This action presents a surprising question of first impression. Does a securities
The following facts are taken as true for the purposes of the present motions.
Plaintiff Scottrade, an Arizona corporation with its principal place of business in Missouri, is a securities broker-dealer registered with the United States Securities and Exchange Commission ("SEC"). (Proposed First Am. Compl. (hereinafter "FAC") ¶ 5.) As relevant to this action, Scottrade operates a website on which customers maintain accounts of securities and through which customers place orders to buy and sell securities. (Id. ¶ 6.) Defendant Genesis,
Between August 2009 and March 2010, Valery Vitalievich Ksendzov—not a defendant in this action—allegedly carried out an elaborate "hack, pump, and dump" scheme by which he made upwards of $650,000 dollars. (Id. ¶ 19.) Ksendzov, a BroCo customer, would first purchase large blocks of thinly-traded domestic securities through the BroCo/Genesis Account. (Id. ¶ 17.) Ksendzov then hacked
Scottrade alleges that Ksendzov's "trading activit[y] so consistently resulted in levels of profitability that are unattainable in the absence of some form of fraud . . . [that defendants] Maltsev, BroCo and Genesis must have known, absent intentional disregard . . . that Ksendzov's trading involved some form of illegal market manipulation." (Id. ¶ 20.) Scottrade also alleges that BroCo and Genesis must have been aware of the fraud because Genesis would generate records of the trading activity in the BroCo/Genesis Account and forward those records to BroCo. (Id. ¶ 22.)
After learning of the fraud, Scottrade "restored the customers' accounts to the state they would have been in, but for the unauthorized transactions." (Id. ¶ 29.) The actual character of that restoration, however, is not clear from the FAC. Scottrade alleges it "incurred" $1,464,690 in "losses" in the process. (Id.)
On March 15, 2010, the SEC brought suit against Maltsev and BroCo, but not against Genesis, seeking a preliminary injunction and related relief. (Compl. at 1, 9-11, United States Securities and Exchange Commission v. BroCo Investments, Inc. and Valery Maltsev (hereinafter "SEC Action"), (S.D.N.Y. Mar. 15, 2010) (No. 10 Civ. 2217).) Then on April 28, 2010, Scottrade filed its original complaint in this action asserting claims for violations of Sections 10(b), 9(a), and 29(b) of the Exchange Act, for violations of Rule 10b-5 promulgated thereunder, and for violations of the CFAA. On June 17, 2010, the Court granted the SEC a preliminary injunction in the SEC action. (Tr. of Hr'g of June 17, 2010 (hereinafter "Oral Arg. Tr.") at 38.) The injunction both froze BroCo and Maltsev's assets and prohibited future violations of the securities laws. (Id. at 47.)
Genesis moved to dismiss the complaint in this action on June 28, 2010. After several extensions of the briefing schedule on that motion, but before Scottrade had filed any opposition papers, Genesis and Scottrade agreed to stay proceedings on the motion to dismiss pending judgment or dismissal of the SEC Action, or an order from the Court lifting the stay. (Order of Sept. 28, 2010 at 1-2.) On December 13, 2010, the SEC Action settled, and the Court lifted the stay and reinstated a briefing schedule the next day. (Order of Dec. 14, 2010 at 1.) Finally on January 11,
To survive a Rule 12(b)(6) motion to dismiss, a complaint must allege "enough facts to state a claim to relief that is plausible on its face." Starr v. Sony BMG Music Entertainment, 592 F.3d 314, 321 (2d Cir.2010) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, ___ U.S. ____, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009). If the factual averments permit no reasonable inference stronger than the "mere possibility of misconduct," the complaint should be dismissed. Starr, 592 F.3d at 321 (quoting Iqbal, 129 S.Ct. at 1950). Thus, "[w]here a complaint pleads facts that are `merely consistent with' a defendant's liability, it `stops short of the line between possibility and plausibility of `entitlement to relief.'" Iqbal, 129 S.Ct. at 1949 (quoting Twombly, 550 U.S. at 557, 127 S.Ct. 1955). In applying this standard of facial plausibility, the Court accepts all factual allegations as true, but it does not credit "mere conclusory statements" or "threadbare recitals of the elements of a cause of action." Id.
"A district court has broad discretion in determining whether to grant leave to amend [pleadings]." Gurary v. Winehouse, 235 F.3d 792, 801 (2d Cir.2000). The court should freely grant leave to amend absent undue delay, bad faith, futility, dilatory motive, or undue prejudice. Aetna Cos. Sur. Co. v. Aniero Concrete Co., 404 F.3d 566, 603-04 (2d Cir.2005). Futility, invoked here by defendants, turns on whether the additions state a claim that could withstand a motion to dismiss pursuant to Fed.R.Civ.P. 12(b)(6). Lucente v. Int'l Bus. Machs. Corp., 310 F.3d 243, 258 (2d Cir.2002).
"It is axiomatic that in order to have standing, a 10b-5 plaintiff in a private damages action must have been either a purchaser or seller of the securities that form the basis of the [] deceptive conduct." In re Van der Moolen Holding N.V. Sec. Litig., 405 F.Supp.2d 388, 404 (S.D.N.Y.2005). The "actual purchaser or seller" rule, articulated by the Second Circuit in Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.1952), "was adopted by the Supreme Court as a bright-line rule in Blue Chip Stamps v. Manor Drug Stores, [421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975)]." In re Refco Capital Markets, Ltd. Brokerage Customer Sec. Litig., 586 F.Supp.2d 172, 178-79 (S.D.N.Y.2008). In Blue Chip Stamps, "[t]he Court specifically rejected a shifting and highly fact-oriented disposition of the issue of who may bring a damages claim for violation of Rule 10b-5 and stated that such an approach would not be a satisfactory basis for a rule of liability imposed on the conduct of business transactions." Id. at 179 (Lynch, J.) (internal quotation marks omitted).
Nowhere in its complaint does Scottrade allege that it purchased or sold any securities. Instead Scottrade seems to allege that it provided the interface and systems
The Court is therefore essentially faced with two questions. First, is Scottrade— an online broker that executed phony orders apparently placed by its customers, and then reimbursed its customers for those customers' losses on the trades—an "actual purchaser or seller" of securities in the traditional 10b-5 case? And second, can Scottrade assert "actual purchaser or seller" standing under any other theory?
Surprisingly, the Second Circuit and no court in this district has addressed these questions. But the Court finds the Second Circuit's decision in Klein Co. Futures, Inc. v. Board of Trade of the City of New York, 464 F.3d 255 (2d Cir.2006) ("Klein II"), and district court cases In re Refco Capital Markets, Ltd. Brokerage Customer Sec. Litig., 586 F.Supp.2d 172 (S.D.N.Y. 2008), and Manufacturers Hanover Trust Co. v. Smith Barney, Harris Upham Co., Inc., 770 F.Supp. 176 (S.D.N.Y.1991), persuasive; and finds that Scottrade was not here an "actual purchaser or seller" of securities.
In Klein, Klein was a "futures commission merchant . . . [that] facilitated the trading and fulfilled certain obligations of its customers who traded through the [Board of Trade of the City of New York
Klein sued Eisler, First West, the NYBOT, and several other entities, for inter alia anti-fraud violations of the Commodity Exchange Act ("CEA"). The district court (Daniels, J.) dismissed on standing grounds, id. at *4, and the Second Circuit affirmed. Klein II, 464 F.3d at 261-62. Section 22 of the CEA, like Section 10(b) and Rule 10b-5 of the Exchange Act, provides that "only purchasers or sellers" have standing. Klein I, 2005 WL 427713, at *3 (emphasis in original). Klein, however, was not a purchaser or seller of the options contracts at issue, nor did it own those contracts. Klein II, 464 F.3d at 260. Instead, "Klein functioned merely as a broker or agent" that "handl[ed] its customers' trades." Id. The trades at issue occurred on Klein's customers' accounts; no trading activity occurred on Klein's own account. Id. at 259 (citing Klein I, 2005 WL 427713, at *4). It was First West, not Klein, that initiated the trades, and Klein had nothing to do with those decisions. Id. at 262. Though Klein might have eventually had to guarantee account deficits, "Klein had no interest in any of the resulting profits or investments losses," resulting from First West's trades. Id. Accordingly, Klein's damages were not the product of its activity as a purchaser or seller of securities; "[q]uite simply, it did not suffer its damages in the course of its trading activities on a contract market." Klein I, 2005 WL 427713, at *4.
The case at bar presents the same standing requirement applied to almost the same factual scenario. Here, the alleged fraud of defendants and a non-defendant third party (Ksendzov) caused Scottrade's customers to engage in unauthorized purchases of securities. Though acting as a broker or agent that handled or "effected" customers' trades, much like Klein, Scottrade initiated no trades, did no trading activity itself, ordered no trades for its own account, and had no input concerning its customers' "decisions" to place orders. Furthermore, Scottrade had no direct interest in the resulting profits or losses on those trades; Scottrade's loss occurred only because it made its customers whole after those customers lost money due to, in part, Scottrade's own computer security failures. But as with the anti-fraud provisions of the CEA, standing under Section 10(b) requires that Scottrade itself have been an actual purchaser or seller of securities. In re Refco, 586 F.Supp.2d at 178. Because Scottrade was not, it lacks standing in this case.
This holding finds support in this District's cases that have come closest to the issue when considering Section 10(b) claims. In Manufacturers Hanover, MHT was a stock transfer agent
MHT argued it had standing as an actual purchaser or seller because (1) it stood in the shoes of DTC; (2) it possessed the stock certificates when they were stolen; (3) its employee's cancellation of the certificates operated as a securities sale; and (4) it was the sole injured party. Id. at 180. The court (Conner, J.) disagreed. The Court found first that the facts did not present a purchase or sale of securities as much as a theft of stock certificates followed by a sale by the thief. Id. Noting that "[a] conversion of securities does not become a purchase or sale of securities merely because the bailee reimbursed the loss," . . . the court stated, "[a] fraudulent change in ownership" does not "constitute sufficient basis for finding a sale of securities," and accordingly MHT lacked "purchaser or seller" standing. Id. The Court went on to find that the fraud did not occur "in connection with" a purchase or sale of securities because "no investment decision [was] made by either DTC or MHT and no such decision was affected by any fraud on defendant's part." Id. at 181.
As with Manufacturers Hanover, the fraud here involved no investment decision by Scottrade, no purchase or sale by Scottrade, and no losses for Scottrade other than due to its reimbursement of its clients. And like that case, Ksendzov's hacking activity sounds more in theft or conversion than in securities fraud; that Ksendzov used that theft to make profitable his own purchasing and selling activity does not, however, make Scottrade a purchaser or seller of securities.
A different but relevant situation was presented in In re Refco Capital Markets, Ltd. Brokerage Customer Sec. Litig., 586 F.Supp.2d 172 (S.D.N.Y.2008). There plaintiffs were holders of "non-discretionary trading accounts at RCM [a brokerage firm], which meant that any transaction made by RCM on [plaintiffs'] behalf required their advance approval." 586 F.Supp.2d at 176. RCM, however, purchased and sold the securities in plaintiffs' accounts without plaintiffs' approval, leading to "hundreds of millions of dollars in losses" in those accounts. Id. at 176-77. The court (Lynch, J.) found that plaintiffs were not actual purchasers or sellers of securities, and therefore lacked standing under Section 10(b), because of the "key
Likewise here, Scottrade's customers' "trades," ordered by Ksendzov, were not made on Scottrade's behalf but instead on those customers' behalf. No trades were made for the benefit of Scottrade, the plaintiff here; and Scottrade bore the losses for those "trades" only because of its decision to make its customers whole. As Judge Lynch noted in In re Refco, "[i]n adopting the Birnbaum rule . . . the Supreme Court itself recognized that the bright-line purchaser-seller requirement, strictly applied, would exclude certain classes of potential plaintiffs who may have legitimate claims of injury." Id. at 180. Thus, "proper application of the [purchaser-seller rule] for standing to sue will undoubtedly prevent some otherwise meritorious claims from surviving motions to dismiss." Id. (citing MBIA Ins. Corp. v. Spiegel Holdings, Inc., No. 03 Civ. 10097, 2004 WL 1944452, at *6 (S.D.N.Y. Aug. 31, 2004)). Accordingly, though Scottrade's decision to restore its customers' accounts might be admirable, Scottrade is not a purchaser or seller for purposes of Section 10(b).
Scottrade argues that "`there is authority in this [C]ircuit that a broker who purchases or sells as agent for his customer satisfies the purchaser-seller requirement.'" (Pl.'s Reply on Pl.'s Mot. to Amend (hereinafter "Pl.'s Reply") at 6 (quoting Odette v. Shearson, Hammill Co., Inc., 394 F.Supp. 946, 959 (S.D.N.Y. 1975)).) But Odette—a 1975 case decided before the Supreme Court's decision in Blue Chip Stamps—and the other cases Scottrade cites do not present the situation at bar. Odette held that standing existed because, as noted in In re Refco, the broker was acting as principal for its own account. Odette, 394 F.Supp. at 959. The authority cited by Odette for the proposition that brokers acting as agents for customers might be purchasers was A.T. Brod Co. v. Perlow, 375 F.2d 393 (2d Cir.1967). But A.T. Brod found that the broker had standing because it purchased securities for its customers and then turned around and demanded payment from those customers before delivering the securities, who did not pay and thereby caused the broker to suffer a loss when it resold the securities in the market. 375 F.2d at 395, 397. This situation—where an eventually non-paying customer orders securities and a broker buys the securities for the customer but takes a loss on its resale when the customer refuses to pay, or conversely where a clearing agent is required to guarantee a non-paying buyer's purchases and pay for and accept receipt from the seller of the securities involved for its own account—makes the broker or agent a "forced" or "compelled" purchaser or seller for purposes of Section 10(b) claims. See Klein II, 464 F.3d at 261; Mishkin v. Ageloff, No. 97 Civ. 2690, 1998 WL 651065, at *7 (S.D.N.Y. Sept. 23, 1998) (collecting cases). But a "forced" or "compelled" purchaser or seller's standing is an exception to the "actual purchaser or seller" rule. Gordon Partners v. Blumenthal, No. 02 Civ. 7377, 2007 WL 431864, at *11 (S.D.N.Y. Feb. 9, 2007) ("The forced sale doctrine relaxes the requirement that only traditional purchasers or sellers of securities have standing to bring a Section 10(b) claim.") (quoting Jacobson v. AEG Capital Corp., 50 F.3d 1493, 1498 (9th Cir.1995)). In any event, it does not apply to this case. Here, Ksendzov stole control of Scottrade's customers' accounts to make unauthorized purchases through Scottrade's online interface. Scottrade did not, however, solicit those customers' orders, place the trades, acquire the securities, and then seek payment for them before turning the securities over to the customers. Nor did
Scottrade also cites to the District of Arizona's 1989 decision in A.G. Edwards Sons, Inc. v. Smith, 736 F.Supp. 1030 (D.Ariz.1989). That citation is similarly unhelpful because that case presented the same situation as A.T. Brod. See A.G. Edwards, 736 F.Supp. at 1032, 1034. Scottrade finally cites to Epstein v. Haas Sec. Corp., 731 F.Supp. 1166 (S.D.N.Y.1990). But that case held that a clearing broker, who purchases securities and holds them as collateral against amounts an ordering customer owes his securities broker, has standing to sue the customer for unpaid debts. Epstein, 731 F.Supp. at 1183-84. That is not this case.
Because Scottrade does not satisfy the "actual purchaser or seller" standing requirement for Section 10(b) and Rule 10b-5 actions, those claims must be dismissed.
In addition to its claims under Section 10(b) and Rule 10b-5, Scottrade brings claims under Section 9(a) of the Exchange Act. Section 9(a) "makes it `unlawful for any person, . . . [f]or the purpose of creating a false or misleading appearance of active trading in any security registered on a national securities exchange, or a false or misleading appearance with respect to the market for any such security,' to engage in certain deceptive practices, in order to `induce the purchase or sale of any security. . . .'" Lowe v. Salomon Smith Barney, Inc., 206 F.Supp.2d 442, 444 (W.D.N.Y.2002) (quoting 15 U.S.C. § 78i(a)). Section 9(f) creates a private right of action, stating,
15 U.S.C. § 78i(f).
Scottrade also seeks rescission under Exchange Act Section 29(b), 15 U.S.C. § 78cc(b), of all trades in which a Scottrade customer was a counterparty to Genesis. (FAC ¶ 54.) Section 29(b) states,
15 U.S.C. § 78cc(b). "To establish a violation of Section 29(b), the plaintiff[] must show that (1) the contract involved a prohibited
Scottrade's claim fails because, quite simply, no contract was ever made between it and Genesis or between its customers and Genesis pursuant to which Scottrade might claim privity. Indeed, all the traditional elements of a contract—including "offer, acceptance, consideration, mutual assent and intent to be bound," Benicorp Ins. Co. v. Nat'l Med. Health Card Sys., Inc., 447 F.Supp.2d 329, 337 (S.D.N.Y.2006)—are missing. Though Section 29(b) would allow Scottrade to rescind a fraudulent contract concerning its property and to which it was party, that section does not allow Scottrade to rescind a contract concerning property that has been stolen from it (or its customers) and to which it was not a party. That claim sounds in conversion, not in securities fraud or contract law.
Scottrade finally brings claims under the CFAA, 18 U.S.C. § 1030(a). (FAC ¶ 58.) As relevant to this opinion, Section 1030 makes unlawful "knowingly and with intent to defraud, access[ing] a protected computer without authorization . . . and by means of such conduct further[ing] the intended fraud and obtain[ing] anything of value." 18 U.S.C. § 1030(a)(4). Thus to maintain its CFAA claim against Genesis, Scottrade must plead, inter alia, "factual content showing that . . . [Genesis] accessed a protected computer without authorization or in excess of [its] authorization." Cenveo, Inc. v. Rao, 659 F.Supp.2d 312, 316 (D.Conn.2009); see also Motown Record Co., L.P. v. Kovalcik, No. 07-CV-4702, 2009 WL 455137, at *3 (E.D.Pa. Feb. 23, 2009) ("a claim under 18 U.S.C. § 1030(a)(4) has four elements: (1) a defendant has accessed a protected computer; (2) has done so without authorization or by exceeding such authorization as was granted; (3) has done so knowingly and with intent to defraud; and (4) as a result has furthered the intended fraud and obtained anything of value.") (internal quotation marks omitted).
Scottrade concedes that Genesis did not access its computer systems without authorization. (Pl.'s Reply at 18 ("Scottrade's computers were hacked without authorization . . . [and] Ksendzov, Bro-Co, and/or Genesis acted in concert to engage in the `hack, pump and dump' scheme.").) Scottrade argues, however, that since Genesis allegedly was involved in and benefitted from the fraudulent
Scottrade is incorrect. The CFAA is primarily a criminal statute—the statute allows for a private civil action alleging a violation of Section 1030(a)(4) at Section 1030(g)—and as such, any ambiguity concerning its scope "should be resolved in favor of lenity." LVRC Holdings LLC v. Brekka, 581 F.3d 1127, 1134 (9th Cir.2009); see also University Sports Pub. Co. v. Playmakers Media Co., 725 F.Supp.2d 378, 384 (S.D.N.Y.2010) ("because the CFAA is principally a criminal statute, the rule of lenity requires courts to interpret it narrowly. Thus, to the extent the statute is ambiguous . . ., that ambiguity must be resolved in a defendant's favor."). And when a statute has both civil and criminal application, this rule of lenity must be applied consistently to both. Leocal v. Ashcroft, 543 U.S. 1, 11 n. 8, 125 S.Ct. 377, 160 L.Ed.2d 271 (2004); University Sports, 725 F.Supp.2d at 384-85 (finding that "the rule of lenity counsels a narrow reading" of the CFAA in a civil case). Because Scottrade does not allege that Genesis hacked into its systems, or otherwise accessed its computers without authorization, Scottrade's CFAA claim against Genesis fails and must be dismissed.
Scottrade's original and proposed amended complaints contain the same allegations relating to standing, Ksendzov's transactions and activities, and Genesis's lack of hacking activity. Accordingly, as the Court grants Genesis's motion to dismiss, it likewise denies Scottrade's motion for leave to amend as futile. Cf. In re Refco, 586 F.Supp.2d at 174, 196 (denying leave to replead and dismissing claims with prejudice when allegations demonstrated that plaintiffs lacked standing to bring securities fraud claims, and when plaintiffs could not cure pleading deficiencies).
For the reasons stated above, Genesis's motion to dismiss is GRANTED in its entirety, and all claims asserted against Genesis in this action are dismissed with prejudice. Scottrade's motion for leave to amend is DENIED in its entirety. The Clerk of the Court is directed to close these motions
SO ORDERED.
