The opinion of the court was delivered by: John G. Koeltl, District Judge
This is a motion to dismiss a complaint brought by the Securities and Exchange Commission ("the SEC") alleging that the defendants Simpson Capital Management, Inc. ("Simpson Capital"), Robert A. Simpson and John C. Dowling violated Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. The Complaint alleges that the defendants conducted a fraudulent scheme by using five separate broker-dealers to place more than 10,700 late trades in over 375 mutual funds. As defined in the Complaint, late trading is the practice of placing orders to buy, redeem, or exchange mutual fund shares after the 4:00 p.m. Eastern Time ("ET") market close while still receiving the current day's mutual fund price, or net asset value ("NAV"). Late trading allegedly harms shareholders in mutual funds by diluting the value of their shares. (Compl. ¶ 20.) The defendants maintain that the Complaint does not allege any actual fraud and oversteps the SEC's legal enforcement authority, and now bring this motion to dismiss the Complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted.
On a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6), the allegations in the Complaint are accepted as true. Grandon v. Merrill Lynch & Co., 147 F.3d 184, 188 (2d Cir. 1998). In deciding a motion to dismiss, all reasonable inferences must be drawn in the plaintiff's favor. Gant v. Wallingford Bd. of Educ., 69 F.3d 669, 673 (2d Cir. 1995); Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). The Court's function on a motion to dismiss is "not to weigh the evidence that might be presented at trial but merely to determine whether the complaint itself is legally sufficient." Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985). The Court should not dismiss the complaint if the plaintiff has stated "enough facts to state a claim to relief that is plausible on its face." Twombly v. Bell Atl. Corp., 127 S.Ct. 1955, 1974 (2007); see also Iqbal v. Hasty, 490 F.3d 143, 157-58 (2d Cir. 2007).
While the Court should construe the factual allegations in the light most favorable to the plaintiff, the Court is not required to accept legal conclusions asserted in the Complaint. See Port Dock & Stone Corp. v. Oldcastle Northeast, Inc., 507 F.3d 117, 121 (2d Cir. 2007); Smith v. Local 819 I.B.T. Pension Plan, 291 F.3d 236, 240 (2d Cir. 2002).
The following facts as alleged in the Complaint are accepted as true for the purposes of this motion to dismiss. The defendant Simpson Capital is the investment adviser to a hedge fund complex consisting of a master fund, Simpson Master Investments, Ltd., which makes investments on behalf of two hedge funds, Simpson Partners, L.P. and Simpson Offshore, Ltd. (Compl. ¶ 2.) Defendant Simpson is the founder, owner, president, and Chief Investment Officer of Simpson Capital and was primarily responsible for all investment decisions at Simpson Capital. (Compl. ¶¶ 12, 24.) Defendant Dowling is the head trader of Simpson Capital and was responsible for executing trades for Simpson Capital. (Compl. ¶¶ 13, 24.)
The Complaint alleges that between May 2000 and September 2003, the defendants Simpson and Dowling, through Simpson Capital, engaged in a scheme to place thousands of trades after 4:00 p.m. ET and improperly receive that day's NAV, either with the intent to deceive the mutual funds and the fund shareholders, or in reckless disregard that mutual fund shareholders were being defrauded. (Compl. ¶¶ 1, 35-36.) The late trader allegedly obtains an advantage, at the expense of other shareholders of the mutual fund, when he learns of market moving information and is able to purchase (or redeem) mutual fund shares at prices set before the market moving information was released. (Compl. ¶ 1.)
The Complaint specifically alleges that Simpson and Dowling knew or were reckless in not knowing that late trading was illegal. Nevertheless, they sought out broker-dealers that would allow them to place trades after 4:00 p.m., and devised a method that would falsely represent to mutual funds that the trades had been received prior to 4:00 p.m. in order to receive that day's NAV. (Compl. ¶ 36.)
Because mutual funds consist of a large basket of underlying equity holdings, their value (or NAV) fluctuates as the value of the underlying shares change. The prices of mutual funds shares are not continually reset over the course of the day, but are typically fixed for an entire day at a single price. Mutual funds, including the funds in which Simpson Capital traded, generally determine the NAV of mutual fund shares at the close of the major United States securities exchanges and markets -- 4:00 p.m. ET. (Compl. ¶¶ 17, 19.) Rule 22c-1(a), 17 C.F.R. § 270.22c-1, adopted pursuant to Section 22(c) of the Investment Company Act of 1940, 15 U.S.C. § 88a-22(c), requires any registered investment company issuing redeemable securities, its principal underwriter, any dealers in its shares, and any person designated in the fund's prospectus as authorized to consummate transactions in securities issued by the fund to sell and redeem fund shares at a price based on the current NAV next computed after receipt of an order to buy or redeem. The mutual funds in which the Simpson Funds traded were registered investment companies subject to Rule 22c-1(a). (Compl. ¶ 22.)
The Complaint alleges that the five brokers described in the Complaint with whom the defendants dealt entered into dealer arrangements with distributors or principal underwriters of various mutual fund families of funds. These agreements allowed the brokers to serve as dealers for the mutual fund families of funds. The brokers also entered into clearing agreements with clearing brokers. The dealer agreements that the brokers and the clearing brokers entered into typically required them to sell mutual funds in accordance with the federal securities laws and the terms of the mutual funds' prospectuses. The mutual funds' prospectuses for the funds that the defendants traded generally stated that the publicly available price for the shares was calculated as of 4:00 p.m. ET or as of the close of the New York Stock Exchange (which is typically also 4:00 p.m. ET). Thus, the Complaint alleges, the brokers were required to receive orders to purchase, redeem, or exchange shares of a fund no later than 4:00 p.m. ET to be executed at that day's NAV. (Compl. ¶¶ 37-40.)
The Complaint alleges that the scheme involved five brokers who time stamped customer order sheets before 4:00 p.m., but who did not actually execute the trades until Simpson and Dowling or a representative called after 4:00 p.m. to confirm which of the orders to execute. The trades were executed after the brokers received the call. (Compl. ¶¶ 35-74.)
The Complaint alleges that the defendants received approximately $57 million for the Simpson Funds as a result of late trading, representing approximately 70 percent of the Simpson Funds' total gains on investments of $81.5 million over that time period. (Compl. ¶¶ 4, 75.) Additionally, Simpson personally earned at least $19 million in fees and profits, and Dowling earned more than $996,000 in salary and bonuses. (Compl. ¶ 78.)
The Complaint asserts a single claim of securities fraud, based on a violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. Section 10(b) makes it unlawful for any person to "use or employ, in connection with the purchase or sale of any security registered on a national securities exchange . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe . . . ." 15 U.S.C. § 78j(b). Rule 10b-5 provides:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5.
Although the Complaint merely repeats the language of 10b-5(a), (b), and (c), the SEC urges in its papers that the alleged violation is premised on a course of deceptive conduct undertaken by the defendants, violative of sections (a) and (c). To state a claim under sections (a) and (c) of Rule 10b-5, a plaintiff must allege that the defendant, in connection with the purchase or sale of a security, "(1) committed a manipulative or deceptive act (2) in furtherance of the alleged scheme to defraud, (3) scienter, and (4) reliance." In re Global Crossing, Ltd., Sec. Litig., 322 F. Supp. 2d 319, 336 (S.D.N.Y. 2004) (citing SEC v. U.S. Envtl., Inc., 155 F.3d 107, 111 (2d Cir. 1998)); see also In re Alstom S.A. Sec. Litig., 406 F. Supp. 2d 433, 474 (S.D.N.Y. 2005); cf. In re Parmalat Sec. Litig., 383 F. Supp. 2d 616, 622 (S.D.N.Y. 2005) (stating that plaintiff must allege that defendant "(1) committed a deceptive or manipulative act, (2) with scienter, that (3) the act affected the market for securities or was otherwise in connection with their purchase or sale, and that
(4) defendants' actions caused the plaintiffs' injuries.") (emphasis in original). At the very least, the plaintiff must allege conduct that is "manipulative or deceptive." In re Refco Capital Markets, Ltd. Brokerage Customer Sec. Litig., No. 06 Civ. 643, 2007 WL 2694469, at *7 (S.D.N.Y. Sept. 13, 2007). Unlike private litigants, the SEC is not required to prove investor ...