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In re Investment Technology Group, Inc. Securities Litigation

United States District Court, S.D. New York

April 26, 2017


          FOR PLAINTIFF METZLER INVESTMENT GmbH: William H. Narwold, Esq. Matthew P. Jasinski, Esq. Gregg S. Levin, Esq. Lance V. Oliver, Esq. William S. Norton, Esq. MOTLEY RICE LLC


          FOR DEFENDANT ROBERT C. GASSER: John F. Baughman, Esq. Julian N. Radzinschi, Esq. PAUL, WEISS, RIFKIND, WHARTON & GARRISON LLP FOR DEFENDANT MATS GOEBELS: John N. Orsini, Esq. Eric Seiler, Esq. Jennifer A. Mustes, Esq. FRIEDMAN KAPLAN SEILER & ADELMAN LLP

          OPINION & ORDER

          John F. Keenan United States District Judge

         This is a putative securities class action brought on behalf of all persons and entities who purchased or acquired the publicly traded common stock of Investment Technology Group, Inc. (“ITG”) between February 28, 2011 and August 3, 2015 (the “Class Period”). The defendants are ITG and three current and former executives who, according to the 122-page amended complaint, allegedly made dozens of statements between 2010 and 2015 that were materially false or misleading in light of the company's failure to disclose Project Omega, a proprietary trading program that improperly used or had access to confidential customer trading information, and the Securities and Exchange Commission (“SEC”) investigation that ensued. As a result of Project Omega's violation of several securities regulations, ITG ultimately agreed to pay a $20.3 million fine. After disclosing Project Omega and its settlement with the SEC, the company's stock price dropped substantially.

         The amended complaint alleges that the defendants are liable under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. The defendants move to dismiss the Section 10(b) and Rule 10b-5 claims on the grounds that the amended complaint fails to plead any actionable material misstatement or omission, or a strong inference of scienter. The defendants also argue that the amended complaint fails to establish control person liability under Section 20(a). For the reasons set forth below, the Court grants in part and denies in part the defendants' motions to dismiss the amended complaint.


         The following facts, which are drawn from the amended complaint (the “Complaint”) and documents incorporated by reference, are accepted as true for the purposes of the motions to dismiss filed by Robert Gasser, Steven Vigliotti, and Mats Goebels (the “Individual Defendants”), and ITG (collectively, the “Defendants”).

         I. The Parties

         Lead Plaintiff Metzler Investment GmbH (“Plaintiff”) is a German capital investment company. (Am. Compl. ¶ 73 [hereinafter Compl.].) Plaintiff's investment funds purchased approximately 100, 000 shares of ITG stock during the Class Period. (Id.) ITG is incorporated in Delaware and maintains its principal executive offices in New York City. (Id. ¶ 74.) Gasser was the company's CEO and president from October 2006 until August 1, 2015. (Id. ¶ 75.) Vigliotti was the company's CFO throughout the Class Period and still holds that position. (Id. ¶ 76.) Gasser and Vigliotti both signed ITG's Form 10-K filed annually with the SEC from 2010 to 2014 and the company's quarterly report for the first quarter of 2015. (Id. ¶¶ 75-76.) Goebels joined ITG in 1998 and was the company's General Counsel and a managing director until August 1, 2015. (Id. ¶ 77.) During the Class Period, Goebels was responsible for all legal and regulatory matters and signed the company's Form ATS[1] filed with the SEC on December 13, 2013 and later published on the company's website. (Id.)

         ITG acts primarily as an agency securities broker, matching customer orders to buy (or sell) a security with orders to sell (or buy) that security. (See, e.g., Id. ¶¶ 10, 13, 17.) The company also provides investment research and analytics products. (See, e.g., Id. ¶ 60.) The company's flagship product is an alternative trading system, or “dark pool, ” known as POSIT. (Id. ¶¶ 2, 12.) When ITG launched POSIT in 1987, it was one of the first dark pools in existence. (Id. ¶ 2.) As of the spring of 2015, POSIT was the ninth largest dark pool, facilitating approximately $109 billion in trades per quarter. (Id. ¶ 11.)

         Dark pools allow customers to trade securities outside the traditional exchanges making up the National Market System, such as the New York Stock Exchange and NASDAQ. (Id. ¶ 13.) Dark pools provide anonymity, allowing investors to trade without immediately revealing their identity or the size of the trade. (Id.) This prevents large trades from immediately moving the stock price and provides liquidity that might not otherwise exist. (Id.)

         POSIT executes trades at or within the National Best Bid and Offer (“NBBO”). (Id. ¶¶ 31-32.) Under the NBBO, the “bid-ask spread” is the difference between the highest bid price and the lowest offer price. (Id. ¶ 31.) In other words, it is the difference between the highest price an investor is willing to pay for a security and the lowest price at which a person holding the security is willing to sell it. The information constituting the NBBO is supplied by a subscription program that consolidates and sells data from all exchanges. (Id.)

         Customers in POSIT have three possible “pegs” that are linked to the NBBO: “passive, ” “midpoint, ” or “aggressive.” (Id. ¶ 32.) A “passive” customer will only buy at the lowest NBBO price or sell at the highest NBBO price. (Id.) Conversely, if a customer chooses to be “aggressive, ” the customer is willing to buy at the highest NBBO price or sell at the lowest NBBO price. (Id.) A midpoint customer is willing to buy or sell in the middle of the spread. (Id. ¶ 33.)

         Through POSIT, ITG built a brand as an independent agency broker. (Id. ¶ 15.) In other words, according to the Complaint, the company was known for facilitating trades rather than making trades for its own account. ITG made several statements between 1999 and 2010 that Plaintiff contends highlighted this reputation. For example, ITG's 1999 Form 10-K stated: “We do not act as a market-maker with respect to any securities or otherwise act as a principal in any securities transactions; we act only on an agency basis. Therefore, we do not have exposure to credit risks in the way that traditional broker-dealers have such exposure.” (Id.) The company also highlighted POSIT's confidentiality, stating in the same filing that POSIT allowed clients “to trade single stocks and portfolios of equity securities among themselves in a confidential environment, ” and explained that “[c]onfidential matching of buy and sell orders eliminates market impact.” (Id. ¶ 14.)

         II. Project Omega

         In light of falling revenues during the economic crisis, in 2009, ITG's senior managers recommended that the company explore trading on its own account using algorithmic high frequency trading. (Id. ¶ 20.) Algorithmic trading uses computer programs to generate and execute orders in markets with electronic access. (Id.) High frequency trading refers to algorithmic trading executed at very high speeds. (Id.)

         In or around early 2010, ITG's board and Gasser approved Project Omega, a limited scope proprietary trading desk. (Id. ¶ 21.) ITG ran Project Omega through AlterNet Securities, Inc., a broker-dealer subsidiary. (Id.) Gasser chose Hitesh Mittal- ITG's global head of liquidity management-to head Project Omega. (Id. ¶¶ 24-25.)

         After engaging in simulated trading in January 2010, Project Omega started live trading for two weeks in April 2010 and then continued live trading again in June 2010. (Id. ¶ 27.) At the beginning of both live trading sessions, ITG's compliance department informed Mittal of certain limits on Project Omega's scope and access to information. (Id. ¶ 28.) Specifically, the compliance department instructed Mittal that Project Omega would not have access to information regarding POSIT's order flow and that the project would be prohibited from coordinating trading strategies or sharing execution information with non-Project Omega employees. (Id.)

         Despite these directives, from April 2010 to December 2010 Project Omega employed two principal trading strategies that relied on ITG employees accessing confidential client trading data in POSIT. (Id. ¶ 30.) The two strategies-the “Facilitation Strategy” and the “Heatmap Strategy”-both involved high frequency buying and selling of stocks to make small profits between the purchase price and sale price within very short time frames. (Id.)

         The Facilitation Strategy used a live feed of customer trading data called the Aleri Feed, which notified Project Omega of customer orders routed through POSIT. (Id. ¶ 35.) The Aleri Feed provided the Project Omega team with real-time data, including a customer's (1) client identifier; (2) symbol; (3) side (i.e., buy side or sell side); (4) the quantity of shares involved; (5) filled shares; (6) target price; (7) ITG algorithm in which the order was located; and (8) the time parameters. (Id. ¶ 36) This information was not available to customers of POSIT and was supposed to be confidential to counterparties in the dark pool. (Id.)

         Using the Aleri Feed, Project Omega would detect an open customer order to buy certain securities in POSIT. (Id. ¶ 37.) Project Omega would then buy the relevant security at a favorable price in another market and sell it at a higher price to the POSIT customer. (Id.) For this process to work to Project Omega's advantage, the POSIT customer would have to be pegged as “aggressive.” (Id. ¶ 39.) For example, the Aleri Feed would identify an order to buy certain securities where the best buying price was $10.00 and the best selling price was $10.02 per share. (Id. ¶ 41.) The Project Omega team would then purchase the shares at $10.00 per share in another market. (Id.) If the customer was pegged as “aggressive, ” it would be willing to buy from Project Omega for the higher price of $10.02 per share. (Id.) This would allow Project Omega to earn the full bid-ask spread as profit. (Id.)

         To make the Facilitation Strategy work, Project Omega had access to the identities of POSIT subscribers and used this information to determine which customers to trade with in POSIT. (Id. ¶ 38.) After trading, the Project Omega team could also determine which customers had been the most profitable to Project Omega. (Id.) Based on this analysis, the Project Omega team made decisions about whether to stop trading with certain customers or continue trading with others. (Id.) Typical POSIT customers did not have this information. (Id.) The Facilitation Strategy also allowed Project Omega to manipulate the pegs of POSIT customers without their knowledge. (Id. ¶ 39.) Mittal directed Project Omega software developers to coordinate with members outside the team to ensure that all traders interacting with Project Omega were pegged as aggressive or to change the client's peg to aggressive in order to facilitate a trade. (Id.)

         From April 2010 to December 2010, Project Omega also used the Heatmap Strategy. (Id. ¶ 43.) This strategy involved trading on markets other than POSIT based on a live feed (the “Heatmap Feed”) of confidential information from trades by ITG customers in external dark pools, not POSIT. (Id.) If the Heatmap Feed showed a number of trades in a given security at midpoint or better in a non-POSIT dark pool, then Project Omega would infer that someone would continue to transact at midpoint or better in that dark pool. (Id. ¶ 46.) So, for example, if the best purchase price for a certain security was $10.00 and the best selling price was $10.02, and the Heatmap Feed detected trades in the middle at $10.01, Project Omega would buy shares of the security for $10.00 and then sell the shares for $10.01 in the external dark pool, producing profits of $0.01 per share for ITG. (Id.)

         In early-to-mid December 2010, ITG's compliance department and senior management learned about Project Omega's use of customer order information through the Facilitation Strategy and Heatmap Strategy and suspended the program's trading. (Id. ¶ 48.) The project was shut down from about December 9, 2010 to December 20, 2010, while ITG's compliance department reviewed Project Omega's activities to make a report to senior management. (Id. ¶ 49.) On or about December 20, 2010, ITG's senior managers met with the compliance department and Gasser reprimanded Mittal. (Id. ¶ 50.)

         Following the meeting, ITG permitted Project Omega to resume live trading. (Id.) On December 21, 2010, Project Omega resumed a modified version of the Facilitation Strategy that did not involve access to the Aleri Feed. (Id. ¶ 51.) On January 24, 2011, Project Omega restarted a modified Heatmap Strategy without direct access to the Heatmap Feed. (Id.) Mittal continued to manage Project Omega and direct its trading strategies while also managing POSIT and ITG's trading algorithms, which included access to confidential customer order and trade information. (Id. ¶ 52.) Despite the removal of the direct feeds, Project Omega continued to have access to information identifying POSIT subscribers. (Id. ¶ 53.) The Project Omega team also continued to coordinate with ITG's POSIT development team to identify the sell-side subscribers for Project Omega to trade with and to ensure that those subscribers were configured to trade “aggressively.” (Id.) Project Omega continued to trade until July 2011, when ITG shut it down for good. (Id. ¶ 54.) Mittal also left ITG in July 2011, ostensibly as part of a “cost-cutting” measure. (Id. ¶ 55.)

         III. Alleged False Statements

         The 122-page Complaint sets forth dozens of allegedly false or misleading statements. For purposes of clarity and economy, only a sample of these statements are quoted and described immediately below. The remaining allegedly false or misleading statements are referenced and analyzed throughout the Court's Opinion.

         A. Project Omega

         Plaintiff alleges that ITG made numerous false or misleading statements in its SEC filings, press releases, and other public statements during the lifespan of Project Omega. Several of these statements were made before the beginning of the Class Period on February 28, 2011. For example, during a conference on December 9, 2010, Gasser stated that ITG is “an agent, which is in and of itself differentiated. We're not informed by your liquidity, by your order flow. We don't have a proprietary trading operation that takes advantage of that.” (Id. ¶ 86.) Plaintiff contends that this statement was false or misleading because, from June 2010 through December 2010, Project Omega continued live proprietary trading using strategies that were informed by customers' order flow and movement in securities. (Id. ¶ 87.)

         On the first day of the Class Period, February 28, 2011, ITG filed with the SEC its Form 10-K for 2010. (Id. ¶ 90.) By this time, ITG's senior management, including Gasser, had allegedly met to discuss Project Omega and were aware of Mittal's misconduct. (Id. ¶ 50.) Project Omega no longer had access to the Aleri Feed or Heatmap Feed, but the Project Omega team allegedly continued to have access to information identifying POSIT subscribers and continued to coordinate with the POSIT development team to identify sell-side subscribers for Project Omega to trade with and to ensure that those subscribers were configured to trade “aggressively.” (Id. ¶¶ 51-54.)

         In its Form 10-K for 2010, ITG stated that it was an “independent agency research broker, ” that asset managers relied on the company's “independence, ” that POSIT provided “anonymous matching, ” and that POSIT incorporated technology “to help ensure that clients are protected from gaming.” (Id. ¶¶ 90, 93.) In the same filing, ITG disclosed that “[a] portion of our revenues is derived from principal trading for our own account where we incur risk, ” but stated that “[a]ll such principal trading activity is conducted in accordance with applicable regulatory requirements, including those pertaining to the maintenance of information barriers.” (Id. ¶ 95.) Plaintiff alleges that these statements were materially false and misleading because ITG was not an independent, agency-only broker, but instead was exploiting confidential client information through Project Omega to trade on its own account, and because ITG's intentional accessing of customer information violated SEC Regulation ATS, which requires, among other things, that an ATS establish safeguards and procedures to protect subscribers' confidential trading information. (Id. ¶¶ 91, 94, 96.)

         According to the Complaint, ITG continued to make false or misleading statements in press releases and SEC filings covering the time period in which Project Omega was in operation. For example, the company continued to describe itself as an “independent agency research broker, ” (id. ¶¶ 101, 106), and described POSIT as “[c]rossing destinations that give buyers and sellers opportunities to match equity orders with complete confidentiality.” (Id. ¶ 100.) Plaintiff alleges that these statements were false or misleading in light of Project Omega's proprietary trading activities using customer information.

         B. Pipeline Controversy and Settlement On October 24, 2011, several months after Project Omega ended, Pipeline Trading Systems LLC (“Pipeline”), an alternative trading system and ITG competitor, settled with the SEC for failing to disclose its proprietary trading. (Id. ¶ 62; see also Press Release, SEC, Alternative Trading System Agrees to Settle Charges That It Failed to Disclose Trading by an Affiliate, available at The next day, ITG sent a letter to its clients stating: “We strictly enforce the order handling and execution rules of [POSIT], which are clearly set forth in Form ATS on file with the Securities and Exchange Commission.” (Compl. ¶ 113.) Soon thereafter, Jamie Selway, a managing director of ITG, gave an interview in which he stated that Pipeline “didn't describe in the Form ATS everything they were doing with their affiliate. . . . Moreover, they aggressively spoke about things that weren't true.” (Id. ¶ 62.) Summing up Pipeline's transgressions, Selway said: “Pipeline cheated. We don't cheat.” (Id. ¶¶ 62, 114.)

         On a November 3, 2011 conference call to discuss ITG's financial performance for the third quarter of 2011, an analyst asked Gasser about the recent disclosures regarding Pipeline. (Id. ¶ 116.) Gasser responded:

I think you're being politically correct, Rich in calling it a faux pas to begin with. I would say that it's surprising, it's shocking, I think for everyone that's engaged in this space, whether or not you're buy-side or sell-side firm.
We've been very clear about our business model and how we execute our business. We've communicated that broadly to clients. As you know we've been talking about various elements of our business very publicly, particularly the sell-side and the spread trading business back to Q1 of ‘09, right and that is no way analogous to what Pipeline was doing, but certainly any nuance to our model we feel absolutely compelled to communicate very clearly and very transparently.


         Plaintiff alleges that these statements were materially false or misleading because they gave the false impression that ITG had not engaged in similar misconduct as Pipeline and omitted that ITG had exploited confidential customer information and had violated Regulation ATS. (Id. ¶¶ 115, 117.) According to Plaintiff, Gasser's statements on the November 3, 2011 conference call also gave the impression that ITG's past representations regarding its business had been complete and transparent when, in fact, they had not. (Id. ¶ 117.)

         C. ITG's Business and Operations After Project Omega

         The Complaint alleges that, after Project Omega, ITG continued to make the same or similar representations about its business practices as it had before and during the project. For example, the company's quarterly SEC filings in 2012 described ITG as an “independent execution and research broker.” (Id. ¶ 127.) Likewise, on an August 9, 2012 conference call, Gasser stated: “ITG has a robust set of risk controls across our platform to prevent major trading errors. Among the controls is our business model. We act as an agent, not a principal, in the vast majority of our trading globally.” (Id. ¶ 137.) On December 18, 2012, Gasser made similar statements while testifying before the U.S. Senate Subcommittee on Securities, Insurance, and Investment Committee on Banking, Housing and Urban Affairs. (Id. ¶ 146.) “ITG is not a market maker, and we do not take on proprietary positions, ” he said. (Id.) “In other words, we do not have skin in the game when it comes to the debates around broker internalization, as our system provides meaningful price improvement to buyside investors, as described in Reg NMS.” (Id.) The Complaint cites dozens of similar statements regarding ITG's business between 2012 and 2015. (See, e.g., Id. ¶¶ 111, 120, 137, 146, 158, 162). Although these statements were made after Project Omega was shut down, Plaintiff contends that they were materially false or misleading because they gave the false impression that, throughout its existence, including during Project Omega, ITG had maintained the same unconflicted business model, protected client information, and complied with applicable regulations.

         D. SEC Investigation

         The SEC allegedly began investigating Project Omega by the fall of 2013, and by May 2015 had informed ITG that it intended to bring charges. (Id. ¶¶ 64, 171.) Plaintiff alleges that ITG made several statements in its SEC filings between 2013 and 2015 that were false or misleading in light of the ongoing SEC investigation. For example, ITG's Forms 10-Q and 10-K from the third quarter of 2013 to the end of 2014 included the following statements regarding the company's involvement in regulatory proceedings and investigations:

We are not a party to any pending legal proceedings other than claims and lawsuits arising in the ordinary course of business. In addition, our broker-dealers are regularly involved in reviews, inquiries, examinations, investigations and proceedings by government agencies and self-regulatory organizations regarding our business, which may result in judgments, settlements, fines, penalties, injunctions or other relief. Although there can be no assurances, at this time, the Company believes, based on information currently available, that the outcome of any such proceeding, review, inquiry, examination and investigation will not have a material adverse effect on our consolidated financial position or results of operations.[2]

(Id. ¶¶ 175, 196, 210, 231.)

         Plaintiff contends that this statement was materially false or misleading each time it was made because, among other reasons, there was “a reasonable probability that ITG would be forced to admit wrongdoing and/or otherwise incur material financial penalties or reputational harm as a result of impending fines and penalties related to the SEC Investigation or other proceedings concerning Project Omega.” (See, e.g., Id. ¶ 176.)

         IV. Disclosure of Project Omega and SEC Investigation

         On August 12, 2015, the SEC announced a settlement with ITG and released an order instituting administrative and cease-and-desist proceedings against ITG and AlterNet. (Id. ¶ 66.) The order included a detailed admission of wrongdoing by ITG and AlterNet and an acknowledgement that their conduct violated federal securities laws. (See generally Id. Ex. A [hereinafter the “SEC Order”].) Specifically, the order stated that ITG and AlterNet had violated §§ 17(a)(2) and 17(a)(3) of the Securities Act by making untrue statements of material fact and material omissions to investors, and also stated that ITG had violated Regulation ATS. (SEC Order ¶¶ 79-80.) In connection with the settlement, ITG agreed to pay approximately $20.3 million in fines and disgorgement of profits, the largest monetary penalty ever imposed against a dark pool. (Compl. ¶¶ 7, 68.) Following the news of ...

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