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DEXTER v. DEPOSITORY TRUST AND CLEARING CORP.

October 22, 2005.

PAUL DEXTER, Plaintiff,
v.
DEPOSITORY TRUST AND CLEARING CORP., et al., Defendants.



The opinion of the court was delivered by: GERARD LYNCH, District Judge

OPINION AND ORDER

In this action, plaintiff Paul Dexter charges the National Association of Securities Dealers ("NASD") with negligence and violations of section 6(b) of the Securities Exchange Act of 1934, and Depository Trust and Clearing Corporation ("DTC") and Cede & Company ("Cede") with negligence and conversion, in connection with a distribution of proceeds from a Litigation Trust. Defendants have moved to dismiss, principally on the ground that they are immune from suit. The motions will be granted. BACKGROUND

The following facts are taken from the complaint, and must be taken as true for purposes of this motion to dismiss.

  Plaintiff Paul Dexter is a former shareholder of United Companies Financial Corporation ("UCFC"), a bankrupt, formerly publicly-traded entity. Pursuant to a reorganization plan ("Plan") ordered by a United States Bankruptcy Court, all equity interests in the company were extinguished. However, the Court created a Litigation Trust to pursue claims of the former shareholders, and the former shareholders became beneficiaries of the Trust. As a result, Dexter owns Trust Certificates that represent his beneficial interest in the Litigation Trust. Such Certificates, by express provision of the Bankruptcy Court's Order, are not tradable. Accordingly, any shares of stock that were traded subsequent to the reorganization did not carry with them Litigation Trust interests under the Plan.

  Normally, when a public company is reorganized in this way, the defendant NASD promptly issues a Uniform Practice Advisory ("UPA") that describes the terms and conditions set by the approved reorganization plan for trading in the company's equity shares. In the case of UCFC, however, the NASD failed to issue a UPA. Instead, the NASD took no action for two years, and even then did not issue a UPA. Instead, it apparently announced on its website in November 2002 that shares traded after October 31, 2000, included beneficial interests in the Litigation Trust, directly contradicting the Plan embodied in the Bankruptcy Court's order. According to the complaint, even this announcement may not have been available to the general public, having appeared on a confidential or secure website not generally available. The NASD's instructions, when coupled with provisions of its Uniform Practices Code governing the "ex-dividend dates" of traded securities, ensured that the eventual distribution of proceeds from the Litigation Trust would go to those who owned UCFC shares as of the date of the distribution, rather than, as provided in the Plan, to shareholders as of the Plan's effective date.

  In December 2003, a lawsuit presenting claims on behalf of UCFC was settled, and the Litigation Trust received a substantial cash payment. Some months later, in June 2004, the Trustee of the Litigation Trust authorized a distribution to the beneficiaries. The court-designated distribution agent duly forwarded a large portion of the proceeds to defendant Cede, a subsidiary of defendant DTC, which was the registered nominee owner of 81% of the outstanding UFTC shares. In accordance with the Plan, these funds should have been distributed to holders of Trust Certificates — in effect, the beneficial owners of UCFC shares as of the Plan's effective date, October 30, 2000. In fact, however, in violation of the Bankruptcy Court's order, but in accordance with the directives issued by the NASD, Cede distributed the proceeds to UFTC shareholders as of June 25, 2004, in effect benefitting those who had purchased cancelled shares of UFTC after the effective date of the Plan at the expense of the proper owners of Trust Certificates as of that date (such as Dexter), who were entitled to the proceeds under the terms of the court-ordered Plan.

  Dexter brought this action, on behalf of himself and others similarly situated, charging that the NASD's actions were taken in bad faith to protect the interests of its members who had profited by trading in cancelled shares of UCFC, and that Cede and DTC acted negligently in distributing the proceeds of the Litigation Trust to the wrong parties in violation of the Plan. DISCUSSION

  I. NASD

  Defendant NASD correctly argues that it is absolutely immune from suit for the actions challenged by Dexter.

  The NASD is a self-regulatory organization ("SRO") registered with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934 ("Exchange Act"). See 15 U.S.C. §§ 78o-3 et seq. Under the Act, the NASD operates under the supervision of the SEC which must approve and may overturn NASD rules, policies, practices, and interpretations. 15 U.S.C. § 78s(b), (c).

  With SEC approval, see, e.g., SEC Release 34-29687, 56 Fed. Reg. 47819 (Sept. 20, 1991), the NASD has adopted the provisions of the Uniform Practice Code, which prescribes the rules and procedures for handling over-the-counter securities transactions, including the delivery, settlement date, and ex-dividend dates for securities so traded. NASD Manual (2004). UPC Rule 11140 authorizes the NASD to set the ex-dividend date, which controls the effective ownership date for dividend and distributions for securities, like those of UCFC, listed on markets under its control. In essence, Dexter's lawsuit challenges the NASD's decision setting the ex-dividend date for the distribution in question, along with certain related directives.

  SROs are absolutely immune "from suit for conduct falling within the scope of the SRO's regulatory and general oversight functions." D'Alessio v. NYSE, 258 F.3d 93, 105 (2d Cir. 2001). See also Barbara v. NYSE, 99 F.3d 49 (2d Cir. 1996). This immunity extends to the NYSD. DL Capital Group, LLC v. Nasdaq Stock Market, Inc., 409 F.3d 93 (2d Cir. 2005). Moreover, the Second Circuit has recently rejected efforts to limit the scope of that immunity, holding that the immunity extends to actions alleging fraud (and thus, a fortiori, actions like this one alleging "bad faith"), and to suits by individual investors as well as suits by members of the SRO. Id. at 98-100.

  This immunity is an integral part of the American system of securities regulation. Congress and the SEC have delegated significant responsibility for regulation of the securities markets to SROs, operating under the supervision of the SEC. Accordingly, SROs such as the NASD "preform[] a variety of regulatory functions that would, in other circumstances, be performed by [the SEC]." Barbara, 99 F.3d at 59. The NASD thus "stands in the shoes of the SEC" in carrying out these functions. D'Alessio, 258 F.3d at 105. Because the SEC would enjoy absolute immunity from suit if it carried out these responsibilities itself, SROs have similar immunity when exercising functions delegated to them by the SEC. Moreover, "absolute immunity must be absolute," DL Capital, 409 F.3d at 95, because only such immunity can protect regulatory agencies from the fear of burdensome damage suits that would inhibit the exercise of their independent judgment.

  The complaint in this case challenges actions taken by the NASD in the core exercise of its regulatory functions. Dexter attacks the NASD's regulatory decision to set an ex-dividend date for UCFC securities; its instructions requiring UCFC shares traded after October 31, 2000, to be accompanied by "due bills"; and its decision to authorize trades for rights to distributions from the Litigation Trust. Regardless of the merits of Dexter's claims with respect to the propriety of these decisions, all were clearly regulatory decisions squarely covered by the NASD's immunity as an SRO. Under the Uniform Practice Code, which has been approved by the SEC, the NASD was specifically authorized to set an ex-dividend date for UCFC securities traded on markets it controlled. UPC Rule 11140. Similarly, its decision to require due bills in connection with certain trades is specifically authorized by rule. UPC Rule ...


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