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Standard Investment Chartered, Inc. v. National Association of Securities Dealers

May 2, 2007


The opinion of the court was delivered by: Shirley Wohl Kram, U.S.D.J.


On March 8, 2007, plaintiff Standard Investment Chartered, Inc. ("Standard") filed a class action complaint challenging the pending regulatory consolidation of the National Association of Securities Dealers, Inc. ("NASD") and the NYSE Group, Inc. ("NYSE") (the "Consolidation"). On March 26, 2007, the Securities and Exchange Commission ("SEC" or "Commission") published notice of proposed rule changes attendant to the Consolidation, and invited comment thereon. Shortly thereafter, Standard filed an amended complaint, asserting several additional claims against the NASD, three NASD officers (together, the "NASD Defendants"), and the NYSE. Now before the Court are motions to dismiss filed by the NASD Defendants and the NYSE on grounds of failure to exhaust administrative remedies, ripeness, immunity, and failure to state a claim upon which relief may be granted. For the reasons that follow, the Court finds that Standard has failed to exhaust its administrative remedies, and grants the defendants' motion to dismiss under Federal Rule of Civil Procedure 12(b)(1).


The NYSE, through its subsidiary, New York Stock Exchange LLC, and the NASD are both self-regulatory organizations ("SROs") registered with the SEC pursuant to the Securities Exchange Act of 1934 (the "Exchange Act"). "As an SRO, the NASD is, like other SROs such as [the NYSE], authorized by Congress to 'promulgate and enforce rules governing the conduct of its members,'" and is subject to oversight by the SEC. DL Capital Group, LLC v. NASDAQ Stock Mkt., Inc., 409 F.3d 93, 95 (2d Cir. 2005) (citing Barbara v. New York Stock Exch., Inc., 99 F.3d 49, 51 (2d Cir. 1996)). The individual defendants, Mary L. Schapiro ("Schapiro"), Richard F. Brueckner ("Brueckner"), and Barbara Z. Sweeney ("Sweeney"), hold various positions of authority within the NASD, and all are alleged to have been actively involved in promoting the Consolidation.

On November 28, 2006, the NASD and the NYSE announced "a plan to consolidate their member regulation operations into a combined organization that will be the sole U.S. private-sector provider of member firm regulation for securities firms doing business with the public." (Am. Compl. ¶ 22.) As the consolidation of these entities requires the NASD to amend its By-Laws, "the defendants solicited votes of NASD members in support of the [Consolidation] pursuant to a proxy statement dated December 14, 2006," and "scheduled a vote [of NASD members] on January 19, 2007" (Compl. ¶ 23), at which time the By-Law amendments were approved by a majority of voting members.

On March 8, 2007, the plaintiff, a member of the NASD, initiated the instant lawsuit as a class action, alleging that the Consolidation will disenfranchise certain NASD members and that the defendants failed to comply with Delaware state law while soliciting support for the Consolidation. The complaint sought an injunction barring the Consolidation and enactment of the proposed By-Law amendments, the issuance of a revised proxy statement, damages, and assorted other relief. On March 19, 2007, the NASD filed with the SEC the proposed By-Law amendments, which the SEC then published on March 26, 2007, in order to solicit comments from interested persons.

On April 10, 2007, the plaintiff filed an amended complaint. In addition to the three claims alleged in its initial complaint--(I) that Schapiro, Brueckner, and Sweeney breached fiduciary duties to the proposed class in negotiating the Consolidation and failing to disclose all material facts in the proxy statement; (II) that all defendants engaged in negligent misrepresentation with respect to the proxy statement; and (III) that the NYSE and the individual defendants will be unjustly enriched by the Consolidation--Standard now alleges (IV) that NASD members have been denied their right to elect Governors of the NASD in violation of section 211 of the Delaware General Corporation Law; (V) that all defendants have improperly converted or, if the Consolidation is effected, will have taken the prospective class members' assets and/or "Member's Equity" (Am. Compl. ¶¶ 87-90); (VI) that all defendants have caused a substantial diminution in the value of NASD membership, with imminent completion of such diminution; and (VII) that all defendants have deprived the prospective class members of their voting membership. In Standard's words, the gravamen of the amended complaint "is that the terms of the consolidation represent a massive disenfranchisement of plaintiff and the members of the Class . . . and that their consent thereto was obtained only through a 'bum's rush' campaign" by the defendants. (Am. Compl. ¶ 2.)


The defendants move to dismiss the amended complaint under Federal Rule of Civil Procedure 12(b)(1) and (6). With respect to Rule 12(b)(1), the defendants argue that the Court lacks jurisdiction to consider the claims in the amended complaint because Standard has failed to exhaust its administrative remedies. See Hayden v. New York Stock Exch., Inc., 4 F. Supp. 2d 335, 338 (S.D.N.Y. 1998). As the following discussion explains, challenges to NASD rulemaking, and the procedures incident to that rulemaking, are subject to the exhaustion doctrine. Because Standard has not exhausted its administrative remedies, the Court dismisses the amended complaint under Rule 12(b)(1). In light of this holding, the Court finds no occasion to reach the defendants' alternative grounds for dismissal under Rule 12(b)(6).

It is settled law that plaintiffs "must exhaust their administrative remedies before the SEC prior to attempting to obtain judicial review" of certain claims against that agency. Touche Ross & Co. v. Sec. & Exch. Comm'n, 609 F.2d 570, 582 (2d Cir. 1979). SROs, such as the NASD and the NYSE, are defined and limned by the Exchange Act, and are granted certain regulatory authority thereunder that would otherwise be exercised by the SEC. Therefore, courts have widely held "that the doctrine of exhaustion of administrative remedies, in appropriate circumstances, appl[ies] to challenges to disciplinary proceedings of" SROs. Barbara, 99 F.3d at 57; accord Swirsky v. Nat'l Ass'n of Sec. Dealers, 124 F.3d 59, 62 (1st Cir. 1997) (invoking exhaustion doctrine in context of a challenge to NASD disciplinary proceedings); Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Nat'l Ass'n of Sec. Dealers, Inc., 616 F.2d 1363, 1370 (5th Cir. 1980) (same); First Jersey Sec., Inc. v. Bergen, 605 F.2d 690, 696 (3d Cir. 1979) (same); Datek Sec. Corp. v. Nat'l Ass'n of Sec. Dealers, Inc., 875 F. Supp. 230, 233 (S.D.N.Y. 1995) (same). Although less common, courts in this District have also concluded that the exhaustion doctrine equally applies to both delisting disputes, see Belfort v. Nat'l Ass'n of Sec. Dealers, Inc., No. 93 Civ. 7159 (JSM), 1994 WL 97021, at *1 (S.D.N.Y. Mar. 24, 1994), and challenges to SRO rule changes. See, Am. Benefits Group v. Nat'l Ass'n of Sec. Dealers, No. 99 Civ. 4733 (JGK), 1999 WL 605246, at *8 (S.D.N.Y. Aug. 10, 1999).

Relying on these precedents, the defendants contend that the proposed By-Law amendments necessary for the Consolidation's consummation are an exercise of the NASD's rulemaking authority, and thus Standard must exhaust its administrative remedies under the Exchange Act before seeking judicial review. In essence, the defendants argue that the exercise of rulemaking authority here falls within the "complex self-regulatory scheme" enforced by the SEC, Merrill Lynch, 616 F.2d at 1368 (5th Cir. 1980), and thus all of the plaintiff's arguments--regarding substantive unfairness resulting from the By-Law amendments, the process by which the amendments were approved, and the alleged unjust enrichment arising therefrom--must be resolved by the SEC in its currently pending review.

Standard counters that it is not challenging the substance of the proposed By-Law amendments or the Consolidation per se;*fn1 rather, it is challenging the "defendants' failure to comply with Delaware state law in soliciting support among NASD members for the proposed NASD-NYSE regulatory consolidation . . . ." (Am. Compl. ¶ 1.) Fundamentally, Standard argues that the defendants' solicitation of support for the Consolidation, most obviously embodied in the proxy statement, and the underlying regulatory consolidation of the two organizations are governed by state corporate law, and thus the exhaustion doctrine is inapplicable.

Therefore, the principal questions before the Court are (1) whether challenges to NASD rulemaking are subject to the exhaustion doctrine; and, if so, (2) whether the procedures incident to the rulemaking at issue here are properly considered a part of the NASD's rulemaking authority, such that challenges to those procedures are subject to the exhaustion doctrine.

The NASD was incorporated on September 3, 1936, as a nonstock corporation in the State of Delaware. See Restated Certificate of Incorporation of Nat'l Ass'n of Sec. Dealers, Inc. Shortly thereafter, on August 7, 1939, the SEC granted the organization's application to become a national securities association pursuant to the Exchange Act. In re Application by Nat'l Ass'n of Sec. Dealers, Inc., 5 S.E.C. 627 (1939). The NASD's certificate of incorporation indicates, inter alia, that it is intended "to provide a medium for effectuating the purposes of [Section 15A of the Exchange Act]," and that "the members shall be entitled to vote . . . on any amendment to the By-Laws of NASD . . . ." See Restated Certificate of Incorporation of Nat'l Ass'n of Sec. Dealers, Inc. In addition, Article XVI of the NASD's By-Laws states that the NASD Board of Governors, following Board approval of a proposed By-Law amendment, "shall forthwith cause a copy to ...

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