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The 2nd U.S. Circuit Court of Appeals will not recognize a fraud exception to the absolute immunity granted Nasdaq and other so-called self-regulatory organizations. Rejecting a lawsuit brought against Nasdaq for canceling trades in 2003, the circuit said that absolute immunity will hold as long as the self-regulatory organizations act consistently within the “quasi-governmental powers” delegated them under the Securities Exchange Act of 1934 and subsequent regulations. “[B]ecause we believe that — at least in the circumstances just described — absolute immunity must be absolute, we reject the calls, inter alia, to carve out a fraud exception to the absolute immunity doctrine or to distinguish suits brought by public investors and suits brought by others such as SRO members,” Judge Robert Katzmann wrote for the court in DL Capital Group v. Nasdaq Stock Market, Inc., 04-3027-cv. The regulatory powers granted the National Association of Securities Dealers have been delegated in part to the Nasdaq Stock Market, which enforces rules and regulations approved by the U.S. Securities and Exchange Commission. One is Rule 11890, which authorizes Nasdaq to cancel any trade that is “clearly erroneous” or is “necessary for the maintenance of a fair and orderly market or [for] the protection of investors and the public interest.” A “clearly erroneous” transaction is one where “there is an obvious error in any term, such as price, number of shares or other unit of trading, or identification of the security.” Nasdaq used the rule on Dec. 5, 2003, to cancel some trades of the stock in Corinthian Colleges after it plummeted from a high of $57.45 to as low as $38.97 between 10:46 a.m. and 10:58 a.m. Nasdaq, Judge Katzmann said, found that the market activity was caused by “multiple orders being routed to multiple market centers and electronics communications networks by a single customer; thus multiple sell orders had been placed erroneously for COCO.” Nasdaq halted trading in the stock at 10:58 a.m. and stated that the drop in share price was due to “misuse or malfunction” of an electronic trading system. Trading was allowed to resume about one hour later, but additional time elapsed before Nasdaq announced it was canceling all trades made during the 12-minute period. DL Capital Group sued Nasdaq because it had bought COCO stock within the 12-minute time frame, but sold it at a profit in the period between the resumption of trading and Nasdaq’s announcement it was canceling trades. The result was that the firm’s purchase was covered by the cancellation, but not its sale, a situation that the firm claimed forced it to buy shares at a higher price. The firm says it was “injured by having to cover the forced short sale at a loss.” The suit accused Nasdaq of fraud for making misleading statements or omissions by failing to disclose sooner its intention to cancel COCO trades from the 12-minute interval. It also sought to hold liable Robert Greifeld, then Nasdaq’s president and chief executive officer, as a “controlling person.” Nasdaq won dismissal of the suit based on absolute immunity in a ruling by Southern District Judge Charles S. Haight Jr. REGULATORY DUTIES On the appeal, Judge Katzmann said, “There is no question that an SRO and its officers are entitled to absolute immunity when they are, in effect, ‘acting under the aegis’ of their regulatory duties,” and the circuit has recognized this fact in more than one case. DL Capital Group contended that absolute immunity does not apply here because the firm is not challenging the decision to suspend and resume trading and cancel trades, only the way Nasdaq announced them. But Katzmann said Judge Haight had it right when he said announcing the “suspension or cancellation of trades is as much a part of defendants’ regulatory duties as is the actual suspension or cancellation of trades.” On the main issue, whether absolute immunity cannot extend to suits charging fraud, Katzmann said, “[T]his Court has already implicitly held that SROs are absolutely immune to suits alleging fraud.” He added, “Not only that, but this Court has, in other contexts, made clear that allegations of bad faith, malice and even fraud — all of which may be relevant to a qualified immunity analysis — cannot, except in the most unusual of circumstances, overcome absolute immunity. Finally, rebuffing DL Capital’s claim that absolute immunity does not apply to suits brought by individual investors, Katzmann said, “[T]his Court has never suggested that the identity of the plaintiff is what drives the absolute immunity analysis.” Judge Ralph Winter and District of Vermont Judge J. Garvan Murtha, sitting by designation, joined in the opinion. DL Capital was represented by Robert I. Harwood, Matthew M. Houston and Joshua D. Glater of Wechsler Harwood in New York and Sherrie R. Savett, Barbara A. Podell and Douglas M. Risen of Berger & Montague in Philadelphia. Douglas R. Cox, F. Joseph Warin and Michael J. Edney of Gibson, Dunn & Crutcher represented Nasdaq and Greifeld.

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