FULL TEXT 2nd Circuit Fezzani v. Bear Stearns

February 6, 2015

In Fezzani v. Bear, Stearns & Co., Inc. (Opinion  on Petition For Rehearing, United States Court of Appeals for the 2nd Circuit, 14-3983,09-4414-cv, January 30, 2015), Appellants sought a rehearing of a portion of a May 7, 2013, 2nd Circuit Opinion and Summary Order affirming the district court's dismissal of federal securities law fraud claims against a clearing broker and individual investors. In part, the Appellants cite Levitt v. J.P. Morgan, (2d Cir., 710 7 F.3d 454, March 15, 2013), as inconsistent with the appealed May 7, 2013, Order as it pertains to Bear Stearns' clearing broker liability for introducing broker A. R. Baron's alleged fraud. The 2nd Circuit denied the petition with a concurrence and dissent in part by Judge Lohier.

In it's January 30, 2015 Opinion , the Circuit reiterated its long-standing position that clearing brokers generally are under no fiduciary duty to owners of the securities that pass through the clearing firm when the clearing firm provides so-called normal clearing services to the introducing broker. The Circuit further notes that such non-liability has even been extended to clearing firms that knew the introducing broker was committing fraud; however, the Circuit allows that in the limited case where the clearing firm is effectively assuming control of the introducing firm and the subject manipulative scheme, that liability may attach to the clearing firm. 

In offering its rationale, the Circuit explains that:

[W]hile the Amended Complaint alleges in conclusory fashion that Bear Stearns asserted "control" over Baron's trading activity, it fails to allege facts showing how this "control" related to fabricating "market" prices of particular securities and communicating them to customers or to manipulating prices with  regard to any particular securities. Appellants allege that Bear Stearns was aware of the manipulations, knew that these manipulations were leading to a crisis, but continued to clear trades that did not involve unnecessary exposure to itself. Knowledge alone, however, is not enough to attach liability to a clearing broker under Section 10(b). ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 102 (2d Cir. 2007). Moreover, there are legitimate reasons for clearing brokers to monitor the rading activities of some introducing brokers. A clearing broker guarantees the performance of buyers and sellers of the securities being traded and often extends credit to clearing brokers. Indeed, the complaint states that Baron was in deep debt to Bear Stearns, reason enough to monitor Baron's activities.

The facts alleged in the Amended Complaint, if proven, would not show that Bear Stearns directed the fraud or instructed Baron Dweck to set up sham transactions. There is a real danger of arm to the financial industry in allowing such allegations to suffice to subject clearing brokers to the cost of discovery and perhaps a trial even though there is no evidence of participation by the brokers in the fraud or manipulation. The potential of such litigation would deter clearing brokers from engaging in normal business activities -- guaranteeing performance, extending credit, and therefore often monitoring the financial condition of introducing brokers -- and drive up costs of trading generally. . .

Pages 7 -8 of the Opinion

Further on in the Opinion, and perhaps expressing a tinge of pique, the Circuit admonishes that:

We write only to state the obvious: our opinion did not require that reliance by a victim on direct oral or written communications by a defendant must be shown in every manipulation case. Indeed, we agree with the propositions of law asserted by the SEC that, in a manipulation claim, a showing of reliance may be based on "market activity" intended to mislead investors by sending "a false pricing signal to the market," upon which victims of the manipulation rely. ATSI, 493 F.3d at 100.

However, the discussion in ATSI of "false pricing signal[s] to the market" is derived from the Supreme Court's use of the efficient market hypothesis to establish a rebuttable presumption of reliance based on the effect of misrepresentations on the market price of securities. Basic Inc. v. Levinson, 485 U.S. 224, 241-45 (1988). ATSI extended a variation of that theory to market prices affected by manipulation. In the present case, however, there is no claim that there existed a market in any sense of the word for the shares Baron sold to appellants. The shares in question are not alleged to have been traded in any  structure reasonably viewed as an independent market with publicly reported prices purportedly representing arms-length transactions based on supply and demand. See ATSI, 493 F.3d at 18 100-01 & n.4. Therefore, there is not a claim that the inflated prices paid by appellants were based on "false pricing signal[s] to the market." The allegations in the present complaint state only that Baron sold shares to appellants at prices that were manufactured by Baron salespeople but were represented as set by trading in a market that was falsely represented to exist.

Page 10 of the Opinion