Standard Inv. V. National Ass'n Securities Dealers, Docket No. 07-3372-cv.

Citation560 F.3d 118
Decision Date18 March 2009
Docket NumberDocket No. 07-3372-cv.
PartiesSTANDARD INVESTMENT CHARTERED, INC., on behalf of itself and all others similarly situated, Plaintiff-Appellant, v. NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., a/k/a Nasd, Nyse Group, Inc., Mary L. Schapiro, Richard F. Brueckner and Barbara Z. Sweeney, Defendants-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Douglas W. Henkin, New York, N.Y. (Manuel Yanez, Milbank, Tweed, Hadley & McCloy, LLP, on the brief), for Defendant-Appellee NYSE Group, Inc.

Before: NEWMAN, SOTOMAYOR, and WESLEY Circuit Judges.

JON O. NEWMAN, Circuit Judge.

This appeal arises out of the consolidation of the member regulation operations of the National Association of Securities Dealers ("NASD") and the New York Stock Exchange Group, Inc. ("NYSE").1 The appeal presents the unusual situation of a case, dismissed for lack of exhaustion of administrative remedies, in which the appellant, Standard Investment Chartered, Inc. ("Standard") contends that the required exhaustion was concluded before argument of the appeal. The appeal is taken from the May 3, 2007, judgment of the District Court for the Southern District of New York (Shirley Wohl Kram, District Judge). See Standard Investment Chartered, Inc. v. NASD et al., 2007 WL 1296712 (S.D.N.Y. May 2, 2007). The appellees are NASD, three of its officers, and NYSE.

The appellant wants us to reverse so that the case may be returned to the District Court. The appellees want us to affirm the dismissal, a result that would also leave the case available for return to the District Court. Under these circumstances, we conclude that the controversy as to the appeal, though not as to the case, has been eliminated, and we therefore dismiss the appeal as moot, without prejudice to the right of any party to pursue any issues sought to be raised on this appeal in the event of a subsequent appeal from a final judgment of the District Court.

Background

The parties and their functions. Standard is a California corporation and a member of NASD. NASD is a Delaware corporation, registered with the Securities and Exchange Commission ("SEC") as a national securities association pursuant to the 1938 Maloney Act Amendments to the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78o-3, 78s(a)(1). NYSE is also a Delaware corporation, registered with the SEC as a national securities exchange. See id. § 78f. Both entities are self-regulatory organizations ("SROs") within the meaning of the Exchange Act. See id. § 78c(a)(26). NYSE exercises its regulatory functions through its wholly-owned subsidiary NYSE Regulation, Inc. ("NYSE Regulation"). As SROs, the NASD and NYSE have "a duty to promulgate and enforce rules governing the conduct of [their] members," under the oversight of the SEC. Barbara v. New York Stock Exchange, Inc., 99 F.3d 49, 51 (2d Cir.1996); see also D'Alessio v. New York Stock Exchange, Inc., 258 F.3d 93, 105 (2d Cir. 2001). This Court has recognized that "the NASD serves as a critical aid to the SEC in implementing and effectuating compliance with the securities laws." DL Capital Group, LLC v. Nasdaq Stock Market, Inc., 409 F.3d 93, 95 (2d Cir.2005).

The Exchange Act grants the SEC "broad oversight" of SROs' promulgation and enforcement of rules. See id. An SRO's rules are broadly defined as including the organization's constitution, articles of incorporation, bylaws, and rules. See 15 U.S.C. § 78c(a)(27). An SRO's proposed rules, and any proposed rule changes, must be filed with the SEC. See id. § 78s(b)(1). With few exceptions not relevant here, an SRO cannot change its rules, including its bylaws, without the SEC's approval. See id.

Under the Exchange Act, the SEC "shall approve a proposed rule change of a self-regulatory organization if it finds that such proposed rule change is consistent with the requirements of [the Exchange Act,] and the rules and regulations thereunder applicable to such organization." 15 U.S.C. § 78s(b)(2). In addition, the Exchange Act authorizes the SEC to "abrogate, add to, and delete from the rules of a self-regulatory organization as the Commission deems necessary or appropriate to conform its rules to requirements of [the Exchange Act] and the rules and regulations thereunder applicable to such organization, or otherwise in furtherance of the purpose of this chapter." Id. § 78s(c).

The consolidation. In November 2006, NASD and NYSE announced a plan to consolidate the member regulation operations of NASD and NYSE Regulation into a combined organization. The regulatory organization created by the consolidation, known as FINRA, would become the sole U.S. private-sector provider of member firm regulation and enforcement. To accommodate the consolidation, NASD's Board of Governors proposed a set of amendments to NASD's bylaws that would modify NASD's governance structure to be compatible with those of the NYSE.2

NASD called a special meeting of its members to vote on the bylaw amendments, permitting members to vote by proxy. The proxy statement explained that NASD members were being asked to vote only on the bylaw amendments, not the transaction itself. The proxy statement described certain aspects of the proposed transaction in addition to the governance changes. In particular, it explained that NASD anticipated substantial cost savings from the consolidation of regulatory functions and proposed to share these saving with members in two ways. First, upon closing, NASD would make a one-time payment to each NASD member of $35,000. Second, for the next five years, NASD would discount all members' annual dues, subject to annual Board approval. The proxy statement asserted that "[a] larger payment [than $35,000] is not possible" because "NASD is a tax-exempt organization and therefore is limited by tax laws regarding size and source of payments it can make to its members. The special member payment of $35,000 per NASD member, or approximately $175 million in the aggregate, will be funded by—and therefore limited by—the expected value of the incremental cash flows that will be produced by the consolidation transaction." In January 2007, the bylaw amendments were approved by a majority of voting members.

The lawsuit. In March 2007, Standard filed the instant lawsuit on behalf of the putative class of NASD members that are not also NYSE members. The complaint alleged that the terms of the proposed consolidation "represent a massively unfair disenfranchisement of NASD members," in both governance and financial terms. The complaint pleaded three claims: the NASD officers breached their fiduciary duties to the proposed class in negotiating the consolidation and failing to disclose all material facts in the Proxy Statement; the defendants engaged in negligent misrepresentation with respect to the proxy statement; and the NYSE and individual defendants would be unjustly enriched by the consolidation.

The defendants-appellees moved to dismiss Standard's complaint pursuant to Rule 12(b)(1) of the Federal Rules of Civil Procedure for lack of subject matter jurisdiction because of Standard's failure to exhaust administrative remedies or, in the alternative, pursuant to Rule 12(b)(6) because NASD's absolute regulatory immunity barred Standard's claim for damages and because Standard failed to state a claim.

Standard filed an amended complaint in response to the defendant-appellees' first motion to dismiss. The amended complaint emphasized that Standard was not challenging the wisdom of the consolidation, but only the manner of accomplishing it. In addition to the original three claims, the amended complaint alleged a denial of state law rights under Delaware corporate law, conversion, substantial diminution of value in membership, and deprivation of voting membership. Standard sought declaratory relief, an injunction prohibiting the consolidation, an order that the NASD prepare a new proxy statement and hold a new vote, compensatory and punitive damages, and an accounting, among other prayers for relief.

The defendants-appellees again filed a motion to dismiss Standard's claims based on their jurisdictional and immunity defenses. While briefing was underway, Standard sought and obtained expedited discovery from all defendants. Standard obtained communications between NASD and the Internal Revenue Service ("IRS") regarding NASD's tax-exempt status and the special $35,000 member payment.

In May 2007, the District Court granted the defendants-appellees' motion to dismiss Standard's amended complaint on the ground that it failed to establish subject matter jurisdiction under Rule 12(b)(1). Standard Investment, 2007 WL 1296712, at *10. The Court held that because the proposed bylaw amendments necessary for the consolidation's consummation were an exercise of the NASD's rule-making authority, Standard was required to exhaust the administrative remedies provided by the Securities Exchange Act and failed to do so. The Court also ruled that Standard's damages claims could not proceed because they were "based entirely on a future contingency — the [c]onsolidation's consummation." Id. at *7. The Court did not reach the defendants-appellees' absolute immunity defense.

Standard then filed a motion for reconsideration of the District...

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