Southern District Of New York Dismisses Securities Short Selling Claims Against Broker-Dealers, Allowing Spoofing Claims To Proceed
On February 9, 2022, Judge Lorna G. Schofield of the Southern District of New York denied in part and granted in part a motion to dismiss a securities fraud action asserting claims related to alleged spoofing and short selling under Sections 10(b) and 9(a)(2) of the Securities Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5 thereunder, against broker-dealers, their Canadian affiliates, and unidentified U.S. and Canadian entities, including market makers, subsidiaries, affiliates, sister companies, and customers of the named defendants (collectively, “defendants”). Harrington Global Opportunity Fund v. CIBC World Markets Corp., 21-CV-761 (LGS) (S.D.N.Y. Feb. 9, 2022). Plaintiff alleged that defendants engaged in spoofing and short selling that caused a healthcare company’s stock, which plaintiff owned, to drop almost 90% over a nine-month period. The Court denied dismissal of plaintiff’s spoofing claims against certain defendants and granted dismissal of plaintiff’s short selling claims against other defendants.
The complaint alleged that certain defendants, comprised of pairs of U.S. and Canadian-based broker-dealers, engaged in a “market manipulation scheme” in which they “place[d] thousands of baiting orders,” each of which allegedly had a “small negative impact” on the healthcare company’s stock over time. The complaint further alleged that, during the scheme in which there were roughly 100,000 spoofing events, other defendants “[o]perat[ed] in concert” with those allegedly engaged in spoofing by “purchas[ing] the shares necessary to deliver on their naked short sales at reduced prices” after a spoofing event.
The Court first rejected the Canadian defendants’ arguments about lack of personal jurisdiction, holding that the complaint adequately alleged that “the conduct of the Canadian defendants on Canadian exchanges was intended to manipulate the price of [the company] shares which were listed and traded on the NASDAQ,” which the Court held was “sufficient to make out a prima facie case of specific personal jurisdiction over the Canadian Defendants under the effects theory.” The Court also separately held that the claims against the Canadian-based defendants alleged to have engaged in spoofing were “within the reach of the Exchange Act” under the Supreme Court’s Morrison decision (and the Second Circuit’s Parkcentral decision) because, the Court found, plaintiff sufficiently alleged that those defendants “engaged in at least some conduct in the United States in their purported effort to manipulate [the healthcare company’s] stock on U.S. exchanges.”
The Court held that the complaint’s acknowledgement that defendants traded both for their own proprietary accounts and their customer accounts did not “undercut” the “numerous allegations that [d]efendants designed and operated the algorithms that spoofed [the healthcare company’s] stock.” The Court also held that the complaint adequately alleged scienter, stating that it alleged “particularized facts constituting circumstantial evidence of conscious misbehavior.” As to defendants’ argument that the complaint failed to adequately allege loss causation because “each spoofing event lasted only fifteen minutes,” the Court stated that it would be improper to infer, at the motion to dismiss stage, “that individual spoofing events cannot have a long-term cumulative effect on the price of a stock.” The Court also held that the complaint sufficiently alleged that plaintiff “relied on an assumption that the market for [the healthcare company’s] shares was efficient and free of manipulation.” Lastly, the Court held that plaintiff’s claim was timely under the Exchange Act.
Turning next to the short selling claims, the Court held that the complaint did not adequately allege a manipulative act, finding that it contained “conclusory allegations that [the short selling defendants] failed to deliver stock without pointing to any specific examples.” The Court noted that neither “high volumes” of short selling and “naked short selling” are, by themselves, “manipulative.” The Court also held that the complaint did not sufficiently plead scienter in connection with the short selling allegations, rejecting plaintiff’s argument that a “high turnover rate” and “high percentage of short sales” sufficed, because “short selling, even some naked short selling, is legal.”