CATHEDRAL TRADING v. THE CHICAGO BOARD OPTIONS EXCHANGE

The opinion of the court was delivered by: Elaine E. Bucklo, United States District Judge

The plaintiffs in this securities fraud action trade options on U.S. options exchanges, including the Chicago Board Options Exchange ("CBOE"). They are not members of the CBOE or other exchanges but are retail customers in the business of trading in options and stocks. The CBOE issues equity and index options individually and also in concert with Options Clearing Corporation ("OCC"), a Delaware corporation, of which the CBOE is a part owner. The OCC provides various facilities for trading options used by several options exchanges, including the CBOE, and the plaintiffs allege that for options issued or settled through the OCC, the CBOE controls the OCC. The plaintiffs say that the defendants have prevented many of their trades from being executed or confirmed and refused to honor consummated transactions. They sue under several federal securities statutes, the federal antitrust laws, and a number of state causes of action, The defendants move to dismiss, and I do so.

I.

Options are securities that give their owners the right to buy or sell other securities at certain prices at a future date. They are traded on several exchanges, including the CBOE, which compete for business. The CBOE is supposed to offer the best quoted price for an option available on its floor, though better prices may be available on other exchanges. The prices are transmitted to a central authority that combines the information, which is used by market makers to set prices and by the public to make investment decisions. Under SEC rules, options have been traded on multiple exchanges since 1990 to reap the benefits of competition for business among exchanges. However, in the 1990s the SEC found that the CBOE had conspired with other option exchanges not to offer multiple listings of many options, see SEC Release No. 34-43268 (Sept. 11, 2000), and the Justice Department investigated antitrust violations connected to the same conspiracy. As a result, the options exchanges began to offer more "multiply-listed" options. With such listings, exchange members and retail customers can both monitor and trade against competing bids offered at various options exchanges. The plaintiffs in this case are retail customers who trade options using sophisticated computer technology. From mid-1999 to the present, the plaintiffs have placed numerous retail orders on a daily basis at the CBOE.

The CBOE and OCC have disseminated a good deal of information to the public in order to solicit business. These defendants maintain a website, http://www.cboe.com, with information about the options, the trading systems, market information, tips on strategy, and free software. This website material represents that CBOE order handling, routing, and execution systems "guarantee our customers the fastest and most equitable transactions." Two documents, one dated April 30, 1997, that the OCC identifies as a "prospectus," and another headed with the CBOE logo and available on the Internet, titled Characteristics and Risks of Standardized Options, which is furnished to investors as required by law, state that the CBOE ordinarily becomes obligated to accept an option transaction on the next business day if reported in a timely way, and that premiums for multiply traded options may differ across markets. An investor may therefore buy a multiply-listed option on the CBOE and offset his position on another exchange.

The CBOE also published an information booklet called Welcome to the Chicago Board Options Exchange (the "Welcome booklet") representing that all equity options are traded under the "Designated Primary Market Maker" ("DPM") system to ensure a fair and orderly, continuous, two-sided market. DPMs are individuals designated to "make" the markets by trading in certain specific ways. The Welcome booklet states that DPMs determine the formula for generating automatically generated market quotations, that the system that disseminates the quotations is accurate, and that DPMs must participate at all times in any automated execution system that may be open, and, moreover, are present at the trading post through the business day, and, with respect to their trades as market makers, effect trades that correlate well with the overall trading pattern for each series in the options classes involved. The Welcome booklet states that if a DPM quotes a price that matches the order of a floor broker's customer, "a trade occurs." CBOE Rule 8.51 states that a "firm quote requirement generally applies at all times" and "obligates the trading crowd to sell (buy) at least the established number of contracts at the offer (bid) which is displayed when a[n] . . . order reaches the trading station."

The OBOE has also developed an electronic order execution system called the Retail Automatic Execution System ("RAES") Literature available on the OBOE website says that orders "that fall within designated premium levels, contract size, and series parameters are guaranteed a fill at the current market bid and offer." The DPMs are authorized to deactivate RAES, thus preventing a trade from being executed automatically, in only two circumstances. The first is if floor conditions become too heavy. In that case, the floor brokers can use a "Public Automated Routing System" ("PAR") to execute trades. This is a PC-based touch-screen, order routing and execution system that allows brokers to present a customer order to DPMs and other market makers. It also allows DPMs to determine the identity of a retail customer or his clearing house before executing the trade. When RARS is deactivated because of heavy trading, the floor brokers can send all their orders from their PAR workstations to an automated customer order book known as the "Electronic Book" ("EBOOK") that automatically sorts and files trades in price and time sequence. The other circumstance in which OBOE represents that RAES may be deactivated is when a competing exchange offers a better price on a multiply-listed option, in which case the order is printed in the public order book and announced to the trading crowd for execution. CBOE rule 6.8 requires market markers to sell/buy a customer's PALS order.

The plaintiffs allege that the defendants, individually and together, have lied in saying that they will execute trades fairly and automatically, inducing the plaintiffs, in reliance on those statements, to trade on what were in fact unfavorable terms, and failed to disclose substantial additional risks that orders would be arbitrarily mishandled to the plaintiffs' detriment. The defendants have prevented many of the plaintiffs' trades from being executed or confirmed, and offered pretextual explanations about why trades were not executed. They have arbitrarily deactivated RAES so that retail customers like the plaintiffs have no access to automatic execution, and refused to execute their trades or "faded," moving the bid or offer away from the plaintiffs' order after the plaintiffs have placed an order on RAES at the market limit price. The defendants have done this because they recognize the plaintiffs as being on the other side of the trade, and would prefer to deal with customers who are less sophisticated, less likely to know that they are being cheated or to complain.

The complaint says that "upon information and belief," the defendants have failed to execute trades with the plaintiffs, bypassing them to execute trades on identical bids or orders with less sophisticated customers, and also on "information and belief," have failed to honor (or "busted") consummated electronic trades if these turn out to be bad for the DPMs and other market makers, while providing various phony excuses for this misconduct. As recently as February 21, 2001, the defendants published a blacklist of persons with a "history of questionable RAES trades or potential manipulative activity," including the plaintiffs; these accusations are false, but as a result, clearing firms have closed the plaintiffs' trading accounts, barring them from the market.

II.

Heightened pleading requirements apply to all the fraud claims.*fn1 Any federal securities fraud claim must comply with the Private Securities Litigation Reform Act ("PSLRA"), requiring the complaint to "state with particularity all facts on which that belief [in scienter amounting to recklessness] is formed." 15 U.S.C. § 78u-4 (b)(1); the complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. § 78u-4(b)(2). Although states of mind "may be pleaded generally, the `circumstances' must be pleaded in detail. This means the who, what, when, where, and how: the first paragraph of any newspaper story." DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990) (Fed. R. Civ. P. 9 (b) context). Under Rule 9(b), heightened pleading standards also apply to other sorts of fraud claims. Id. Despite the wealth of detail about options trading in this 44-page complaint, the actual fraud allegations are vague, generic, and nonspecific.

The plaintiffs fail to identify any specific transactions constituting the fraud, the "what" about which they complain. Fraud cases have been dismissed for failure to satisfy the specificity requirements when the plaintiff failed to provide "a single concrete example" of a particular fraudulent activity. DiLeo, 901 F.2d at 626. The plaintiffs do not offer any concrete examples. Plaintiffs are not required to `plead facts to which they lack access prior to discovery," Katz v. Household Int'l., Inc., 91 F.3d 1036, 1040 (7th Cir. 1996), but here the plaintiffs claim they have the information on which their claims are based. Also unsatisfactory are allegations like those in ¶ 53, that, upon "information and belief," the defendants bypassed the plaintiffs' retail orders and failed to honor executed trades. "Allegations made upon information and belief are insufficient [to allege fraud] . . . unless the plaintiff states the grounds for his suspicions." See Uni*Quality, Inc. v. Infotronx, Inc., 974 F.2d 918, 924 (7th Cir. 1992); 15 U.S.C. § 78u(b)(1)(B). The plaintiffs fail to do so here.

The PSLRA requires that the plaintiffs specify "each statement" alleged to have been misleading. 15 U.S.C. § 78u-4 (b)(1). The plaintiffs do quote two particular statements from literature published by the CBOE and the OCC, i.e., that OBOE order handling, routing, and execution systems "guarantee our customers the fastest and most equitable transactions," and that "trades automatically occur" when certain requirements are met, Complaint ¶ 59, which if false and believed, would substantially increase the risks of trading on the OBOE. These statements are not puffery; they rule out deliberate discrimination against the plaintiffs, and would clearly matter to an investor. See Searls v. Glasser, 64 F.3d 1061, 1066 (7th Cir. 1995) (standard for puffery). However, "`plaintiff[s] alleging securities fraud cannot simply quote verbatim from annual reports and press releases and assert that the statements are untrue; [they] must explain in [their] complaint what is untrue about each of the challenged statements.'" 15 U.S.C. § 78u-4 (b)(1)(B). Clark v. TRO Learning, Inc., No. 97 C 8683, 1998 WL 292382, at *4 (N.D. Ill. May 20, 1998). The plaintiffs fail to do this with reference to any particular transaction with the level of detail that would allow me to conclude that, if the specific allegations were true, the statement would be false. The other alleged omissions and affirmative misstatements characterized, e.g., as "various oral statements" and "misleading explanations as to why trades were not executed," Complaint ¶ 56, are too vague to be actionable. The plaintiffs must say what was said or suppressed and why it was fraudulent to say or suppress it.

The "when" is not satisfactorily pleaded either. The plaintiffs allege, basically, that the conduct of which they complain has been going on since mid-1999. They do not give a specific date for any particular act. But it is not enough to allege that the defendants defrauded the plaintiffs in some way over a period of months or years. Servpro Indus., Inc. v. Schmidt, No. 94 C 5866, 1997 WL 361591, at *8 (N.D. Ill. June 20, 1997) (Ashman, M.J.) (Allegations of misrepresentations "in or about 1991," "prior to March of 1985," and "subsequent to the execution of the agreement" not sufficiently specific); Brandt v. Jack Levy Assocs. Inc., No. 92 C 5075, 1993 WL 95383, at *1 (N.D. Ill. Mar. 30, 1993) (Duff., J.) (Same with allegations of lies "in early 1991 (no later than July of 1991 . . . ...