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CATHEDRAL TRADING v. THE CHICAGO BOARD OPTIONS EXCHANGE
April 30, 2002
CATHEDRAL TRADING, LLC, LTC TRADING, INC., ELIZABETH ECKLUND SMOLINSKI, KRISTOPHER SMOLINSKI, RAY BARKER, BRIAN GILL, MATTHEW KUNDRAT, AND MICHAEL POWERS, PLAINTIFFS,
V.
THE CHICAGO BOARD OPTIONS EXCHANGE AND THE OPTIONS CLEARING CORPORATION, DEFENDANTS.
The opinion of the court was delivered by: Elaine E. Bucklo, United States District Judge
MEMORANDUM OPINION AND ORDER
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.
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 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.
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 . . . ...