Electronic Trading v. Banc of America: Federal Securities Laws Preclude Antitrust Laws re: Short Sale Litigation

The U.S. Court of Appeals for the Second Circuit dismissed a putative antitrust case relating to short sale transactions on the grounds that federal securities laws precluded the application of antitrust laws to short sale transactions. The case, Electronic Trading Group LLC v. Banc of America Securities LLC (aka In re Short Sale Antitrust Litigation) 588 F.3d 128 (2nd Cir. 2009), marked the Second Circuit’s first application of the implied preclusion doctrine outlined by the U.S. Supreme Court in Credit Suisse Securities (USA) LLC v. Billing, 551 U.S. 264 (2007). The decision essentially insulates prime brokers who allegedly collude regarding short sellers from any Sherman Act claim, at least in the Second Circuit.

Plaintiff Electronic Trading Group LLC was a “short seller” of securities. It filed a putative class action against certain financial institutions that serve as prime brokers in short sale transactions, alleging that they arbitrarily designated certain securities as “hard-to-borrow,” then agreed to fix the minimum price for borrowing these securities (higher than the price of other securities) in violation of Section 1 of the Sherman Act, 15 U.S.C. section 1. The plaintiff also alleged state law claims of breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and unjust enrichment.

The defendants moved to dismiss, arguing that the Sherman Act claims were subject to the doctrine of implied preclusion of antitrust claims by the securities laws. The plaintiffs argued, among other things, that preclusion should not apply because no actual or potential conflict between antitrust and securities laws exist, since neither allows the collusive fixing of borrowing fees. The United States District Court for the Southern District of New York agreed with the defendants and dismissed the Sherman Act claim with prejudice. The District Court also dismissed the state law claims without prejudice.

The Billing factors support a finding of implied preclusion of antitrust claims

In affirming the District Court’s decision, the Second Circuit panel applied the considerations on preclusion of antitrust claims outlined by the U.S. Supreme Court in Credit Suisse Securities (USA) LLC v. Billing, 551 U.S. 264 (2007). In Billing, the Supreme Court found implied preclusion of an antitrust claim where underwriters were accused of requiring buyers to take additional shares at escalating prices, forcing them to pay high commissions on subsequent buys, and requiring them to purchase less desirable securities.

Billing set forth four considerations that must be examined to determine whether the securities laws are “clearly incompatible” with antitrust laws in a particular context, thus warranting implied preclusion. Billing, 551 U.S. at 285. The four considerations are whether 1) the area of conduct is “squarely within the heartland of securities regulation”; 2) the Securities and Exchange Commission (SEC) has the authority to regulate the conduct; 3) there is ongoing SEC regulation; and 4) a conflict exists between the antitrust and securities laws and regulation. Billing, 551 U.S. at 285.

As to the first Billing consideration, the Circuit Court found that “short selling is market activity regulated by the securities law” and therefore in the heartland of securities regulations. Electronic Trading, 588 F.3d at 134. As to the second consideration, even though no specific current SEC provision explicitly references the regulation of borrowing fees, the SEC does have the authority to regulate the role of prime brokers and the borrowing fees they charge. Id. at 134-135. As to the third consideration, the Circuit Court found that the SEC’s general regulation of the role of prime brokers in short selling weighed in favor of preclusion, even though the SEC had not focused on the regulation of borrowing fees in particular. Id. at 135-136.

Regarding the fourth consideration, the Circuit Court reasoned that because it “is permissible for brokers to communicate about the availability and price of securities,” the imposition of “antitrust liability could create actual and potential conflicts” because it would inhibit this conduct on the part of prime brokers “that the SEC currently permits and that benefits the efficient functioning of the short selling market.” Id. at 137.

Moreover, the Circuit Court found another potential conflict between securities law and antitrust law, “based on the possibility that the SEC will act upon its authority to regulate the borrowing fees set by prime brokers.” Id. at 138. Despite the plaintiff’s argument to the contrary, the Circuit Court said that it is “not decisive that neither securities law nor antitrust law allows – or encourages – the collusive fixing of borrowing fees.” Id.

Because consideration of all four Billing factors weighed in favor of preclusion, the Circuit Court upheld the District Court’s dismissal of the case.

CONCLUSION

In Electronic Trading, the Second Circuit took the opportunity to apply the Billing doctrine to find implied preclusion in an area not currently covered by securities regulations. The result: prime brokers who allegedly collude in setting borrowing fees for short sellers cannot be sued in federal court for violating the Sherman Act.

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Josh Lawler

Joel Ginsberg

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