Nasdaq Omx Grp., Inc. v. Ubs Sec. LLC

• Decision Date: 18 June 2013
• Docket Number: No. 13 Civ. 2244.,13 Civ. 2244.
• Parties: The NASDAQ OMX GROUP, INC. and The NASDAQ Stock Market LLC, Plaintiffs, v. UBS SECURITIES LLC, Defendant.
• Court: U.S. District Court — Southern District of New York

957 F.Supp.2d 388

The NASDAQ OMX GROUP, INC. and The NASDAQ Stock Market LLC, Plaintiffs,

v.UBS SECURITIES LLC, Defendant.

No. 13 Civ. 2244.

United States District Court,

S.D. New York.

June 18, 2013.

Ballard Spahr LLP By: William A. Slaughter, Esq., Paul Lantieri, III, Esq., Stephen J. Kastenberg, Esq., Philadelphia, PA, for Plaintiffs, The NASDAQ OMX Group, Inc. and The NASDAQ Stock Market LLC.

Paul, Weiss, Rifkind, Wharton & Garrison By: Leslie Gordon Fagen, Esq., Charles E. Davidow, Esq., Daniel J. Toal, Esq., New York, NY, for Defendant, UBS Securities LLC.

OPINION

SWEET, District Judge.

Plaintiffs The NASDAQ OMX Group, Inc. and The NASDAQ Stock Market LLC (collectively “NASDAQ” or the “Plaintiffs”) have moved to enjoin an arbitration filed by defendant UBS Securities LLC (“UBS” or the “Defendant”), and UBS has cross-moved to dismiss NASDAQ's complaint (the “Complaint”) with prejudice.

Upon the facts and conclusions set forth below, NASDAQ's motion for preliminary injunction is granted and UBS' cross-motion to dismiss is denied.

I. Prior Proceedings

This dispute arose from system failures during the May 18, 2012 initial public offering (“IPO”) of Facebook, Inc. (“Facebook”) by NASDAQ.

On March 15, 2013, UBS filed with the American Arbitration Association (the “AAA”) an arbitration demand and statement of claims (the “Demand”). UBS asserted four claims of relief in the Demand for: (i) breach of contract of the Services Agreement for NASDAQ's alleged failure to honor its indemnification obligations; (ii) indemnification under the NASDAQ Services Agreement (the “Services Agreement”); (iii) breach of contractual duty of good faith and fair dealing arising from NASDAQ's alleged failure to timely inform its members of its systems issues, and refusal to cancel certain UBS trades as allegedly would have been permitted by Exchange rules; (iv) gross negligence based on NASDAQ's use of allegedly insufficiently tested and unprecedented systems and procedures during the Facebook IPO. (Demand ¶¶ 58–76). According to UBS, it suffered monetary damages “believed to be in excess of $350 million.” ( Id. ¶ 76).

Pursuant to AAA rules, NASDAQ's answering statement to UBS' Demand was due on April 4, 2013. On that day, NASDAQ filed its Complaint for declaratory and injunctive relief in the Southern District of New York and moved to enjoin UBS from proceeding with the arbitration. UBS opposed NASDAQ's motion and made a cross-motion to dismiss the Complaint. Both motions were marked fully submitted on May 2, 2013.

II. Background

The following factual background is drawn from the Complaint, the Demand, and from documents referenced in or integral to the Complaint as submitted by the parties.

UBS is a Delaware limited liability company with its principal place of business in New York, New York. ( Id. ¶ 9). It is a registered broker-dealer and investment adviser that provides financial services to private, corporate and institutional clients. ( Id.).

NASDAQ is a major American stock exchange and a self-regulatory organization (“SRO”) registered with the Securities and Exchange Commission (“SEC”) to operate a national securities exchange under Section 6 of the Securities Exchange Act of 1934(the “Exchange Act”), 15 U.S.C. § 78f. (Compl. ¶ 11); See In the Matter of the NASDAQ Stock Mkt. LLC for Registration as a Nat'l Sec Exchange; Findings, Opinions, and Order of the Common, SEC Rel. No. 34–53128 (Jan. 13, 2006), 71 Fed.Reg. 3550 (Jan. 23, 2006). It has operated as a for-profit publicly traded company since 2000.

The Facebook IPO

After engaging in a competitive bidding process with the New York Stock Exchange (the “NYSE”), NASDAQ won the right to host the eagerly anticipated IPO of Facebook. On May 18, 2012, Facebook offered 421 million shares of its common stock to the public at $38.00 per share on the NASDAQ stock exchange, thereby valuing the total size of the IPO at more than $16 billion. The IPO was initially set to open at 11:05 am Eastern Standard Time under the NASDAQ ticker symbol “FB,” but was delayed. See In re Facebook, Inc., IPO Sec. & Deriv. Litig., 922 F.Supp.2d 475, 477–78 (S.D.N.Y.2013) (“Zack ”).

According to NASDAQ's proposal to amend Rule 4626,¹ starting at 11:05:10 a.m., having proceeded with the Display–Only period and the Quote–Only period, NASDAQ experienced system difficulties during the NASDAQ Halt and Imbalance Cross Process (the “Cross”), until 11:30 a.m. See Notice of Filing of Proposed Rule Change to Amend Rule 4626—Limitation of Liability, SEC Rel. No. 34–67507 (July 26, 2012), 77 Fed.Reg. 45,709 (Aug. 1, 2012) (the “Accommodation Proposal”). The cross process during the first minutes of the Facebook IPO did not operate as expected. ( Id.). To protect the “integrity of the IPO process, the system [for executing the Cross] is designed to recalculate the IPO auction if the matching engine's view of the auction book has changed between the time of the final calculation and the printing of the opening trade.” ( Id.). In the case of the Facebook IPO, “[a]fter the initial calculation of the Cross was completed, but before the opening trade was printed, additional order modifications were received by the system, changing the auction order book.” ( Id.). “As designed, the system recalculated the Cross to factor in the new state of the book[, but again], changes were received before the system could print the opening trade.” ( Id.). “This condition persisted, resulting in further delay of the opening print.” ( Id.).

NASDAQ determined that a system modification was needed to resolve these issues and determined to institute the modification, but it proceeded with the IPO rather than to halt the Cross auction process. ( Id.). “At 11:30:09 a.m., NASDAQ completed the Cross, printed [the opening trade] at $42.00 to the tape, and opened continuous trading,” which proceeded without incident. ( Id. at 45, 709).

New order, cancel and replace messages received before approximately 11:11 a.m. were acknowledged and incorporated into the Cross order book in real time. ( Id.). Some orders received by NASDAQ between 11:11 a.m. and 11:30 a.m., however, were not executed in the Cross; some were cancelled in the ordinary course by members before the Cross; some were entered into the continuous trading market at 11:30 a.m. as they should have been, and the remainder were either cancelled or released into the market at 1:50 p.m. ( Id. at 45,709 n. 23). In addition, transaction confirmation messages for orders executed in the Cross at 11:30 a.m. were not disseminated until 1:50 p.m. ( Id. at 45,709). In the period between 11:30 a.m. and 1:50 p.m., although system issues had prevented NASDAQ from immediately disseminating Cross transaction reports, NASDAQ determined not to halt trading in Facebook stock. ( See id. at 45,707).

Following the commencement of trading, NASDAQ believed that the remaining system issues would be resolved promptly, and also concluded that there was an orderly, liquid and deep market in Facebook stock, with active trading in the stock on NASDAQ and other markets. ( Id.). This assessment also led NASDAQ to conclude that the conditions after 11:30 a.m. did not warrant a halt of trading. ( See id.; see also Exchange Rule 4120(a)) (addressing the Exchange's authority to halt trading).

The Exchange Rules

With limited exceptions, the SEC approves all exchange rules, policies and practices prior to implementation. 15 U.S.C. §§ 78f & 78s. Before it may permit the registration of an exchange as a SRO under the Exchange Act, the SEC must determine, among other things, that the exchange will have a set of rules that is “consistent with the requirements of the Exchange Act, 15 U.S.C. § 78s(b)(2), and designed

to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system,and, in general, to protect investors and the public interest ....

15 U.S.C. § 78f(b)(5).

To trade on NASDAQ, a member must submit an application for membership, be approved, and enter into the NASDAQ Membership Agreement, which broadly governs the conditions of the membership in NASDAQ (the “Membership Agreement”). Among other things, prospective members agree “[t]o comply with the federal securities laws, the rules and regulations thereunder, the NASDAQ rules and all rulings, orders, directions and decisions issued and sanctions imposed under the NASDAQ rules[.]” (Membership Agreement ¶ A). NASDAQ Rule 4611(a)(3) also provides that “[p]articipation in the Nasdaq Market Center ... requires ... compliance with all applicable rules and operating procedures of Nasdaq and the [SEC] in their use of the System.” NASDAQ Rule 4611(a)(3).

Further, the Exchange Act requires exchanges to enforce compliance with their rules by their members. See15 U.S.C. §§ 78f(b)(1) & 78s(g)(1). Members that do not comply with NASDAQ's rules may be subject to discipline by NASDAQ, and those determinations may be appealed to the SEC and ultimately, the federal appellate courts. See NASDAQ Rules 9200 et seq. (“Disciplinary Proceedings”) & 9300 et seq. (“Review of Disciplinary Proceeding by Nasdaq Review Council and Nasdaq Board; Application for Commission Review”); see also15 U.S.C. § 78y (review of final SEC orders by Courts of Appeal).

NASDAQ is likewise obligated to comply with its rules and regulations, or be subject to sanction by the SEC for failure to do so. See15 U.S.C. § 78s(g)(1) (“Every self-regulatory organization shall comply with the provision of [the Exchange Act], the rules and regulations thereunder, and its own rules....”); 15 U.S.C. §§ 78u(d, f) (SEC enforcement authority); 15 U.S.C. § 78s(h)(1, 4) (remedies available...