Rabin v. NASDAQ OMX PHLX LLC

• Citation: 182 F.Supp.3d 220
• Decision Date: 21 April 2016
• Docket Number: CIVIL ACTION No. 15-551
• Parties: I. Stephen Rabin, on behalf of himself and all others similarly situated, Plaintiff, v. NASDAQ OMX PHLX LLC et al., Defendants.
• Court: U.S. District Court — Eastern District of Pennsylvania

182 F.Supp.3d 220

I. Stephen Rabin, on behalf of himself and all others similarly situated, Plaintiff,

v.NASDAQ OMX PHLX LLC et al., Defendants.

CIVIL ACTION No. 15-551

United States District Court, E.D. Pennsylvania.

Signed April 21, 2016

David J. Stone, Jeffrey H. Squire, Lawrence P. Eagel, Bragar Eagel & Squire PC, New York, NY, Lawrence Deutsch, Robin Switzenbaum, Berger & Montague, P.C., Deborah R. Gross, Kaufman, Coren & Ress, PC, Phyllis M. Parker, Berger & Montague, Philadelphia, PA, for Plaintiff.

Stephen J. Kastenberg, Ballard Spahr Andrews & Ingersoll, Lisa B. Swaminathan, Ballard Spahr LLP, Paul Lantieri, III, Ballard Spahr et al., Richard L. Scheff, K. Carrie Sarhangi, Sidney S. Liebesman, Montgomery McCracken Walker & Rhoads LLP, Steven J. Engelmyer, Eric J. Schreiner, Kleinbard LLC, Paige M. Willan, Klehr Harrison Harvey Branzburg LLP, William A. Harvey, Klehr Harrison Harvey Branzburg & LLP, Laura Hughes McNally, Morgan Lewis & Bockius LLP, Malini Rao, Dilworth Paxson LLP, Lisa B. Wershaw, Law Offices of Michael Lipuma, Philadelphia, PA, David C. Bohan, Hannah O. Koesterer, Patrick M Smith, Katten Muchin Rosenman LLP, Elaine Wyder-Harshman, Zachary J. Ziliak, Ziliak Law, LLC, Kyle David Rettberg, Phillip L. Stern, Neal Gerber & Eisenberg LLP, Chicago, IL, Christopher M. Hohn, Jennifer A. Baumann, Kenton E. Knickmeyer, Thompson Coburn LLP, St. Louis, MO, Lee D. Unterman, Rimma Tsvasman, Montgomery McCracken Walker & Rhoads LLP, Amy J. Greer, Morgan, Lewis & Bockius LLP, Richard M. Asche, Litman, Asche, Gioiella, LLP, New York, NY, Harry Philip Lamberson, Lake Forest, IL, Steven B. Mirow, Michael D. Lipuma, Philadelphia, PA, for Defendants.

MEMORANDUM OPINION

MCHUGH, United States District Court Judge

This case takes me far down the rabbit hole of securities litigation, an area of law that can be as opaque as some of the investment vehicles it seeks to regulate.

Plaintiff in this purported securities class action alleges that Defendants, certain Members of the Philadelphia Stock Exchange, and the Philadelphia Stock Exchange itself (owned and operated through a subsidiary by a Delaware corporation, NASDAQ, OMX Group, Inc.), conspired to deprive Plaintiff of dividends that he and other class members expected to receive by engaging in a highly sophisticated trading strategy that involves "market makers" acting in concert to increase their chances of success. The question before me is whether that strategy, now rendered obsolete by rule changes, crossed the line from heavy-handed to unlawful.

The parties have filed several motions to dismiss Plaintiff's claims. These motions make many overlapping or related arguments attacking perceived procedural and substantive failures of Plaintiff's Complaint (currently, a "Correct Second Amended Complaint" listed on the Docket at Document 105). In the interest of addressing these overlapping and related arguments in a consistent and clear manner, and because the facts are very detailed and it would be highly tedious to repeat them across many opinions, I have decided to address all of these motions in one Memorandum.

For the reasons that follow, I have decided to grant portions of Defendants' Motions and ultimately dismiss all of Plaintiff's Complaint.

I. Allegations

Plaintiff, I. Stephen Rabin, is a lawyer and an investor. He has on multiple occasions engaged in a trading strategy which has been called a "dividend play" and is at the heart of this litigation. See, OCC to Adopt a Policy to Restrict Exercises to Net Long Positions (available at http://www.optionsclearing.com/about/newsroom/releases/2013/05_23.jsp) (last visited April 14, 2016) (describing dividend plays). Clarity requires a few definitions and a brief description of how this trading strategy operates.

A stock option is a contract to buy or sell a specific underlying security. When the contract grants its buyer the right to purchase the underlying security at a certain price, the option is known as a "call." Compl. at ¶ 32. The buyer pays a premium for the option and later has the right to purchase the underlying security. When an investor sells a number of options, he has taken a "short" position, and when an investor purchases a number of options, he has taken a "long" position.

Investors do not enter into options contracts directly with one another. Instead, options all pass through the "Options Clearing Corporation" (OCC).¹ Compl. at ¶ 30. When an investor has purchased a call and wishes to execute her right to buy the underlying security, the OCC randomly selects an option-seller to be assigned the obligation to sell the shares he promised when writing the option. Compl. at ¶ 39.

A "dividend," of course, is a payment that a company makes to investors holding its securities. Companies only make dividends to investors who own the security on a particular date preceding the dividend. This date is the "ex-dividend date." An investor who holds an option for a security must exercise the option to buy the security before the ex-dividend date in order to receive the dividend.

If an investor has purchased a call and the price of the underlying security is higher than the purchase price for the option, the option is said to be "in the money." Compl. at ¶ 35. If the investor exercises the call, she will purchase the security for less than its current price on the open market for a net gain. If an investor exercises an "in the money" option before the ex-dividend date, she will make money on the option and receive the dividend. Conversely, if an investor has sold a call option, and the option is "in the money" just before the ex-dividend date, the holder of the option is very likely to call the option, and the investor will have sold the underlying securities for less than its current price and lost the ability to collect a dividend.²

Although an investor who holds an in the money call just before the ex-dividend date is very likely to exercise the call, not all investors do. According to Plaintiff, "[t]his failure to exercise is due to various reasons, including mistake or oversight, lack of economic resources to exercise the option, or ignorance of the process." Compl. at ¶ 40.³ These unexercised options are called "open interest." Id. Because some call holders do not tell the OCC they wish to exercise their calls, the OCC does not assign some call sellers to turn over shares. Consequently, some call sellers reap a windfall, randomly finding themselves retaining securities that could have been called away, together with the premium for the options and the dividend for the security. An investor in this position has "skated." Compl. at ¶ 41.

Plaintiff alleges that he has engaged in multiple transactions with the expectation that he would be able to "skate" on some portion of those options. He further alleges that Defendants have conspired to make it nearly impossible for investors such as himself to successfully "skate."

Most of the Defendants here are "Market Makers." Market Makers are investors who are members of an exchange. They undertake certain responsibilities, such as agreeing to "create liquidity by being continuously willing to buy and sell the security in which they are making a market." Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc. , 135 F.3d 266 (3d Cir.1998). They also receive certain privileges. Plaintiff contends that market makers "are the only options industry participants that are permitted to be in both long and short identical option contracts and to exercise any long options contracts prior to the OCC netting at the end of the day." Compl. at ¶ 42. According to Plaintiff, they are also the only entities who can exercise just one side of a position that has both long and short positions. Id.

Plaintiff asserts that market makers' special privileges enable them to arrange huge options trades with each other just before the ex-dividend dates. Compl. at ¶ 46. The market makers participating in these trades "exercise their open long call options after the end of the day" and leave their short option positions unexercised. Compl. at ¶ 47. When the OCC assigns options and it becomes clear who is skating, "the probability of the market makers' positions not being assigned is maximized" because the market makers' huge trades make up an overwhelming proportion of the entire pool of options. Compl. at ¶ 47. Plaintiff contends that their gain comes at his expense because the odds that a small retail investor such as Rabin will skate are correspondingly reduced.

The remaining Defendants are NASDAQ OMX PHLX LLC and NASDAQ OMX GROUP, INC. (Exchange Defendants).

The former is a "Self-Regulatory Organization" registered with the Securities and Exchange Commission (SEC). It owns and operates the Philadelphia Exchange (PHLX). NASDAQ OMX GROUP, INC. is the for-profit company that owns NASDAQ OMX PHLX LLC. Plaintiff alleges that these Defendants created a cap on fees that market makers must pay for trading on the market. The cap makes the massive options trades Plaintiffs challenge feasible because without the cap the trades would be too expensive to make money. Plaintiff accuses the Exchange Defendants of enacting the fee cap specifically to enable the Market Maker Defendants to deprive Plaintiff of expected dividends.

Plaintiff accuses all Defendants of combining in a single conspiracy to engage in or promote these "dividend plays." He specifically identifies several occasions when these trades occurred. In August 2010, Plaintiff's call options in Pfizer Inc. securities were assigned as a consequence, according to Plaintiff, of Defendants manipulations. Compl. at ¶¶ 61–65. Then again in December, 2010, Plaintiff wrote 100 Pfizer calls which were assigned. Compl. at ¶ 66. Plaintiff alleges that Defendants engaged in a dividend play that "drastically increased the open interest pool" in options for the CME group in December 2013. Compl. at ¶¶ 68–73.

Plaintiff does not say that every market maker engaged in the...