United States District Court, S.D. New York
October 22, 2005.
PAUL DEXTER, Plaintiff,
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
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
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
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 11630(d). Finally, the NASD's decision to
authorize (or not to authorize) trading in certain securities is
a core regulatory function that is covered by absolute immunity.
Sparta Surgical Corp. v. NASD, 159 F.3d 1209, 1215 (9th Cir.
Dexter's argument that immunity does not apply because the
NASD's actions violated a bankruptcy court order and § 12(a) of
the Exchange Act, in the furtherance of "unprotected illegal,
proprietary profit-making activities" (P. Mem. 2), miss the point
of absolute immunity. The purpose of absolute immunity is to
protect all conduct of an SRO from liability, so long as the
conduct "aris[es] out of the discharge of its duties under the
Exchange Act." D'Alessio, 258 F.3d at 104. Thus, assuming
arguendo that the NASD's conduct was incorrect and unlawful, it
is nevertheless protected. There would be no point to an immunity
that only protected actions that were in any event correct. Since
"absolute immunity must be absolute," DL Capital,
409 F.3d at 95, it must protect even actions that a plaintiff could
ultimately establish were in violation of law. Nor do SROs lose
their immunity because, in addition to their regulatory
functions, they also are profit-making and profit-seeking
enterprises. The immunity is driven by "the SRO's function as a
quasi-governmental authority." Id. at 99 (emphasis in
original). In D'Alessio, the Second Circuit rejected the
argument that the NYSE should not be given immunity because
plaintiff had alleged that the challenged NYSE decisions were
made to increase its profits. 258 F.3d at 98. When a governmental
agent has absolute immunity, its "motivation in performing [its governmental] functions is irrelevant to the applicability of
absolute immunity." Bernard v. County of Suffolk, 356 F.3d 495,
502 (2d Cir. 2004).
Accordingly, however badly motivated, inept, or even unlawful
the NASD's actions may have been, it is absolutely immune from
suit on both federal and state claims brought by Dexter. Because
the NASD is immune from any suit based on its exercise of its
regulatory functions, all of plaintiff's claims against the NASD
must be dismissed, and the Court need not reach the NASD's other
arguments for dismissal.
II. DTC and Cede
DTC and Cede (collectively, the "DTC defendants") argue that
they too are effectively immune from plaintiff's suit. Their
argument is slightly more complex, but ultimately is equally
meritorious. Accordingly, the complaint will also be dismissed as
Section 17A of the Exchange Act, added in 1975, gave the SEC
authority to regulate all persons involved in processing
securities transactions, in an effort to create a uniform
national system for the prompt and accurate clearance and
settlement of securities transactions.
15 U.S.C. § 78q-1(a)(1)(A), (a)(2)(A)(I). Under this statute, clearing
agencies are required to adopt rules, subject to SEC approval, to
further these goals. 15 U.S.C. § 78q-1(b)(3)(F). As a registered
clearing agency that has adopted such regulations, DTC is also an
SRO. In re Depository Trust Co., SEC Release No. 34-47978, 2003
WL 21288541, at *6 & n. 50 (June 3, 2003).
The complaint asserts state law causes of action against the
DTC defendants for both negligence and conversion. In essence,
however, both of these claims rest on the claim that DTC and Cede
violated plaintiff's rights by distributing funds to the
beneficial owners of securities held by Cede as nominee in
accordance with the ex-dividend date set by the NASD. The NASD's regulatory decisions would be meaningless unless a
clearing agency such as DTC carried out its directives. DTC's
actions here were ministerial in nature. It would be illogical to
clothe the NASD with absolute immunity for its regulatory
decisions, and then to impose liability on a clearing agent that
simply carried out its functions in obedience to, and in express
reliance on, those decisions.
Dexter attempts to defeat the logic of this argument by citing
In re Blech Sec. Litig., 94 Civ. 7696 (RWS), 2003 WL 1610775
(S.D.N.Y. Mar. 26, 2003). At issue there was whether the
defendant Bear Stearns, which acted as a clearing broker, was a
knowing participant in a securities fraud perpetrated by Blech.
In ruling on a motion in limine by plaintiffs seeking to exclude
evidence of Bear Stearns's purported compliance with NYSE
regulations, the court ruled that compliance with SRO regulations
was relevant to the defense as "evidence of industry practice,"
but did "not constitute an exemption from liability." Id. at
*4. In Blech, however, defendants were charged with fraud, and
the factual issue at trial was to be "whether Bear Stearns
performed its functions pursuant to the SRO Rules and the
Clearing Agreement `knowingly in such a manner as to enhance the
Blech market manipulation scheme.'" Id., quoting In re Blech
Sec. Litig., 94 Civ. 7696 (RWS), 2002 WL 31356498, at *6
(S.D.N.Y. Oct. 17, 2002). This case is entirely different.
Plaintiff does not allege any cause of action based on fraud, and
there is no allegation that the DTC defendants did anything other
than ministerially execute a distribution in accordance with the
directives of the NASD.
Under these circumstances, the DTC defendants cannot be liable
for negligence or conversion. As a matter of law, the DTC
defendants cannot have breached any duty of due care by executing
a distribution in accordance with governing directives of the
regulatory agency responsible for directing its activities. Nor can the DTC
defendants be found to have converted plaintiff's property, since
their actions, taken in reliance on the authority of such an
agency, are privileged. An act which would otherwise constitute
conversion is privileged when it is committed pursuant to a court
order valid on its face. Calamia v. City of New York,
879 F.2d 1025, 1031 (1989); American Law Institute, Restatement (Second)
of Torts, § 266 (1965). Similar protection should be extended to
a clearing agency that carries out its normal ministerial
function in accordance with the directives of governing
regulatory authority. Accordingly, plaintiff's claims against the
DTC defendants must be dismissed.
For the reasons stated above, plaintiff's complaint is
dismissed in its entirety.
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