The opinion of the court was delivered by: STANTON
Defendants The Options Clearing Corporation ("OCC") and American Stock Exchange, Inc. ("AMEX") move pursuant to Fed. R. Civ. P. 12(b)(6) to dismiss the complaint for failure to state a claim upon which relief can be granted, on the ground that there is no private right of action under the applicable provisions of the Securities Exchange Act of 1934 ("Exchange Act" or "Act"), 15 U.S.C. § 78a et seq., under which plaintiff sues; and pursuant to Fed. R. Civ. P. 9(b) for failure to allege fraud or bad faith with the requisite particularity.
The AMEX and OCC are both "self-regulatory organizations" ("SROs") under the Exchange Act, 15 U.S.C. § 78c(a)(26). The AMEX is registered as a national securities exchange pursuant to § 6 of the Exchange Act, 15 U.S.C. § 78f, and OCC is a registered clearing agency pursuant to § 17A of the Act, 15 U.S.C. § 78q-1. Plaintiff is an investor who wrote options on stock issued by Phillips Petroleum Company ("Phillips"). The AMEX provides an exchange market for the trading of options with standard terms, and options on Phillips stock were and are listed and traded at the AMEX. All trades in these options are cleared by the OCC.
Plaintiff alleges that at the close of business on March 1, 1985, he held short positions in put options on Phillips stock, under which he was obligated to purchase Phillips stock at the exercise price if the holder of the option required it of him. Between the close of business on March 1, 1985 and the opening of business on March 4, 1985, Phillips, then the target of a hostile takeover, announced a financing scheme or "offer",
whereby it would issue a package of debt securities in return for approximately half of its outstanding shares of stock. The Phillips plan was formally announced by a prospectus dated March 4, 1985. While the plaintiff's explanation of the plan's effect upon him is less than clear, it is evident that it caused the price of Phillips stock to fall substantially and thus increased the value of put options and the burdens on plaintiff in meeting his obligations as a writer of puts.
Pursuant to AMEX Rules 902 and 903
and OCC By-Laws, Article VI, Section 11 (the "OCC Adjustment Rule"),
when a company announces a reorganization that affects its securities, the Securities Committee, consisting of two representatives of each Exchange on which option contracts in that underlying security are trading and the Chairman of the OCC, shall "make such adjustments in the exercise price . . . as that Committee in its sole discretion determines to be fair" to the holders and writers of option contracts. Upon the announcement by Phillips of its financing plan, defendants' representatives duly met but decided to make no adjustment to the options on Phillips stock.
Plaintiff claims that defendants should have reduced his burdens by an adjustment such as altering his obligation to purchase under the puts he had written, or reducing the exercise price. He alleges that defendants, in failing to adjust option contracts on Phillips stock in response to Phillip's "plan of recapitalization", failed to comply with their own rules and thus violated §§ 6(b), 17A(b)(3) and 19(g)(1) of the Exchange Act, respectively 15 U.S.C. §§ 78f(b), 78q-1(b)(3) and 78s(g)(1). Although those sections do not expressly grant plaintiff a private right of action against defendants, he argues that such a right of action is implied to allow an injured investor to sue an exchange or clearing agency which fails to comply with its own rules.
Plaintiff relies heavily on Baird v. Franklin, 141 F.2d 238 (2d Cir.), cert. denied, 323 U.S. 737, 89 L. Ed. 591, 65 S. Ct. 38 (1944), in which the Court of Appeals for the Second Circuit held that an investor had a private right of action, under the then § 6(b) of the Act,
against an exchange for failure to enforce its rules. In that case the defendant New York Stock Exchange had failed to discipline a member broker firm which converted the plaintiff's securities, in violation of the Act and of the Exchange's Rules. At that time Section 6(b) provided that the SEC would not register an exchange unless its rules provided for appropriate discipline of its members for conduct "inconsistent with just and equitable principles of trade". Section 6(d) required that the exchange be "so organized as to be able to comply with the provisions of this title and the rules and regulations thereunder and that the rules of the exchange are just and adequate to insure fair dealing and to protect investors". Those sections imposed "the twofold duty upon an exchange of enacting certain rules and regulations and of seeing that they are enforced." Baird at 244. The court observed that a primary purpose of the Act is the protection of the general investing public, and that for that purpose it was necessary to grant investors "individual causes of action to enforce the statutory duties imposed upon the exchanges." Id., at 245.
At that time, only two sections of the Act, §§ 19 and 23 (15 U.S.C. §§ 78s, 78ff), explicitly imposed sanctions on an exchange for violations, and they provided for the withdrawal of an exchange's registration and suspending or fining its officers or members. The court found both inadequate to protect the defrauded investor, since they were "punitive and remedial measures, rather than compensatory". Ibid. It held that to construe § 6 as granting no private right of action would defeat the statute's purpose of protecting investors. That the statute itself provided no procedure by which the injured investor could proceed was immaterial, because "[i]t is well established that members of a class for whose protection a statutory duty is created may sue for injuries resulting from its breach and that the common law will supply a remedy if the statute gives none." Ibid. see Texas & P.R. Co. v. Rigsby, 241 U.S. 33, 60 L. Ed. 874, 36 S. Ct. 482 (1916).
Plaintiff contends that Baird supports the conclusion that the present sections 6(b), 17A(b)(3) and 19(g)(1) imply he has a right of action against both defendants for their failure to comply with their rules.
For over 30 years this Circuit and other federal courts followed Baird and recognized an implied right of action against an exchange under then § 6(b). See Arneil v. Ramsey, 550 F.2d 774 (2d Cir. 1977); Lank v. New York Stock Exchange, 548 F.2d 61 (2d Cir. 1977); Rich v. New York Stock Exchange, 522 F.2d 153 (2d Cir. 1975); Rich v. New York Stock Exchange, 509 F. Supp. 87 (S.D.N.Y. 1981); Kroese v. New York Stock Exchange, 227 F. Supp. 519 (S.D.N.Y. 1964); Hughes v. Dempsey-Tegeler & Co., [1973 Transfer Binder] CCH Fed. Sec. L. Rep. P94, 133 (C.D. Cal. 1974), aff'd, 534 F.2d 156 (9th Cir. 1976), see also Hochfelder v. Midwest Stock Exchange, 503 F.2d 364 (7th Cir.), cert. denied, 419 U.S. 875, 42 L. Ed. 2d 114, 95 S. Ct. 137 (1974) (assumed for purposes of the decision that § 6 created duty in Exchange enforceable in private action, but found no connection between losses and asserted breach of duty, and found in favor of defendant). At least one federal court did not. See Walck v. American Stock Exchange, Inc., 687 F.2d 778 (3rd Cir. 1982); compare, Gustafson v. Strangis, 572 F. Supp. 1154 (D. Minn. 1983) (no private right of action under § 15A against NASD for failure to enforce rules). Significantly, however, every decision in this Circuit following Baird was decided on facts existing prior to the 1975 Amendments to the Exchange Act. Those Amendments restructured § 6, added new §§ 17A and 19(g), and strengthened the role of the SEC in overseeing the activities of SROs' to ensure that they act in the public interest. See §§ 19(h) and 21(d) and (e). As discussed more fully below, the Amendments end the continuing vitality of Baird.
A second development subsequent to most of the Second Circuit decisions following Baird is a series of Supreme Court decisions setting stricter standards for the implication of private remedies where statutes do not expressly provide them. Thus, although a private damages remedy was held to be implied in former § 6 of the Act, whether one should now be implied from the present statute is a different question.
Realizing that the securities industry was faltering under inefficiencies and inadequate regulation and enforcement, Congress amended the Act in 1975. Of significant concern were the SROs' failures to respond appropriately to their statutory obligations. In an effort to preserve their self-regulation yet increase regulatory oversight of SRO activities and functions, Congress amended the provisions dealing with SROs better to define their obligations, see §§ 6, 17A and 19(g), and simultaneously broadened the oversight and enforcement powers of the SEC. Sections 19(h) and 21(d) and (e). Congress developed a comprehensive scheme, contemplating that "self-regulation would be continued, but the SEC would be expected to play a much larger role than it has in the past to ensure that there is no gap between self-regulatory performance and regulatory need." Senate Committee on Banking, Housing and Urban Affairs, S. Rep. No. 75, 94th Cong., 1st Sess. 23, reprinted in 1975 U.S. Code Cong. & Ad News 179, 181 ("Senate Report").
In the new section 6(b), Congress for the first time expressly required that an exchange, to be registered, must enforce its own rules. That section directs, in relevant part, that --
(b) an exchange shall not be registered as a national securities exchange unless the Commission determines that --
(1) Such exchange is so organized and has the capacity to be able to carry out the purposes of this chapter and to comply, and (subject to any rule or order of the Commission pursuant to section 78q(d) or 78s(g)(2) of this title) to enforce compliance by its members and persons associated with its members with the provisions of ...