiming that the exchange secretly offered extra-fast access only to specially selected high-frequency traders or just that the Merc sells enhanced high-speed data to anyone willing to pay for it. If the former is true – and if, of course, the class has much more substantial evidence than its complaint suggests – the Merc would be in trouble. But based on my conversation Monday with Tamara de Silva of The Law Offices of R. Tamara de Silva, the lawyer who filed the class action on behalf of everyone who relies on the exchange’s assurances of real-time futures market data, it appears that the suit is based on the exchange’s much-discussed sales of enhanced data streams. De Silva said she didn’t want to disclose her evidence, but she contends the general public isn’t aware that exchanges sell superior access to high-frequency traders willing to pay a premium price. The Chicago exchange, she said, misleads the market when it represents that price and order information available to the general public is undistorted, when it’s actually out-of-date by the time ordinary market participants see it.

Can SAC insider trading target Elan force hedge fund to pay legal fees?

Alison Frankel
Apr 8, 2014 20:57 UTC

Elan Pharmaceuticals believes it was victimized twice over by SAC Capital, the notorious hedge fund now called Point72. The first time was when SAC obtained insider information about unsuccessful trials of the Alzheimer’s drug bapineuzumab and dumped $700 million in shares of the Irish drug company and its drug development partner Wyeth. But to add insult to that injury, Elan had to spend a small fortune, about $1.6 million, in legal fees and costs stemming from the government’s investigation of SAC’s insider trading. That is money SAC should have to pay, according to Elan. With the hedge fund due to be sentenced Thursday by U.S. District Judge Laura Taylor Swain of Manhattan, the pharma company’s lawyers at Reed Smith have submitted a letter asking Swain to recognize Elan as a victim of SAC’s crimes and order the hedge fund to pay it $1.6 million in restitution.

It’s a fascinating request. You probably recall that in a couple of high-profile cases in the recent spate of insider-trading prosecutions, Morgan Stanley and Goldman Sachs won rulings that former employees (in a broad sense of that word) were on the hook for legal fees the banks incurred as a result of the employees’ crimes. In February 2013, U.S. District Judge Jed Rakoff held that under the federal victims’ restitution law, former Goldman director Rajat Gupta owes the bank $6.2 million — the money Goldman laid out to Sullivan & Cromwell to investigate Gupta’s conduct internally and to cooperate with government investigators. Last July, the 2nd U.S. Circuit Court of Appeals affirmed a similar ruling by U.S. District Judge Denise Cote. She had concluded in 2012 that Morgan Stanley was the victim of insider trading by FrontPoint hedge fund manager Chip Skowron, so Skowron was responsible not just for repaying the bank the cost of his own defense but also for restitution of the legal fees Morgan Stanley advanced to other FrontPoint employees.

The 2nd Circuit’s ruling in the Skowron case didn’t leave much doubt that employers can receive restitution as victims for the money they spend to cooperate with government investigations of employees who go on to plead guilty or be convicted. Elan, however, didn’t employ SAC or Mathew Martoma, the former SAC trader who was convicted of trading on inside information about the company. On Monday, in a response to Elan’s letter requesting restitution, SAC’s lawyers at Paul, Weiss, Rifkind, Wharton & Garrison said Elan’s theory of restitution is “without precedent.”

Can banks force clients to litigate, not arbitrate?

Alison Frankel
Apr 3, 2014 20:38 UTC

If you are a customer of a big bank — let’s say a merchant unhappy about the fees you’re being charged to process credit card transactions — good luck trying to bring claims in federal court when you’re subject to an arbitration provision. As you probably recall, in last term’s opinion in American Express v. Italian Colors, the U.S. Supreme Court continued its genuflection at the altar of the Federal Arbitration Act, holding definitively that if you’ve signed an agreement requiring you to arbitrate your claims, you’re stuck with it even if you can’t afford to vindicate your statutory rights via individual arbitration.

But what if you’re a bank customer who wants to go to arbitration — and, in a weird role-reversal, the bank is insisting that you must instead bring a federal district court suit? Will courts show the same deference to arbitration when a plaintiff, rather than a defendant, is invoking the right to arbitrate and not litigate?

On Friday, the 2nd Circuit Court of Appeals will hear a rare tandem argument in two cases that present the question of whether bank clients have the right to arbitrate their claims even though they’ve signed contracts with forum selection clauses directing disputes to federal court. Believe it or not, the 2nd Circuit will be the third federal appellate court to answer this question, which has divided its predecessors. In January 2013, the 4th Circuit ruled that a UBS client may proceed to arbitration, but on Friday, the 9th Circuit held that a Goldman Sachs customer who agreed to a nearly identical forum selection clause must sue in federal court. To add to the confusion, the 9th Circuit panel was split, which led the majority to call the case “a close question.”

Sotheby’s shareholders defend activist investors in suit vs board

Alison Frankel
Apr 2, 2014 20:13 UTC

The heat surrounding so-called activist investors — hedge funds that buy up big chunks of a company’s stock, then leverage their position to mount proxy campaigns or otherwise force boards to change the way the company is managed — could hardly be more intense than it is now. Well, okay, maybe there would be even more controversy if Michael Lewis wrote a book about a genius upstart who defied accepted deal conventions and revolutionized corporate takeover battles. But putting aside the Wall Street tizzy inspired by this week’s publication of Lewis’s new book about high-frequency trading, the deal world’s favorite topic remains activist investors like Carl Icahn, Paul Singer, William Ackman and Dan Loeb.

Just in the last two weeks, Chief Justice Leo Strine of the Delaware Supreme Court published his extraordinary essay on shareholder activism at the Columbia Law Review, the Wall Street Journal did a fabulous story on hedge funds tipping each other off about their targets, and Martin Lipton of Wachtell, Lipton, Rosen & Katz — whose avowed disdain for short-term investors has recently manifested in litigation with Icahn — revealed at the Tulane M&A fest that there are actually a couple of activist funds he respects. (He said he wouldn’t go so far as to say he “likes” them, though.)

A new shareholder derivative complaint against the board of the auction house Sotheby’s is the latest contribution to the furor over activist investors. Two of the most successful shareholder firms in the game, Bernstein Litowitz Berger & Grossmann and Grant & Eisenhofer, filed the class action Tuesday night in Delaware Chancery Court on behalf of St. Louis’s employee pension fund. The suit squarely aligns shareholders with activist investor Loeb and his Third Point hedge fund, which owns nearly 10 percent of Sotheby’s stock and has launched a proxy contest for three board seats at the auction house.

U.S. stays out of Argentina pari passu case at SCOTUS – for now

Alison Frankel
Mar 26, 2014 19:18 UTC

France, Brazil and Mexico told the U.S. Supreme Court this week that the 2nd Circuit Court of Appeals has endangered sovereign debt markets with its ruling last year against the Republic of Argentina. In amicus briefs supporting Argentina’s petition for Supreme Court review, the foreign sovereigns argue that the 2nd Circuit gravely misinterpreted the so-called “pari passu” (or equal footing) clause of Argentina’s sovereign debt contracts. By ruling that Argentina may not pay bondholders who exchanged defaulted bonds for restructured debt before it pays hedge fund creditors that refused to exchange their defaulted bonds, the amicus briefs argue, the 2nd Circuit has undermined international debt restructurings, permitting vulture investors to hold entire foreign economies hostage.

The United States made quite similar arguments, as you may recall, when Argentina’s pari passu case was before the 2nd Circuit. But there’s no filing from the Justice Department among the 10 new amicus briefs urging the Supreme Court to take Argentina’s appeal. Does that mean Argentina has lost its most influential friend in the U.S. court system?

It does not, but it does mean that the administration is waiting for an invitation from the Supreme Court justices before it takes a position in the Argentina pari passu case. And there’s at least some chance the invitation will never come.

Strine: Stop shareholder activism from hurting American investors

Alison Frankel
Mar 25, 2014 19:32 UTC

This country’s most important arbiter of corporate law – Chief Justice Leo Strine of the Delaware Supreme Court – believes that shareholder democracy has run amok. In a startling new essay for the Columbia Law Review, “Can We Do Better by Ordinary Investors?” Strine outlines the deleterious long-term effects of subjecting corporate decision-makers to shareholder votes dominated by short-term investors. These ill consequences range, according to Strine, from the outright dollars corporations must spend to educate shareholders about everything they’re entitled to vote on all the way to excessive risk-taking and regulatory corner-cutting by executives and directors worried about delivering quick returns lest they be ousted by shareholders. Strine is deeply worried about a divergence of interests between money managers, who wield the power of shareholder votes, and ordinary investors in their funds, who are typically saving for retirement or their kids’ education. He’s convinced that the entire American economy will suffer unless short-term investors are reined in.

Strine’s diagnosis is interesting enough, though he’s previously written about what he considers to be the cancer of short-term investing. In the new essay, though, he also suggests a cure: eight actual suggestions to restore power to corporate boards and long-term investors (plus a pie-in-the-sky fantasy about changing the U.S. tax code to encourage shareholders to take a long view of their investments). Strine, who calls himself “someone who embraces the incrementalist, pragmatic, liberal tradition of addressing the world as it actually is,” argues that his proposals do not roll back shareholders’ hard-won rights to a voice in corporate affairs. Instead, he says, he’s “trying to create a system for use of those rights that is more beneficial to the creation of durable wealth for them and for society as a whole.”

The proposals make Strine’s paper indispensable reading if you run a corporation or advise corporate decision-makers. Even if you’re put off by his somewhat tedious rhetorical device of styling the essay as a response to Harvard Law professor Lucien Bebchuk – who advocates relentlessly for expanding shareholders’ franchise and apparently plays Dungeons & Dragons – or by the 154 dense footnotes in Strine’s 54-page article, you should take a look at his suggestions, which begin on page 29. Strine has done more thinking, reading and writing about the real-world consequences of shareholder power than anyone I can think of. He spent 16 years, after all, as a judge in Delaware Chancery Court, three of them as chancellor, before ascending to the Supreme Court this year. And based on those 154 footnotes, Strine seems to have devoted most of his time off of the bench to reading academic papers on corporate governance and shareholder rights. (Or, at least, whatever he could spare from keeping abreast of pop culture.)

As Basic hangs in the balance, next SCOTUS securities case looms

Alison Frankel
Mar 4, 2014 19:28 UTC

On Wednesday, the U.S. Supreme Court will hear oral arguments in Halliburton v. Erica P. John Fund, the most momentous securities case of the last quarter century. When this term ends in June, we’ll know whether the fraud-on-the-market theory that the Supreme Court codified in the 1988 case Basic v. Levinson will remain intact as the foundation of the securities class action industry or whether shareholders will lose the leverage of classwide damages claims for supposed fraud under the Exchange Act of 1934. I’ve been saying it for months: Untold billions of dollars hang on the justices’ determination in the Halliburton case.

The stakes are admittedly not quite as high in Omnicare v. Laborers District Council Construction Industry Pension, which the justices have just agreed to hear next term. Omnicare presents the question of whether plaintiffs asserting claims under Section 11 of the Securities Act of 1933 must only show that defendants made objectively false statements in offering documents – as the 6th Circuit Court of Appeals held in the Omnicare case – or must also show that defendants didn’t believe the supposedly false statements at the time they were made, as at least two other federal circuits have concluded. Section 11 class actions, as you know, aren’t historically as prevalent as Exchange Act fraud class actions. But if the Supreme Court overturns Basic v. Levinson, Securities Act claims will be one of the few remaining avenues for shareholders who want to sue through class actions. The justices’ reasoning on the standard of proof will go a long way toward determining how big a threat these cases present to issuers – and to their underwriters, auditors and lawyers.

To set that standard, the Supreme Court will have to resolve apparent tension between two of its own precedents. In the court’s 1991 ruling in Virginia Bancshares v. Sandberg, the majority considered “the actionability per se of statements of reasons, opinions or belief” under Section 14 of the Exchange Act. Because that sort of statement “purports to express what is consciously on the speaker’s mind,” the Supreme Court said, it made sense to limit any discussion of liability to misstatements that did not reflect the speakers’ true beliefs and opinions. According to Omnicare’s petition for certiorari, the 2nd, 3rd and 9th Circuits have all relied on that holding in Virginia Bancshares to conclude that even under Section 11 of the Securities Act – which calls for a more expansive view of liability than the Exchange Act provision at issue in the Virginia Bancshares case – defendants can only be sued for statements that depart from their actual opinions.

In new amicus brief, SEC wants to protect whistleblowers – and itself

Alison Frankel
Feb 21, 2014 19:30 UTC

In 2012 and 2013, when the 5th Circuit Court of Appeals was considering the question of whether Dodd-Frank’s anti-retaliation provisions protect whistleblowers who report their concerns internally, rather than to the Securities and Exchange Commission, the SEC stayed out of the fray. The case, Khaled Asadi v. G.E. Energy, centered on the tension between two sections of Dodd-Frank, one of which seemed to define whistleblowers only as those who tip the SEC about potential misconduct by their employers. In its Dodd-Frank implementation process, the SEC attempted to resolve the tension, issuing rules to clarify that whistleblowers are protected from retaliation regardless of whether they report concerns to the agency or up the chain of command through internal compliance programs, as the older Sarbanes-Oxley Act had encouraged. The SEC’s rules have convinced most of the federal trial judges who have considered the scope of Dodd-Frank whistleblower protections; courts have typically cited the deference due to the agency’s interpretation of a law it is responsible for enforcing.

Not the 5th Circuit, however. Last July, the appeals court dismissed Asadi’s retaliation suit against G.E., holding that he is not a Dodd-Frank whistleblower because he first informed his boss, and not the SEC, about possible Foreign Corrupt Practices Act violations in G.E. Energy’s dealings with Iraqi officials. The 5th Circuit said it didn’t need to reach the SEC’s interpretation because the statutory language of Dodd-Frank is unambiguous: Whistleblowers are defined as those who report suspicions to the SEC.

The same issue of the scope of protection for whistleblowers who have reported internally is now before the 2nd Circuit, in a Dodd-Frank retaliation case brought by Meng-Lin Liu, a former Taiwanese compliance officer for a Chinese subsidiary of Siemens. And this time, the SEC isn’t taking any chances that the appeals court will ignore the agency’s prerogatives. On Thursday, the SEC filed an amicus brief explaining its position – and explaining why the courts owe deference to the agency’s statutory interpretation.

New ruling puts Bank Hapoalim in hot seat in terror finance case

Alison Frankel
Feb 14, 2014 20:24 UTC

Israel’s Bank Hapoalim is going to have to do some explaining about 16 wire transfers that originated at Hapoalim branches in Israel and ended with $266,000 in the Bank of China accounts of the alleged leader of a group called the Palestinian Islamic Jihad. On Thursday, U.S. District Judge Shira Scheindlin of Manhattan ruled that Bank of China, as the defendant in a politically charged suit brought by the family of the victim of a 2006 bombing in Tel Aviv, is entitled to depose a witness from Bank Hapoalim, despite the Israeli bank’s arguments that the testimony would violate Israel’s bank secrecy laws.

Scheindlin’s ruling effectively reverses a previous decision by U.S. Magistrate Judge Gabriel Gorenstein, who held last October that, as a matter of procedure, he could not require Hapoalim, as a third party in the case, to produce a witness from beyond the 100-mile reach of his jurisdiction. In Thursday’s opinion, Scheindlin noted that after Gorenstein’s decision, the procedural rules changed and Bank of China’s lawyers at Patton Boggs narrowed their demand for information from the Israeli bank. So rather than focus on the 100-mile subpoena limit, she weighed the merits of Bank of China’s subpoena request against Bank Hapoalim’s opposition. She concluded that the Chinese bank deserves to hear crucial information Hapoalim can supply about the Israeli government’s efforts to block financing to the alleged Palestinian Islamic Jihad leader, Said al-Shurafa.

That testimony, Scheindlin said, would help solve a central mystery of this case. The family of Daniel Wultz, who died in the bombing in Tel Aviv, contends that Israeli counterterrorism officials warned the Chinese government at a meeting in Beijing in 2005 that Shurafa was using his accounts at Bank of China to facilitate the militant group’s activities. According to the Wultzes’ lawyers at Boies, Schiller & Flexner, that warning should have put the Chinese Bank on notice about Shurafa. But the Wultzes have struggled to produce evidence of what Israeli officials said at the 2005 session in Beijing. The family has asserted that the government of Prime Minister Benjamin Netanyahu originally encouraged the suit against Bank of China, but as Israel’s ties to China have deepened, Israel has actively blocked testimony from former official Uzi Shaya, who supposedly attended the 2005 meeting with the Chinese government.

Big guns roll out to defend securities class actions as SCOTUS amici

Alison Frankel
Feb 6, 2014 19:40 UTC

Conventional wisdom has it that the future of most securities fraud class actions will come down to U.S. Supreme Court Chief Justice John Roberts (and possibly Justice Samuel Alito, who, as a judge on the 3rd Circuit Court of Appeals, wrote quite interesting decisions about fraud-on-the-market reliance). Last term, in dissents in Amgen v. Connecticut Retirement Plans, Justices Antonin Scalia, Clarence Thomas and Anthony Kennedy made clear their skepticism about the court’s 1988 precedent in Basic v. Levinson, the case that made securities fraud class actions possible via its holding that shareholders may be presumed to have relied on corporate misstatements about a stock that trades in an efficient market. Based on the Amgen majority opinion, Justices Ruth Bader Ginsburg, Stephen Breyer, Elena Kagan and Sonia Sotomayor seem disinclined to overturn Basic when the court once again takes up the issue of classwide shareholder reliance on March 5 in Halliburton v. Erica P. John Fund.

Presumably with Chief Justice Roberts in mind, the Erica P. John Fund and its lawyers at Boies, Schiller & Flexner made deference to Supreme Court precedent a major theme of the merits brief they filed last week. As I told you, Boies Schiller cast Basic as a decision rooted in the 80-year-old history of this country’s securities laws, entwined with government regulation of the securities markets and implicitly endorsed by Congress, which has had multiple opportunities over the last 25 years to roll back the presumption of reliance and has repeatedly declined to do so.

As of late Wednesday, it’s not only Boies Schiller saying so to the Supreme Court. Erica P. John – and, by extension, the securities class action industry – has received powerful support in amicus briefs from (among many others) the Justice Department; two former chairmen of the Securities and Exchange Commission (one Republican, one Democrat); 11 current and former members of Congress; and scholars of the doctrine of stare decisis, whose filing was authored by Harvard Law professor Charles Fried – the onetime U.S. solicitor general who wrote the Justice Department brief supporting investors in the original Basic case at the Supreme Court.

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