On December 20, 2007, the United States District Court for the Southern District of New York dismissed federal antitrust claims asserted against 13 institutional broker/dealers, alleging that the financial institutions had acted in concert to inflate the fees charged to customers who engaged in short sales of securities characterized as "hard to borrow." In re Short Sale Antitrust Litigation, 06, Civ. 2859 (December 20, 2007)1 In dismissing the complaint, the Court held that the antitrust claims were implicitly precluded by the extensive federal securities regulation of short selling activity, and that dismissal was required by the recent Supreme Court decision in Credit Suisse Secs. (USA) LLC, v. Billing, 127 S. Ct. 2383 (2007).
The Allegations Regarding Short Selling Fees
The complaint in In re Short Sale Antitrust Litigation alleged that the members of the putative class acted as short sellers, i.e., they sold securities they did not own in the expectation that the price of the security would decline.
In a typical short sale, the seller's broker/dealer will locate and borrow the security on its customer's behalf, and deliver the security to the buyer's broker/dealer. Plaintiff alleged that class members paid their broker/dealers fees for locating and borrowing such securities. For securities that were in short supply, or hard to borrow, the fees were generally higher than for securities that were more readily available.
The gist of plaintiff 's claim was that the financial institution defendants supposedly engaged in daily communications to agree on which securities to classify as hard to borrow and to fix the minimum borrowing fee for those securities. Plaintiff also alleged that, in certain instances, class members purportedly were charged fees for locating and borrowing a hard-to-borrow security, even though the broker/dealer allegedly did not locate or borrow the security, and failed to deliver the security to the buyer's broker/dealer on the settlement date.
The complaint also alleged that defendant financial institutions, some of which acted generally as broker/dealers for both short sellers and buyers, agreed with each other to tolerate failures to deliver, and not enforce delivery requirements, in those instances where a particular defendant failed to deliver a hard-to-borrow security. Plaintiff claimed that, instead of forcing delivery, defendants maintained running IOU tallies among themselves with regard to the hard-to-borrow securities that had not been delivered.
Based on these allegations, plaintiff claimed that defendants violated Section 1 of the Sherman Act, and breached their fiduciary duties to class members, by purportedly acting in concert to charge artificially inflated and unjustified fees in connection with short sales of hard-to-borrow securities.
The Grounds for Dismissal
In dismissing the complaint, Judge Marrero relied on the Supreme Court's decision in Credit Suisse Secs. (USA) LLC, v. Billing, 127 S. Ct. 2383 (2007), which held that the federal securities laws implicitly precluded application of the antitrust laws to allegedly collusive conduct among underwriters in connection with marketing and distributing newly issued securities. The Supreme Court held that application of the antitrust laws to underwriting activity was "clearly incompatible" with the extensive federal regulation of initial public offerings, which in many respects encouraged the type of cooperative conduct among underwriters forming the basis of the antitrust claim.
In considering whether to apply Billing beyond the underwriting activity at issue in that case to conduct regarding short sales, Judge Marrero reviewed the four "critical factors" identified by the Billing court for determining within a given context whether securities laws and antitrust laws are clearly incompatible:
"(1) the possible conflict affected practices that lie squarely within an area of financial market activity that the securities laws seek to regulate. . . (2) the existence of regulatory activity under the securities laws to supervise the activities in question. . . (3) evidence that the responsible regulatory entities exercise that authority. . . and (4) a resulting risk that the securities and antitrust laws, if both applicable, would produce conflicting guidance, requirements, duties, privileges or standards of conduct." Slip Op. at 8.
The Court found the first three of the Billing factors were readily satisfied. It determined that short selling provides the securities markets with market liquidity and pricing efficiency, and that short sale transactions are "central to the proper functioning of well-regulated capital markets" and squarely "within the heartland" of federal securities regulation. Id., at 11. The SEC has explicit regulatory authority to supervise short sale transactions and to oversee the national securities and settlement system. Id., at 12. The SEC has exercised that authority, and has adopted Regulation SHO which sets forth prerequisites for effecting short sale transactions and defining broker/dealer's delivery obligations. Id., at 13.
The Court also determined that the securities laws are "in serious conflict" with the antitrust laws within the context of short selling, and that the antitrust claims therefore could not stand. Id., at 14. In the course of their normal activity in connection with short sale transactions, broker/dealers enter into arrangements to borrow securities and such conduct, the Court found, necessarily involves the exchange of information regarding the availability and price of securities which are "implicitly permitted" by SEC's Regulation SHO. Id., at 15. Allowing the antitrust suit to continue would deter broker/dealers from engaging in necessary conduct, lawful under the SEC's regulatory scheme because, the Court reasoned, in support of its conspiracy claim, plaintiff would likely seek to introduce evidence of defendants' daily permissible conversations regarding securities trading information. Id., at 16.
Judge Marrero likewise determined that plaintiff 's allegations of an antitrust conspiracy among defendants to tolerate failures to deliver, like plaintiff 's other allegations, conflicted with the securities laws. Under SEC's Regulation SHO only a failure to deliver involving a security defined as a "threshold" security violates the securities laws, and the SEC has elected not to impose a delivery requirement where the security does not meet the requirement of a "threshold" security. Allowing plaintiff to use the antitrust laws to attack defendants' alleged decisions not to force delivery in other securities would impose de facto delivery requirements on all short sales in spite of the SEC's reluctance to impose such blanket requirements. Id., at 17.
Conclusion
In Billing, the Supreme Court provided clear guidance for dismissing claims in conflict with the comprehensive regulatory scheme governing securities transactions. The decision in In re Short Sale Antitrust Litigation represents an early application of the principles articulated by the Supreme Court in a context different than the particular context under which Billing arose. Other district courts can look to In re Short Sale Antitrust Litigation for guidance as they are called upon to apply the Billing principles in still other contexts. District Courts, for example, may need to decide whether claims based on laws other than the antitrust laws, such as federal RICO or ERISA statutes, are inconsistent with the securities laws, or other federal laws and regulations, under the Billing standard.
Endnote
1 The defendants in In re Short Sale Antitrust Litigation included Morgan Stanley, Bear Stearns, Goldman Sachs, UBS, Merrill Lynch, Citigroup, Credit Suisse, Deutsche Bank, Lehman Brothers, Bank of America Securities, Van der Moolen and CIBC. Proskauer represented one of the defendants.
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