The exchanges (and by implication high-frequency traders) have won a victory in the U.S. District Court for the Southern District of New York.
In an opinion issued April 28th, the Hon. Katherine Forrest dismissed a complaint brought by Harold R. Lanier against several exchanges, including BATS, the CBOE, the ISE, and the New York Stock Exchange.
Lanier filed this lawsuit last May, alleging that the exchanges in question have allowed preferred data customers receipt of “unconsolidated market data before that data arrives at the processor responsible for consolidating it and distributing it to other customers.”
State Law/Common Law Claims
One unusual feature of Lanier’s claims is that he didn’t make any under federal law. He brought the suit under state law as a breach-of-contract claim, though he brought it in federal court because of diversity of citizenship. He resides in Alabama; the defendants are Delaware corporations with their headquarters in a number of states.
Lanier has entered into contracts with the defendant exchanges, which on their face obligate them to provide him with valid market data. Under standard contract-law conceptions, this obligation comes with an implicit obligation of “good faith and fair dealing.” It is that combination – the duty to deal fairly in connection with the provision of valid market data – that gave rise to Lanier’s breach claim.
What the exchanges have been providing to Lanier and others similarly situated is the Subscriber Feed or SIP. But (in the words of Judge Forrest, paraphrasing the complaint), “most if not all defendants charge a substantial premium to Preferred Data Customers in return for receiving the data before it is received by Subscribers.” These preferred data customers, i.e. HFT firms, can with only an edge of 1,499 microseconds, “cancel orders and execute trades before Subscribers” [ordinary people] “even receive the market data.”
The complaint included this diagram:
Judge Forrest didn’t enter into the issues of fact raised by the complaint (or, at least, not very far). On a motion to dismiss, she didn’t have to. Rather, she dismissed because state law claims have been preempted by the Securities Exchange Act and the regulations promulgated thereunder. Congress has occupied the field and done so in a way that excludes Lanier’s state-law/common law claims.
Intent to Displace
In a 1947 decision, the Supreme Court said that intent to displace state law may be “inferred from a framework of regulation so pervasive … that Congress left no room for the States to supplement it….” Accordingly, the court reviewed the system of federal regulations surrounding the SUP. The Securities and Exchange Commission has approved the self-regulatory organizations’ use of proprietary feeds and has recognized (in for example a March 26, 2009 release) that exchanges have developed prop feeds to address the needs of latency-sensitive traders, and those who want the data “to power certain trading algorithms or smart order routers.”
It is of course possible to “question the wisdom of the SEC’s stance on this issue and its fairness to ordinary investors,” but the court isn’t in the business of second guessing the wisdom of regulation. “Thus, were Lanier to succeed on his contract claims, there would be a conflict between state law and federal law. Lanier’s claims are therefore preempted for this reason alone.”
The judge went further and looked into the merits of the breach-of-contract argument. Her inferences were not favorable. The subscriber agreements expressly disclaim warranties as to the timeliness or accuracy of their data. Further, Lanier’s attempt to get around that language by reference to “good faith and fair dealing” doesn’t help. Those duties do not provide a cause of action in themselves, outside of the four corners of the underlying contract.
No Absolute Immunity
One small bit of consolation that opponents of the SEC’s scheme might take from this decision is to be found in a footnote on p. 24 of the judge’s decision. The Defendants sought a still-more-sweeping ruling from the court, acknowledging their immunity from any lawsuits “challenging their performance of delegated governmental powers” as SROs.
The court refused to give them that blanket immunity. To do so, under the prevailing test in the 2d Circuit, would be to determine that the SROs’ transmission of data to their paying clients is itself a “regulatory act.” That is not clear. Tus, the court doesn’t reach the question “of whether defendants enjoy absolute immunity from suit for the conduct alleged in Lanier’s complaints.”
So although Lanier’s theories now have been rather definitively disposed of for the southern district, there is still life in other challenges to the same behavior, challenges that will work through rather than seeking to avoid, the pertinent federal statutes.