Allegations of flash trading that involve a pattern of orders placed and then canceled milliseconds later are not enough, standing alone, to create the strong inference of scienter required to state a securities fraud claim under the Exchange Act and the PSLRA.
CP Stone Fort Holdings, LLC vs. Doe, No. 16 C 4991 (N.D. Ill., 10/11/16).
Plaintiffs allege that unnamed John Does committed securities fraud and market manipulation by flash trading in the U.S. Treasuries markets. The flash trading involved a pattern of significant orders placed and then canceled milliseconds later, followed shortly by orders placed in the opposite direction. Plaintiff alleges that defendants’ conduct evidences intent because defendants “could not have legitimately changed their minds as to the direction of the market so quickly, so often and with such precision.”
Plaintiff Has Standing
Defendant John Doe #1 moves to dismiss on grounds of standing, timeliness and failure to state a claim. The Court denies the challenge to plaintiff’s standing to bring the claim as assignee of the original participant in the Treasuries market. While the law typically prohibits assignment of 10b-5 claims due to concerns over nuisance litigation, this is a different situation. When the original trading entity that is the alleged victim was sold to a third party, the owners wanted to retain the ability to bring a market manipulation claim and formed plaintiff holding company for the express purpose of receiving an assignment of the claim. Plaintiff thus has standing to bring the suit.
The Suit Is Timely
The Court likewise denies the challenge to the timeliness of the suit. A 10b-5 plaintiff has two years to file suit from discovery of the facts constituting the violation. While the complaint’s allegations make clear that the flash trading began more than two years before plaintiff filed suit, the allegations do not show that plaintiff knew or should have known the losses it was suffering were due to market manipulation by defendants. The complaint was thus timely.
Was the Flash Trading Illegal?
The Court, however, grants the motion to dismiss for failure to state a claim. Under the PSLRA, a securities fraud complaint must allege with particularity facts giving rise to “a strong inference” that defendant acted with intent to deceive, manipulate or defraud. Here, the challenged conduct – placing an order and then cancelling it – is legal. While certain conduct is patently manipulative and serves no purpose other than to transmit false information to the market, there is nothing inherently “improper or illegitimate about placing passive orders … and then reversing position.” The orders in question could have been filled and the complaint contains no allegations of “how many orders were executed, how long the ultimately canceled orders had remained … available for execution prior to cancelation, or whether the platform rules required the orders to be exposed further.” Plaintiff has thus failed to allege “anything more than legitimate trading activity that permissibly influences price.” The complaint is thus dismissed.
(J. Komie: In 2015, the Northern District of Illinois denied a motion to dismiss by a criminal defendant alleged to have engaged in similar flash trading in the commodities markets. That defendant was subsequently convicted by a jury. The likely reason for the different outcomes is that the Commodities Exchange Act expressly prohibits “spoofing,” while the Exchange Act and regulations thereunder do not. Plaintiff here thus had to fit its claim within the Exchange Act’s typical fraud and market manipulation standards.)
(SLC Ref. No. 2017-02-09)
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