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From Securities Regulation Daily, February 26, 2016

Korean stock index futures were not 'domestic transactions' under Morrison

By Lene Powell, J.D.

The Southern District of New York dismissed a putative class action alleging illegal “spoofing” of commodity futures based on a Korean stock index, ruling that the plaintiffs did not establish that the trades were “domestic transactions” for purposes of Morrison and the Commodity Exchange Act. The court also held that the manipulation claim did not sound in fraud, so the more lenient Rule 8(a) pleading standard applied. The plaintiffs were given leave to amend (Choi v. Tower Research Capital LLC, February 25, 2016, Wood, K.).

Alleged spoofing. The plaintiffs consisted of individual purchasers who bought commodity futures contracts based on the KOSPI 200, a Korean stock index. Orders for KOSPI 200 futures contracts are entered through KRX, a Korean exchange. During the night market, the orders are matched on CME Globex, an electronic trading platform in Illinois operated by the CME Group.

The plaintiffs alleged that traders at Tower Research Capital, a high-frequency trading firm, illegally manipulated KOSPI 200 futures by entering hundreds of large-volume orders they did not intend to execute, creating a false impression of market demand and driving prices in the direction they desired. The plaintiffs argued that this conduct was illegal “spoofing” in violation of Sections 6(c), 6(d), 9(a), and 22(a) of the Commodity Exchange Act (CEA).

Pleading standard: 8(a) or 9(b)? In analyzing which pleading standard should be used, the court explained that generally, if a theory of manipulation is based on misleading statements or omissions, it sounds in fraud and the heightened Rule 9(b) standard applies. If the complaint merely alleges a scheme based on a manipulative trading strategy or abuse of market power, the more relaxed Rule 8(a) standard is more appropriate.

Here, although plaintiffs used language implying fraud like “fictitious” and “misleading,” the attempted manipulation was accomplished through a particular trading strategy and did not involve misleading statements or omissions. The submission of an above- or below-market bid did not constitute a false or misleading statement, even if the plaintiffs did not plan to execute it. Accordingly, the court said the Rule 8(a) pleading standard should be used.

Foreign or domestic transactions? Next, the court considered whether the transactions were foreign or domestic. Under Morrison v. National Australia Bank Ltd. (U.S. 2010), the Exchange Act does not apply to conduct that occurs abroad, but applies only to the purchase or sale of a security that: (1) is made in the United States; or (2) is listed on a domestic exchange. Courts have held that this test applies to the CEA also.

The court concluded that the transactions were not domestic under either prong of Morrison, and so the CEA did not govern. The plaintiffs did not support their assertion that the “meeting of the minds” took place in Illinois. Further, they did not plead any facts to establish that CME Globex—as distinct from CME itself—qualified as a domestic exchange, rather than simply a technological platform used by other exchanges to execute trades. Therefore, the CEA did not apply to the trades and the complaint failed to state a claim.

No unjust enrichment. The court also dismissed a state unjust enrichment claim, finding that the plaintiffs failed to allege any direct dealing or actual, substantive relationship with the defendants. The court granted the plaintiffs leave to amend the complaint.

The case is No. 14-CV-9912 (KMW).

Attorneys: Daniel Stephen Sommers (Cohen Milstein Sellers & Toll PLLC) for MyunUk Choi. Matthew Beville (WilmerHale) and Robert Walter Trenchard (Gibson Dunn & Crutcher LLP) for Tower Research Capital LLC.

Companies: Tower Research Capital LLC

MainStory: TopStory CommodityFutures Derivatives DoddFrankAct FraudManipulation NewYorkNews

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