Nasdaq Omx PHLX, Inc. v. Pennmont Sec.

• Decision Date: 19 September 2012
• Citation: 2012 PA Super 145,52 A.3d 296
• Parties: NASDAQ OMX PHLX, INC., Appellee v. PENNMONT SECURITIES and Joseph D. Carapico, Appellants.
• Court: Pennsylvania Superior Court

52 A.3d 296

2012 PA Super 145

NASDAQ OMX PHLX, INC., Appellee

v.PENNMONT SECURITIES and Joseph D. Carapico, Appellants.

Superior Court of Pennsylvania.

Argued Nov. 15, 2011.

Filed July 16, 2012.

Reargument Denied Sept. 19, 2012.

Lynanne B. Westcott, Philadelphia, for appellants.

Stephen J. Kastenberg, Philadelphia, for appellee.

BEFORE: BENDER, MUNDY and FITZGERALD^*, JJ.

OPINION BY FITZGERALD, J.: ^*

Appellants, PennMont Securities (“PennMont”) and Joseph D. Carapico, appeal from the order entered by the Philadelphia Court of Common Pleas granting summary judgment in favor of Appellee, NASDAQ OMX PHLX, Inc. (“Exchange”). We hold that the Exchange had no authority to initiate a private right of action to collect disciplinary fines imposed by Exchange Rule 651, a rule enacted by the Exchange pursuant to the federal Securities Exchange Act of 1934 ¹ (“Exchange Act”). We further hold that even if the Exchange had such authority, and the Exchange had properly pleaded the cause of action as one for breach of contract, the courts of this Commonwealth do not have subject matter jurisdiction. Accordingly, we vacate the order appealed from and remand with instructions to dismiss the lawsuit.

We state the facts as set forth by the United States Court of Appeals for the Third Circuit:

The ... Exchange is a registered national securities exchange. As a registered exchange, it is deemed a self-regulatory organization [ (“SRO”) ] by the [Exchange Act]. See15 U.S.C. § 78c(a)(26). Like all similar entities, the Exchange “has a duty to promulgate and enforce rules governing the conduct of its members.” See Barbara v. N.Y. Stock Exch., Inc., 99 F.3d 49, 51 (2d Cir.1996).

In 1998, the Exchange entered into negotiations to sell its assets to the American Stock Exchange (“AMEX”). This sale would have generated more than $100 million for the Exchange, but also would have divested Exchange members of certain governance and equity trading privileges. Penn Mont Sec. v. Frucher, 534 F.Supp.2d 538, 539 (E.D.Pa.2008). PennMont, a member of the Exchange, vehemently objected to the sale, arguing that it would have drastically devalued PennMont's ownership stake in the Exchange. PennMont subsequently brought an action against the Exchange, seeking to enjoin the sale. Although the trial court denied PennMont's injunction, the sale to AMEX fell through while the case was pending.

Several years later, the Exchange's leadership again earned the ire of PennMont. In 2003, the Exchange attempted to alter its corporate structure by converting the Exchange from a non-stock company, with ownership interest measured by seats on the Exchange, to a stock corporation, with ownership interests measured by shares. As with the proposed sale to AMEX, this planned restructuring would have diminished the value of PennMont's ownership stake in the Exchange. PennMont amended its complaint in the previous action to challenge this “demutualization.” Again, the trial court denied the injunction. The [Exchange and the other defendants PennMont sued] subsequently moved for summary judgment, which was ultimately granted by the trial court.

In August 2004, shortly before the trial court ruled on the summary judgment motion, the Exchange passed a fee-shifting provision pursuant to its rule-making authority. The provision in question—Rule 651—states that

[a]ny member, member organization, foreign currency options participant, foreign currency options participant organization, or person associated with any of the foregoing who fails to prevail in a lawsuit or other legal proceeding instituted by such person or entity against [the Exchange] or any of its board members, officers, committee members, employees, or agents, and related to the business of [the Exchange], shall pay to [the Exchange] all reasonable expenses, including attorneys' fees, incurred by [the Exchange] in the defense of such proceeding, but only in the event that such expenses exceed $50,000. This provision shall not apply to disciplinary actions by [the Exchange], to administrative appeals of [the Exchange] actions or in any specific instances where the Board has granted a waiver of this provision.

Self–Regulatory Organizations; Philadelphia Stock Exchange, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to Legal Fees Incurred by the Exchange, S.E.C. Rel. No. 34–50159, 2004 WL 2049378, at *1 (Aug. 5, 2004). This rule, in sum, would require a member of the Exchange to reimburse the Exchange for its legal fees if the member failed to prevail in a lawsuit it initiated against the Exchange, and the Exchange spent more than $50,000 defending itself.

Approximately one month after the Exchange instituted Rule 651, the Exchange won its summary judgment motion against PennMont. The decision was affirmed by the Pennsylvania Superior Court in 2006.

In November 2007, more than a year and a half after the Superior Court affirmed the grant of summary judgment, the Exchange invoked Rule 651 and billed PennMont $925,612 for legal fees incurred in defending the lawsuit. This bill included fees incurred well prior to passage of Rule 651. The Exchange stated that it would debit the amount from PennMont's clearing account if PennMont refused to pay. PennMont objected to the invoice and then moved for a [temporary restraining order (“TRO”) ] and preliminary injunction enjoining the collection of attorneys' fees.

While the District Court considered PennMont's motion, the Exchange's Special Committee to Review Delinquencies and Payments (“Special Committee”) reviewed PennMont's objections to the invoice. The Special Committee conducted a telephone hearing that was presided over by three Exchange board members, one of whom was a named party in the 1998 lawsuit. PennMont did not participate in this hearing. Approximately two weeks after the hearing, the Special Committee issued an order and opinion upholding the imposition of attorneys' fees. ² The Exchange assured the District Court, however, that it would not attempt to collect the funds until the District Court ruled on PennMont's TRO and preliminary injunction.

On February 12, 2008, the District Court denied PennMont's motion for a TRO and preliminary injunction and also dismissed the case for failure to state a claim. Specifically, the District Court noted that: (1) courts have upheld fee shifting provisions mirroring those in Rule 651 time and time again as consistent with the Exchange Act; (2) the Securities and Exchange Commission (“SEC”) declared Rule 651 “effective upon filing” and has not attempted to amend or abrogate the rule since; and (3) the Exchange's decision to apply or not apply an internal rule governing the conduct of its members constitutes an exercise of delegated regulatory power and therefore cannot serve as the basis for a private civil suit in a district court. Accordingly, the District Court held that the Exchange had absolute immunity from suit and thus PennMont could not show a likelihood of success on the merits, nor state a claim upon which relief could be granted. The District Court noted, however, that PennMont was not completely without remedies—it could appeal the Special Committee's decision to the SEC, and thereafter appeal the SEC's decision to the Court of Appeals.

PennMont Sec. v. Frucher, 586 F.3d 242, 243–45 (3d Cir.2009) [hereinafter Frucher ] (footnotes omitted), cert. denied,––– U.S. ––––, 130 S.Ct. 1698, 176 L.Ed.2d 182 (2010).

With respect to Rule 651, the Frucher Court observed:

As pointed out by the District Court, regulations similar to Rule 651 have been consistently approved by the SEC. See, e.g.,Order Granting Approval to Proposed Rule Change by the Pacific Stock Exchange, Inc., Relating to the Liability of the Exchange and its Governors, Officers and Agents, S.E.C. Release No. 37563, 62 S.E.C. Docket 1527, 1996 WL 466637 (Aug. 14, 1996) (“Pacific Stock Exchange Rule”). The Pacific Stock Exchange Rule—which contains an attorney fee provision largely identical to Rule 651—applies to “a member or associated person who fails to prevail in a lawsuit or other legal proceeding instituted by that person against the Exchange or other specified persons, and related to the business of the Exchange....” Id. The SEC found that this rule was consistent with the Pacific Stock Exchange's mandate under the Exchange Act to craft rules “provid[ing] for the equitable allocation of reasonable dues, fees, and other charges among its members....” Id. (citing 15 U.S.C. § 78f(b)(4)).

Id. at 246–47.

PennMont appealed from the District Court's order. On August 17, 2009, the Third Circuit “dismiss[ed] this appeal for lack of subject matter jurisdiction and remand[ed] to the District Court with instructions to vacate its order and to dismiss this action for lack of subject matter jurisdiction.” Id. at 247. The District Court dismissed the case on October 6, 2009. Order, 10/6/09. PennMont subsequently exhausted all administrative remedies contesting the imposition of fees. See PennMont Sec. v. SEC, 414 Fed.Appx. 465 (3d Cir.2011).

Meanwhile, on March 10, 2008, the Exchange suspended the membership of PennMont and Carapico, a general partner of PennMont. In re PennMont Sec., Exchange Act Release No. 61967, 98 SEC Docket 1255, 2010 WL 1638720 (Apr. 23, 2010) (appl. for review of disciplinary action taken by Exchange); Pl.'s Compl. at ¶ 4. On April 4, 2008, while PennMont's appeal was pending before the Third Circuit, the Exchange sued Appellants for breach of contract in the Philadelphia County Court of Common Pleas. The Exchange claimed Appellants were required to comply with Rule 651. See Pl.'s Compl. at ¶ 4. The Exchange averred it sent an invoice to Appellants for $925,612.20, but later reduced the amount owed to $913,963.38. See id. at ¶ 10. Appellants failed to pay, the Exchange claimed, and thus owed $913,963.38, plus interest, under Rule 651. See id. at 5.³ Specifically, the Exchange alleged...