Vanguard Municipal Bond v. Cantor, Fitzgerald L.P.

• Decision Date: 22 March 1999
• Docket Number: No. 97 Civ. 6874 (SHS)(AJP).,97 Civ. 6874 (SHS)(AJP).
• Citation: 40 F.Supp.2d 183
• Parties: VANGUARD MUNICIPAL BOND FUND, INC., et al., Plaintiffs, v. CANTOR, FITZGERALD L.P., et al., Defendants.
• Court: U.S. District Court — Southern District of New York

40 F.Supp.2d 183

VANGUARD MUNICIPAL BOND FUND, INC., et al., Plaintiffs, v. CANTOR, FITZGERALD L.P., et al., Defendants.

No. 97 Civ. 6874 (SHS)(AJP).

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

March 22, 1999.

Scott Gene Early, Foley & Lardner, Chicago, IL, Joseph G. Reimer, Richard C. Raymond, Reimer & Raymond, LLP, New York City, for plaintiffs.

James F. Rittinger, Satterlee Stephens Burke & Burke, New York City, for defendants.

ORDER

STEIN, District Judge.

In a Report and Recommendation dated December 21, 1998, Magistrate Judge Andrew J. Peck recommended that defendants' motion to dismiss the complaint or in the alternative for summary judgment be granted.

After a de novo review of Magistrate Judge Peck's Report and Recommendation dated December 21, 1998,

IT IS HEREBY ORDERED that that Report and Recommendation is adopted by this Court, and that defendants' motion for summary judgment dismissing the complaint is granted.

SO ORDERED.

REPORT AND RECOMMENDATION

PECK, United States Magistrate Judge.

Plaintiffs Vanguard Municipal Bond Fund, Vanguard Ohio Tax-Free Fund, Vanguard New York Insured Tax-Free Fund, Vanguard New Jersey Tax Free Fund, Vanguard Pennsylvania Tax-Free Fund, Vanguard Fixed Income Securities Fund and Vanguard Admiral Funds (collectively "Vanguard"), mutual funds and members of the Vanguard Group of Investment Companies, are suing defendants Cantor Fitzgerald Municipal Brokers, Chapdelaine & Co., J.F. Hartfield & Co., J.J. Kenny Drake, Municipal Partners and Titus & Donnelly (collectively the "Pricing Brokers") for negligence and negligent misrepresentation arising out of the Pricing Brokers' December 19, 1995 pricing of The Bond Buyer Municipal Bond Index (the "BBI"), against which Vanguard's December 1995 Long-Term Municipal Bond Index Futures Contracts were settled. The Pricing Brokers have moved to dismiss the complaint for failure to state a claim upon which relief can be granted, or, in the alternative, for summary judgment. For the reasons set forth below, because the Pricing Brokers' did not owe any duty to Vanguard, I recommend that the Court grant defendants' motion.¹

FACTS

Long-Term Municipal Bond Index Futures Contracts

In 1985, the Chicago Board of Trade (sometimes referred to herein as the "CBOT") created and began trading in Long-Term Municipal Bond Index Futures Contracts ("Futures Contracts"). (2d Am.Compl.¶ 20.) Futures Contracts "are issued and trade with various monthly settlement (i.e., expiration) dates.... The price at which [Futures Contracts] settle on their respective expiration dates is established by reference to the BBI." (2d Am.Compl. ¶¶ 22-23; see also Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶ 3; Affidavit of Carol Burke, V.P. of Chicago Board of Trade, ¶ 2.)

The Chicago Board of Trade has promulgated regulations to govern the trading of Futures Contracts. (See Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶ 4; Burke Aff. ¶ 3 & Ex. A: Chapter 19 of the CBOT Regulations.) As provided in Regulation 1950.01(a), the BBI is comprised of 40 long-term municipal bonds (the "Constituent Bonds") that "must meet various criteria as to size, rating, maturity and other factors." (2d Am.Compl. ¶ 24; see also Pricing Brokers & Vanguard Rule 56.1 Stmts. at ¶¶ 4-5; Affidavit of Matthew Kreps, Statistics Editor at The Bond Buyer, ¶ 5; Burke Aff.Ex. A at Reg. 1950.01(a).) The BBI is calculated by and published in The Bond Buyer, pursuant to Regulation 1950.01(b) and agreement with the Chicago Board of Trade, which granted The Bond Buyer "a license to compute and publish the BBI in accordance with price evaluations submitted by major municipal bond dealer-to-dealer brokers." (2d Am.Compl. ¶¶ 23, 25; see also Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶¶ 7, 9 12; Burke Aff. ¶ 9 & Ex. A at Reg. 1950.01(b); Burke Aff. Ex. B: 1985 CBOT — Bond Buyer Agreement.)² Each day, the prior day's BBI is published in The Bond Buyer. (Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶ 2; Kreps' Aff. ¶¶ 2, 3.)

Each of the Pricing Brokers entered into a contract with the CBOT — Bond Buyer partnership ("Pricing Broker Contract") to perform price evaluations "for the purpose of permitting The Bond Buyer[] to compute the value of the BBI." (2d Am.Compl. ¶ 26; Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶¶ 11, 14; Burke Aff. ¶¶ 9, 12; Poto Cantor Fitzgerald) Aff. ¶¶ 3, 6; Hoerrner (Chapdelaine) Aff. ¶¶ 3, 6; Byram (J.J. Kenny) Aff. ¶¶ 3, 6; Caffrey (Titus & Donnelly) Aff. ¶¶ 3, 6; Cashman (Municipal Partners) Aff. ¶¶ 3, 6; Epstein (Hartfield) Aff. ¶¶ 3, 6. Under the Pricing Broker Contracts, the Pricing Brokers:

(b) undertake to provide accurate actual price quotations for the Constituent Bonds or, in the event there is not a sufficient volume of timely and current trading activity in such bonds, to provide an evaluation of what actual price quotations would have been had there been a sufficient volume of trading activity;

(c) expressly represent and warrant the accuracy of the actual and evaluated price quotations the Pricing Brokers submit; ...

(2d Am.Compl. ¶ 26; see Burke Aff. Exs. G-L: Pricing Broker Contracts ¶¶ 2.1, 2.2.) The Pricing Broker Contracts provide for compensation to the Pricing Brokers based on a formula that takes into account the number of quotations they submit plus a "bonus" based on the "average daily trading volume of futures contracts." (2d Am.Compl. ¶ 26; Burke Aff. Exs. G-L, ¶¶ 4.1, 4.4.)

Pursuant to Regulation 1950.01(b) and the Pricing Broker Contracts, the Pricing Brokers evaluate the price of the Constituent Bonds twice each day in order that the Bond Buyer may compute the BBI twice daily. (2d Am.Compl. ¶ 28; Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶ 14; Burke Aff.Ex. A at Reg.1950.01(b); Poto Aff. ¶¶ 4-5; Hoerrner Aff. ¶¶ 4-5; Byram Aff. ¶¶ 4-5; Caffrey Aff. ¶¶ 4-5; Cashman Aff. ¶¶ 4-5; Epstein Aff. ¶¶ 4-5.) The Pricing Brokers submit the morning valuation between 11:45 a.m. and 12:00 p.m. New York time and the afternoon valuation between 2:45 p.m. and 3:00 p.m. New York time. (2d Am.Compl. ¶ 28; Kreps Aff. ¶ 6; Poto Aff. ¶ 4; Hoerrner Aff. ¶ 4; Byram Aff. ¶ 4; Caffrey Aff. ¶ 4; Cashman Aff. ¶ 4; Epstein Aff. ¶ 4.)

"Any member of the investing public may purchase or sell a CBOT Futures Contract[], which are valued at $1,000.00 times the BBI." (Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶ 16; see also Burke Aff.Ex. A at Reg.1904.01.) Vanguard does not dispute that any member of the investing public may purchase or sell a Futures Contract but adds that since the value of each Futures Contract exceeds $100,000, "[f]or the most part, ... Futures contracts are regularly and routinely traded by sophisticated investors." (Vanguard Rule 56.1 Stmt. ¶ 16; see also Affidavit of Anthony Jiorle, a Principal of Vanguard, dated 6/8/98, ¶ 6.)

"Pursuant to the CBOT's regulations, futures contracts expire on a specified date during one of four `settlement months' — March, June, September or December of a given year." (Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶ 16; see also Burke Aff.Ex. A at Reg.1905.01.) The December Futures Contracts expired on December 19, 1995. (2d Am. Compl. ¶ 32.) Prior to the expiration date, prices for Futures Contracts are set in the open market by buyers and sellers in Futures Contracts. (2d Am.Compl. ¶ 30.) "There is virtually no trading in [Futures Contracts] on its Expiration Date." (2d Am.Compl.¶ 30.) The settlement price for a Futures Contract is set by reference to the afternoon BBI on its expiration date. (2d Am.Compl. ¶ 30; Pricing Brokers & Vanguard Rule 56.1 Stmts. ¶ 17; Burke Aff.Ex. A Reg.1942.01.)

The December 19, 1995 Futures Contracts and Vanguard's Allegations in the Complaint

Vanguard traded in December Futures Contracts and, on December 19, 1995, owned an aggregate of 3,420 December Futures Contracts, which represented 75% of the open December Futures Contracts on that date. (2d Am.Compl. ¶¶ 1, 33-34; Jiorle 6/8/98 Aff. ¶ 7.) Vanguard's complaint alleged the following with respect to the Pricing Brokers' December 19, 1995 afternoon valuations for computation of the BBI:

35. In the week preceding December 19, 1995, there was substantial discussion among market professionals with respect to whether the Federal Reserve Board would take action to reduce interest rates at its scheduled Open Market Committee meeting on December 19, 1995.

36. [B]y December 18, the great majority of analysts believed the Federal Reserve Board would take no action, due principally to the federal budget impasse which had led to a partial shutdown of the federal government on December 18.

....

38. Notwithstanding the prevailing opinion in the market, at approximately 2:15 p.m. New York time on December 19, 1995, the Federal Reserve Board announced that its Open Market Committee had reduced the federal funds rate by 25 basis points (one quarter of one percent).

39. Reaction to the Federal Reserve Board announcement was sharp and immediate. Within minutes of the announcement, the Dow Jones Industrial Average had risen by more than 25 points and prices for the bellweather 30-year Treasury bond had increased as well. In fact, stock and bond prices increased across the board immediately following the announcement.

40. Nonetheless, the afternoon (i.e., the 3:00 p.m. E.S.T.) BBI did not reflect any price movement. The morning BBI on December 19, 1995 was 118 19/32. The afternoon BBI that was published at 3:00 p.m. — which was calculated based on price data submitted by the Defendant Pricing Brokers after the Federal Reserve Board announcement and which set the settlement price for the December [Futures] Contracts — was 118 26/32, down 15/32 from the previous day's closing.

41. Although the BBI failed to reflect the underlying price movements in the bond markets on the afternoon of December 19, 1995, the prices of other [Futures Contracts] that did not expire that afternoon increased immediately and sharply....

42. In fact, the BBI did...