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The 2d U.S. Circuit Court of Appeals has reinstated a claim by institutional investors alleging that the New York Stock Exchange had engaged in misconduct in its dealings with seven firms that process stock transactions. In re NYSE Specialists Securities Litigation, No. 06-1038-cv. The 2d Circuit revived the claim of the California Public Employees’ Retirement System and other plaintiffs that the exchange had misrepresented its market integrity and internal operations. The court said the investors had standing to make that claim. However, the circuit handed the exchange a legal victory by affirming the finding of Judge Robert W. Sweet of the U.S. District Court for the Southern District of New York that it was entitled to absolute immunity from claims that it failed to regulate and provide a fair and orderly market. The panel remanded the case to Sweet for further proceedings. Writing on behalf of the court, Judge Sonia Sotomayor declined to decide whether the investors’ misrepresentation pleadings were adequate to state a claim, but suggested that the exchange might have a strong case. She noted that the remaining claims “do not appear to be of the nature where the fraud-on-the-market theory would apply, where the misrepresentation itself affects the market price of the security purchased.” The complaint followed revelations in 2003 that several specialists were accessing inside information and making millions of dollars trading stocks they supervised. In 2005, the U.S. Securities and Exchange Commission fined the firms nearly $250 million, and the New York Stock Exchange (NYSE) entered into a settlement with the SEC and agreed to spend $20 million to implement new oversight methods. A federal grand jury indicted 15 ex-traders on criminal charges, but U.S. Attorney Michael Garcia had difficulty prosecuting these cases. The government dropped charges against seven of the defendants. Two former traders, Michael Stern and Michael Hayward of Van der Moolen Specialists USA, were convicted, two were acquitted and two pleaded guilty. One remains at large. David Finnerty, another former trader, had his jury conviction overturned. In their lawsuit, the investors argued that NYSE’s repeated public statements about the operation of its specialist firms and its oversight of their daily functions deliberately created the false impression that NYSE was “overseeing and operating its auction market in accordance with laws, rules and regulations that l[ed] investors to believe that the NYSE was an honest and fair market,” and that they had relied on these statements in trading stocks. The investors argued that the doctrine of absolute immunity applies solely when self-regulated organizations like NYSE act affirmatively and consistently with the powers delegated to them in their quasi-governmental role. Because the allegations demonstrate that the exchange failed to regulate and at times actually participated in the fraud, the doctrine does not bar their claims. The 2d Circuit disagreed, saying that extending absolute immunity “only to affirmative acts is neither warranted by our case law nor consonant with the purposes of absolute immunity.” The court, however, backed the investors on the standing issue. Sweet cited the 2d Circuit’s opinion in Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Corp., 369 F.3d 27 (2d Cir. 2004), in support of his decision that the investors lacked standing to sue the exchange for alleged misrepresentation. But Sotomayor said the lower court judge “incorrectly read Nortel Networks to mean that an action under Rule 10b-5 for false statements about a security purchased by the plaintiff lies only against the issuer of the security, or that only statements about a security issuer are actionable.”

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