Nasdaq, Inc. v. Exch. Traded Managers Grp., LLC

• Decision Date: 20 December 2019
• Docket Number: 17 Civ. 8252 (PAE)
• Citation: 431 F.Supp.3d 176
• Parties: NASDAQ, INC. , Plaintiff, v. EXCHANGE TRADED MANAGERS GROUP, LLC , and ETF Managers Group, LLC, Defendants.
• Court: U.S. District Court — Southern District of New York

431 F.Supp.3d 176

NASDAQ, INC. , Plaintiff,

v.EXCHANGE TRADED MANAGERS GROUP, LLC , and ETF Managers Group, LLC, Defendants.

17 Civ. 8252 (PAE)

United States District Court, S.D. New York.

Signed December 20, 2019

David Axelrod, I. Lindsey Zionts, Stephen J. Kastenberg, Ballard Spahr LLP, Philadelphia, PA, Justin Ward Lamson, Ballard Spahr LLP, New York, NY, for Plaintiff.

John Patrick Coffey, Jeffrey S. Trachtman, Leah Friedman, Michael Jason Calb, Kramer Levin Naftalis & Frankel, LLP, New York, NY, Brian J. Fruehling, Brian J. Fruehling, Esq., Madison, NJ, for Defendants.

OPINION AND ORDER

PAUL A. ENGELMAYER, District Judge:

This decision sets out the Court's findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52, following a 10-day bench trial.

This case principally involves reciprocal claims of contract breaches among entities in a corner of the securities industry—that involving the development, operation, and marketing of exchange-traded funds ("ETFs"). Plaintiff/counterclaim defendant is Nasdaq, Inc. ("Nasdaq"). Nasdaq owns the second largest stock exchange in the world and offers a variety of financial services. In June 2016, Nasdaq acquired International Securities Exchange ("ISE"). ISE's business lines included constructing indexes that it licensed to ETFs and, relevant here, supplying the capital to launch and support ETFs in exchange for a share of the profits, if any, from the ETFs' operation. In the latter capacity, ISE was party to contracts with service providers, including ETF Managers Group, LLC and Exchange Traded Managers Group, LLC (together, "ETFMG"), defendants/counterclaim plaintiffs here.¹ By contract, ETFMG was responsible for, inter alia , managing certain ETFs (the "PureShares ETFs") for which it served as fund advisor. When Nasdaq acquired ISE, it succeeded to ISE's rights and obligations in connection with these ETFs and to ISE's business arrangements with ETFMG.

In early to mid-2017, the working relationship between Nasdaq and ETFMG ruptured, with reciprocal allegations of breaches and, eventually, letters purporting to terminate the parties' contracts. This lawsuit followed.

In brief, Nasdaq claims that ETFMG, irked by Nasdaq's lukewarm commitment to the PureShares ETFs and fearful that Nasdaq intended to shrink and eventually shutter this business line, unlawfully seized and asserted entitlement to the stream of profits from these ETFs. In fact, Nasdaq claims, those profits belonged to Nasdaq and a business partner, PureShares LLC, with whom Nasdaq had conceived of and developed these funds. ETFMG counters that it was entitled to keep these profits, or at least the profits from one ETF, a fund focused on cybersecurity issuers known as HACK, which was by far the most profitable of the PureShares ETFs. ETFMG alternatively claims that Nasdaq had materially breached its obligations to ETFMG in various ways, justifying ETFMG in terminating its agreements with Nasdaq and thereafter retaining the profits earned by these ETFs.

Trial was held between May 13 and 30, 2019. The Court heard testimony from 15 live witnesses;² received deposition testimony from two witnesses;³ and received hundreds of exhibits.

The findings of fact that follow are based on the Court's review of the entire trial record. Where based in whole or part on a witness's testimony, the Court's findings reflect credibility determinations based on the Court's assessment of, inter alia , the relevant witness or witnesses' experience, knowledge, and demeanor.

For the reasons set forth below, the Court finds that Nasdaq, with PureShares, was contractually entitled to the profits from the PureShares ETFs, including profits from HACK. ETFMG's compensation for its services, the Court finds, was specifically delineated by written contracts. ETFMG's compensation did not include a right to residual profits of the ETFs after payment of this delineated compensation. The Court further finds that ETFMG blatantly breached its contractual duty to furnish those profits to Nasdaq and PureShares by appropriating these profits for itself, as it continues to do to this day. The Court does not find any material breaches on Nasdaq's part.

As damages, the Court finds that ETFMG owes $78,403,172.36 to Nasdaq, plus prejudgment interest. This sum principally reflects the profits that ETFMG misappropriated from Nasdaq during the parties' relationship and the profits that the Court projects Nasdaq would have earned from three PureShares ETFs (HACK, SILJ, and IPAY) in future years. This sum includes the share of the profits to which Nasdaq's venture partner PureShares was entitled, and which, but for ETFMG's theft of all profits, Nasdaq would have remitted to PureShares.

This decision is in five sections.

First, the Court sets forth its findings of fact as to the parties and the broad chronology of events.

Second, the Court sets forth its findings of fact on a discrete but central issue: the contractual right to the profits earned from HACK.

Third, the Court sets forth its findings of fact on Nasdaq's contractual right to profits earned from two other ETFs, SILJ and IPAY, that were profitable and whose profits ETFMG appropriated for itself prior to the termination of the parties' relationship in mid-2017.

Fourth, the Court reviews and resolves, and sets forth its conclusions of law, as to the parties' respective claims of breach. The Court finds three breaches, all by ETFMG: ETFMG's (1) misappropriation of the profits from three PureShares ETFs (HACK, SILJ, and IPAY); (2) violation of the Wholesaling Agreement; and (3) continued operation of two other ETFs, known as GAMR and IFLY, which Nasdaq had instructed ETFMG to terminate.

Fifth, and finally, the Court tabulates the damages due Nasdaq from ETFMG.⁴

I. Findings of Fact: The Parties and the Chronology of Events

A. The Parties

Nasdaq is a publicly-traded Delaware corporation, headquartered in New York City. Nasdaq owns the second largest stock exchange in the world. In 2016, Nasdaq acquired ISE, including ISE's business developing and marketing various exchanged-traded funds, or ETFs. As part of this acquisition, Nasdaq acquired all the assets, investments, and intellectual property owned by ISE.

Before its acquisition, ISE had been an electronic securities exchange that operated the nation's largest options trading exchange. One division of ISE, ETF Ventures, is relevant here. ETF Ventures was in the business of constructing indexes that it licensed to ETFs. ETF Ventures constructed options indexes that it licensed to ETFs. ETF Ventures also sometimes operated as an ETF sponsor, supplying the capital to launch and support ETFs in exchange for a share of the profits, if any, derived from the ETF's operation. ISE employee Kris Monaco headed ETF Ventures.

Exchange Traded Managers Group, LLC, is the corporate parent of ETF Managers Group, LLC. Samuel Masucci is the co-founder and CEO of each company.⁵ ETFMG's business, as explained in more detail below, involves assisting other companies to issue and operate ETFs. ETF Managers Group, LLC, acts as an investment advisor to ETF Managers Trust (the "Trust"), formerly known as Factorshares Trust. The Trust has a three-member board of trustees, two of whom must be independent of the investment advisor.

ETF Managers Group is the successor in interest to a number of companies that Masucci previously owned and/or operated. These include Gencap Advisors, LLC ("Gencap" or "Gencap/ETFMG") and Factor Advisors, LLC ("Factor" or "Factor/ETFMG").⁶

Non-party PureShares, LLC, doing business as PureShares ("PureShares") is a Delaware limited liability company with its principal place of business in New York. During the relevant period, it was headed by Andrew Chanin. PureShares' business involves the marketing and branding of ETFs.

B. General Background on ETFs

A brief explanation of the supply side of the ETF industry is useful here.

An ETF is an exchange-listed investment product that tracks a specific index.⁷ Indexes may track the overall financial market, targeted subsets of the overall market, or other collections of stocks, bonds, commodities, and currencies. An index-based ETF allows investors to invest in indexes that cannot be invested in directly—e.g. , an investor can invest in an ETF that tracks the S & P 500 market index, even though that investor cannot directly invest in the S & P 500. Investors can buy and sell shares of ETFs throughout the trading day, much as they trade shares of stocks, on a major exchange. Gedeon Aff. ¶ 2.

An index provider such as ISE generally designs and supports an index that will, in turn, be licensed for use in, and tracked by, the ETF. Id. ¶¶ 3–4. The index provider develops a methodology governing the composition of the index. Id. ¶ 3. The methodology consists of a set of rules that the index provider sets and must follow to decide whether to include individual stocks in an index, and what weight to assign to these stocks. Id. Index providers generate revenue by licensing their indexes to one or more third-party asset managers. Tr. at 689 (Wade).

An entity that sponsors an ETF typically makes money based on the ETF's revenues, less the ETF's expenses. The ETF's revenues derive primarily from the management fee charged to investors in the ETF. Many ETFs prove unprofitable; the majority of those unsuccessful ETFs liquidate in the three years after they first launch. Juneja Aff. ¶ 56. The management fee charged to each investor consists of a small percentage of that investor's total holdings in the ETF. As an ETF attracts more investors and generates a greater volume of assets under management ("AUM"), and hence management-fee revenue, it is more likely to succeed. Id.

In addition to requiring a sponsor and an index provider, an ETF, to launch, requires a trust to issues shares of the ETF. The Investment Company Act of 1940 (the "1940 Act") governs the management and administration of ETFs. It requires that ETFs...