firm liability for acts of an
introductory firm; (2) manifestly disregarded the evidence in finding the
intent required to establish aiding and abetting fraud; (3) manifestly
disregarded the burden of proof required for aiding and abetting fraud;
and (4) failed to find proximate cause.
1. Manifest Disregard for the Law*fn8
a. The Law on Clearing Firm Liability
Under New York law, the elements for a claim of aiding and abetting
fraud are: (1) an existing fraud, (2) knowledge of the fraud, and (3)
substantial assistance to advance the fraud's commission. See Cromer v.
Berger, 137 F. Supp.2d 452, 470 (S.D.N.Y. 2001) (citing Wight v.
BankAmerica Corp., 219 F.3d 79, 91 (2d Cir. 2000)). Generally,
"substantial assistance" exists where: (1) a defendant "affirmatively
assists, helps conceal, or by virtue of failing to act when required to
do so enables the fraud to proceed," and (2) "the actions of the
aider/abettor proximately caused the harm on which the primary liability
is predicated." Id. (citing Diduck v. Kaszycki & Sons Contractors, Inc.,
974 F.2d 270, 284 (2d Cir. 1992); Nigerian Nat'l Petroleum Corp. v.
Citibank, N.A., No. 98 Civ. 4960, 1999 WL 558141, at *8 (S.D.N.Y. July
30, 1999); Kolbeck v. LIT Am., Inc., 939 F. Supp. 240, 249 (S.D.N.Y.
1996)). Where defendant does not owe a fiduciary duty directly to the
plaintiffs, however, mere "inaction" by the defendant cannot constitute
"actionable participation." Id. (citing Kolbeck, 939 F. Supp. at 247);
see also Stander v. Fin. Clearing & Svcs., 730 F. Supp. 1282, 1287
(S.D.N.Y. 1990). Indeed, "the `scienter' requirement scales upward," and
plaintiffs have the additional burden of showing that the assistance
rendered is "both substantial and knowing;" in other words, there must be
"something close to an actual intent to aid in fraud" or "scienter of the
`conscious intent' variety." Ross v. Bolton, 639 F. Supp. 323, 327
(S.D.N.Y. 1986) aff'd, 904 F.2d 819 (2d Cir. 1990) (quoting Edwards &
Hanly v. Wells Fargo Sec. Clearance Corp., 602 F.2d 478, 384 (2d Cir.
1979) and ITT, an Int'l Inv. Trust v. Cornfield, 619 F.2d 909, 925 (2d
It is well-settled that, when a clearing firm acts merely as a clearing
agent, it owes no fiduciary duty to the customers of its introducing
broker and cannot be held liable for the acts of an introducing firm. See
Greenberg, 220 F.3d at 29; Carlson v. Bear, Stearns & Co., 906 F.2d 315,
318 (7th Cir. 1990); Warren v. Tacher, 114 F. Supp.2d 600, 603 (W.D. Ky.
2000); Cromer, 137 F. Supp.2d at 470; Connolly v. Havens, 763 F. Supp. 6,
10 (S.D.N.Y. 1991); Dillon v. Militano, 731 F. Supp. 634, 636 (S.D.N.Y.
1990); Stander, 730 F. Supp. at 1286. As the Second Circuit clearly
The simple providing of normal clearing services to a
primary broker who is acting in violation of the law
does not make out a case of aiding and abetting
against the clearing broker.
Greenberg, 220 F.3d at 28 (quotation marks omitted). Moreover, courts
have refused to hold clearing firms liable for the practices of
introducing brokers even where the clearing firm continued to provided
clearing services after it knew or should have known of the introducing
broker's fraudulent scheme. See Ross,
639 F. Supp. at 327 (dismissing
claim against Bear for aiding and abetting the fraud of an introducing
broker where "the complaint does not specify what assistance Bear Stearns
rendered other than to continue to clear transactions when it `knew or
should have known' that" the introductory firm was engaging in fraud); In
re Blech Secs. Litig., 961 F. Supp. 569, 584 (S.D.N Y 1997) ("Blech II")
("Even assuming Bear Stearns had knowledge of the [introductory firm's]
scheme, primary liability [under Section 10(b)] cannot attach when the
fraudulent conduct that is alleged is no more than the performance of
routine clearing functions."); In re Blech Secs. Litig., 928 F. Supp. 1279,
1295-96 (S.D.N.Y. 1996) ("Blech I"); Connolly, 763 F. Supp. at 10.
On the other hand, where a clearing firm moves beyond performing mere
ministerial or routine clearing functions and becomes actively and
directly involved in the introductory broker's actions, it may expose
itself to liability with respect to the introductory broker's misdeeds.
See Berwecky v. Bear Stearns & Co., 197 F.R.D. 65 (S.D.N.Y. 2000)
(finding plaintiffs' claim against Bear viable where complaint alleged
that Bear "shed [its] role as a mere clearing broker for [Baron], and
with actual knowledge, directly participated in the heretofore described
scheme."); Koruga v. Fiserv Correspondent Servs., No. CV 00-1415-MA, 2001
U.S. Dist. Lexis 2417, at *7 (D. Or. Feb. 7, 2001) (confirming
arbitration award finding clearing firm and introductory broker jointly
and severally liable for fraud where "panel made specific factual
findings that [clearing firm] was directly involved in the challenged
transaction and materially participated in the wrongdoing."); Blech II,
961 F. Supp. at 585 (finding complaint against clearing firm viable where
plaintiffs alleged that Bear engaged in activities that did not "reflect
. . . the standard practice of [a] clearing broker."); Hirate v. J.B.
Oxford & Co., 193 F.D.R. 589, 600 (S.D. Ind. 2000) (denying clearing
firm's motion to dismiss because facts might establish that clearing firm
"materially aided" introductory broker's securities law violation);
Margaret Hall Found. Inc. v. Atlantic Fin. Mgmt., Inc., 572 F. Supp. 1475,
1480-81 (D.Mass. 1983) (denying clearing firm's motion to dismiss 10b-5
claim where complaint alleged "a very close relationship" between
clearing firm and introductory broker); Cannizzaro v. Bache, Halsey,
Stuart, Shields, Inc., 81 F.R.D. 719, 721 (S.D.N.Y. 1979) (denying motion
to dismiss aiding and abetting claim against clearing firm where facts
might show that clearing firm performed more than mere mechanical
functions for introductory broker); see also, Michael G. Shannon,
"Clearing Firm Liability — Has the Dam Really Cracked?," 1196
PLI/Corp. 677, 690-97 (Aug. 2000); Gerald B. Kline & Raymond L. Moss,
"Liability of Clearing Firms: Traditional and Developing Perspectives,"
at 144 ("[A] clearing broker may suffer liability exposure when it moves
beyond performing its routine clearing functions or pressures the
introducing broker to act wrongfully.").
b. The Panel Did Not Ignore the Law
As an initial matter, the Panel did not "ignore" the law on clearing
firm liability. To the contrary, the Panel cited and discussed several
cases denying clearing firm liability, explaining that Bear's involvement
in Baron's affairs went "far beyond" the factual patterns in those
cases. Award at 25. Thus, the case law denying clearing firm liability
was distinguished, not ignored.
c. The Panel Did Not Refuse to Apply the Law
Bear argues that, although the Panel "paid lip service" to the law on
clearing firm liability, it "did not honor"
these legal principles when
it found that Bear's involvement in Baron's activities went beyond the
ordinary clearing function. Def. Mem. at 31. Recent New York and Southern
District decisions involving Bear's clearing operations are instructive
in distinguishing between normal clearing operations, which do not expose
a clearing firm to liability for its introducing broker's misconduct, and
activity which is active and direct, for which liability may attach.
In Blech I, Judge Robert Sweet of this Court dismissed a claim of
manipulation against Bear on the ground that Bear's activity as a
clearing firm, standing alone, was not grounds for liability. See
928 F. Supp. at 1295. The next year, in Blech II, the court denied Bear's motion
to dismiss the amended complaint, finding that the amendments alleged
direct action by Bear Sterns that went beyond ordinary clearing
functions. See 961 F. Supp. at 585. Among other things, the amended
complaint alleged that:
• Bear was motivated to artificially inflate the
market prices for Blech Securities by its desire to
decrease its own risk of loss and eliminate the
debit balance outstanding at Bear;
• Bear had "access to confidential, non-public
information concerning Blech Co's financial
condition, liquidity, and net capital position;"
• Bear had the "power to extend or deny credit to
Blech & Co. based upon the value of Blech Securities
held as collateral," and "the power and control to
determine whether or not to execute securities
transactions on behalf of Blech & Co. and its
• Bear demanded that Blech sell certain securities
in order to reduce the debt owed to Bear and
eliminate Bear's own exposure.
Id. at 577-78. Based on these allegations, Judge Sweet found that the
alleged "pressure exerted by Bear Stearns on Blech to reduce Blech's
debit balance, when combined with Bear Stearns' knowledge of Blech's sham
trading and its clearing of such trades does not `reflect . . . the
standard practice of [a] clearing broker'." Id. at 585 (quoting Blech I,
928 F. Supp. at 1295) (ellipse and parenthesis in original).
In Cromer Finance, Judge Denise Cote of this Court held that plaintiff
investors failed to state a claim for aiding and abetting fraud against
Bear where Bear had acted as the clearing firm for an off-shore
investment fund. See 137 F. Supp.2d at 471-72. The court held that
plaintiffs' allegations that Bear "fail[ed] to enforce margin
requirements, or continu[ed] to execute trades despite margin violations"
or "execut[ed] trades in order to reduce `a loan of money under margin'"
did not make out a claim of "substantial assistance".*fn9 Id. (citing
Dillon, 731 F. Supp. at 637, 639; Stander, 730 F. Supp. at 1287 and
quoting Ross, 639 F. Supp. at 327).
In Schwarz v. Bear, Stearns & Co., No. 603795/97, 1998 WL 672708
(Sup.Ct. N.Y. Co. Aug. 24, 1998), aff'd, 698 N.Y.S.2d 855 (1st Dep't
1999) (mem.), a case involving Bear's activities as clearing agent for
Baron, the New York Supreme Court dismissed plaintiffs' complaint for
failure to state a claim. In a summary paragraph, the Complaint alleged:
A.R. Baron was able to engage in this massive fraud
only because Bear, Stearns provided the firm with
the necessary administrative, carrying and clearing
functions to stay in business. Had Bear, Stearns
refused, based on its knowledge of A.R. Baron's
activities to provide its institutional support to
A.R. Baron, that firm would have closed its doors
on July 20, 1995 and its customers would not have
been defrauded after that date.
Shannon, "Clearing Firm Liability — Has the Dam Really Cracked?" at
698 (quoting Schwarz complaint). The Schwarz court held that plaintiffs'
causes of action for negligence and negligent misrepresentation must fail
because "[it] is undisputed that Bear Stearns was acting as Baron's
clearing broker at the time plaintiff's alleged losses were sustained
[and] [i]t has been determined that `as a matter of law, a clearing
broker owes no duty of disclosure to the clients of an introductory
broker.'" Schwarz, 1998 WL 672708 at *2 (quoting Blech I, 928 F. Supp. at
1295-96); see also Schwarz, 698 N.Y.S.2d at 885 ("[D]efendants, as
clearing brokers, had no duty to disclose to the introducing broker's
clients, and thus the statutory cause of action, as well as the
negligence claim, were properly dismissed.").
In Berwecky, which also involved allegations against Bear as clearing
agent for Baron, Judge John Sprizzo of this Court sustained the complaint
against Bear. See 197 F.R.D. at 68 (granting class certification);
10/20/98 Order of Judge Sprizzo, Ex. C. to Declaration of Jonathan Kord
Lagemann, counsel for plaintiffs ("Lagemann Dec. No. 1) (denying Bear's
motion to dismiss). In that case, plaintiff alleged that Bear "shed [its]
role as a mere clearing broker for A.R. Baron, and with actual
knowledge, directly participated in the heretofore described scheme."
197 F.R.D. at 67. Specifically, the complaint alleged that after Baron was
sanctioned by the NASD, Bear "asserted control over Baron's trading
operations" by: (1) "placing Bear, Stearns' employees at Baron's offices
to observe Baron's trading activities," (2) "approving or declining to
execute certain trades," (3) "imposing restrictions on Baron's
inventory," and (4) "loaning funds to Baron." Id. The complaint further
alleged that Bear took these actions "in order to keep A.R. Baron a
viable concern while Bear, Stearns and Harrington continued to reap the
large profits that they received from their activities with A.R. Baron."
Id. In light of these allegations, Judge Sprizzo concluded that
plaintiffs had a viable claim against Bear for knowing participation in
Baron's fraudulent scheme. See id. at 68; 10/20/98 Order of Judge
The most recent Southern District case involving Bear's role as
clearing agent is Goldberger v. Bear Stearns & Co. Inc., No. 98 Civ.
8677, 2000 WL 1886605 (S.D.N.Y. Dec. 28, 2000). In Goldberger, Judge John
Martin of this Court granted Bear's motion to dismiss the complaint
alleging that Bear knowingly participated in price manipulation by the
introductory broker. Id. at *5. Distinguishing the case from Berwecky and
Blech II, Judge Martin explained:
Here, there are no allegations that Bear Stearns
instigated trading that it "knew or should have
known would result in fraudulent trades that would
artificially inflate the price" of the manipulated
securities. Nor are there allegations that Bear
Stearns "asserted control over [the Introducing
Brokers'] trading operations by, inter alia,
placing Bear, Stearns' employees at [their] offices
to observe [their] trading activities, approving or
declining to execute certain trades, imposing
restrictions on [their] inventory, and loaning
funds to [them]." . . . the complaint does no more
than allege that Bear Stearns performed the normal
function of a clearing broker.
Id. at *6 (quoting Blech II, 961 F. Supp. at 584-85; Berwecky,
197 F.R.D. at 67) (parentheses in original).