On March 28, 2019, Judge Ronnie Abrams of the United States District Court for the Southern District of New York largely denied a motion to dismiss a putative class action asserting claims under the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In re Global Brokerage, Inc., 17-cv-00916 (RA) (S.D.N.Y. Mar. 28, 2019). Plaintiffs principally alleged that defendants, a foreign exchange trading and services company and certain of its executives, made misleading statements or omissions regarding (a) the company’s reliance on an agency-trading model and (b) the nature of payments the company received from another company, “Effex,” that had been spun-off from the defendant company. The Court had dismissed plaintiffs’ prior amended complaint without prejudice, holding, inter alia, that plaintiffs had not adequately alleged scienter. The Court held, however, that plaintiffs’ second amended complaint adequately alleged actionable misrepresentations and scienter as to the majority of claims and all but one individual defendant.
Plaintiffs alleged that the company falsely claimed to use an agency-trading model whereby it would find the best foreign exchange rate for its customers and treat all market makers the same. In fact, plaintiffs alleged, the company routed the majority of customers’ orders to Effex, which held contrary trading positions and paid “kickbacks” tied to its trading profits and losses to the defendants. Slip op. at 8-10. The Court held that plaintiffs sufficiently alleged that defendants were responsible for actionable misstatements that its agency-trading model was “fundamental to [its] core business philosophy” under which it acted as a “credit intermediary, or riskless principal.” Id. at 19. While defendants argued that these statements did not imply that all trading providers were treated equally, the Court determined that plaintiffs sufficiently alleged that the company was falsely “leading customers to believe that it was not profiting from taking positions against its customers’ interests.” Id. at 20.
The Court also held that plaintiffs adequately alleged the company made false and misleading statements regarding purported “order flow” payments from Effex to the company. While defendants disclosed generally that the company made payments for order flow, the Court found plaintiffs sufficiently alleged that these statements were misleading because they failed to disclose that the challenged payments were essentially profit-sharing agreements with a single market making company. Id. at 21-22.
Plaintiffs also asserted that defendants violated GAAP by failing to disclose Effex as a “Variable Interest Entity”—because it was allegedly subject to defendants’ determination about whether to route customer orders there and was dependent on defendants for business—or, alternatively, as a “related company” because it had been started by the defendant company, funded with an interest-free loan from it, and shared a close relationship. Id. at 10-11. The Court agreed and held that, although GAAP violations alone, without more, would be insufficient to support a claim for securities fraud, in this case plaintiffs had sufficiently alleged other independent misrepresentations and the alleged GAAP violations did not stand alone.
The Court dismissed, however, plaintiffs’ claims that regulatory investigations had not been properly disclosed, holding that the company’s disclosure that the CFTC was examining the relationship between the company and one of its liquidity providers was sufficient and that the existence of a tolling agreement did not render legal action “highly likely or imminent.” Id. at 27-28.
The Court also found that plaintiffs had adequately pleaded scienter with respect to two individual defendants who were alleged to have been “heavily involved in the creation and funding” of the market making company, having hired an individual to create the high frequency trading algorithm at issue, provided him with start-up capital, and oversaw the spin-off of the company. Id. at 31-32. However, the Court held that plaintiffs failed to plausibly allege scienter as to another individual defendant, and instead merely stated in conclusory and “boilerplate” fashion that he “must have been aware” as CFO that the order flow payments were, in reality, a form of profit-sharing. Id. at 33.
Finally, the Court held that loss causation was adequately alleged and that there was “little doubt” that the disclosure—which included disclosure of a regulatory settlement and an order that the company effectively stop doing business within the United States—had an “immediate and tangible effect,” as the next day the company’s stock allegedly lost half its value and its notes allegedly fell 37%. Id. at 36.
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