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From Securities Regulation Daily, January 30, 2015

Petition for rehearing on fraudulent parking transactions stalls out

By Amy Leisinger, J.D.

The Second Circuit has denied rehearing on its affirming of a dismissal of a fraud claim regarding parking transactions. According to the court, the prices used in the parking transactions were not reported in a market or made known to the purchasers of the securities and were not shown to be sold at prices “signaled” by prices used in the parking transactions. In addition, the court acknowledged an amicus brief filed by the SEC and agreed that reliance on an actual communication by a defendant need not be shown in every manipulation case (Fezzani v. Bear, Stearns & Co., Inc., January 30, 2015, Winter, R.).

Background. The case began in early 1999 when the plaintiffs filed suit against more than 50 corporate and individual defendants. The action was brought against defunct brokerage A.R. Baron & Co. (Baron) and asserted securities fraud claims, market manipulation, RICO violations, aiding and abetting breach of fiduciary duty, and common law fraud. According to the complaint, the defendants, including Isaac Dweck, assisted Baron in its manipulation of the share prices of a few small companies that it helped to take public by purchasing stock from Baron with the agreement that the brokerage would retain the risk of loss and later buy back the stock, an activity known as “stock parking.”

In 2008, the district court dismissed the action as to all defendants, save one group. Later, after the action had been dormant for nearly a year, the court dismissed the entire action sua sponte. The plaintiffs appealed both orders. In a summary order without precedential effect (covered in the Securities Regulation Daily Wrap Up for May 8, 2013), a Second Circuit panel affirmed in part a district court judgment dismissing an action for failure to state a claim and vacated the dismissal of state laws claims against certain defendants.

In June 2013, the SEC filed an amicus brief (covered in the Securities Regulation Daily Wrap Up for June 24, 2013) challenging the Second Circuit’s decision with respect to the finding that allegations of stock manipulation against Dweck were not sufficiently pleaded because the plaintiffs did not allege that he made a false or misleading statement. The decision cannot be reconciled with Supreme Court precedent, the Commission stated, and it also created an intracircuit split. Specifically, according to the SEC, the decision improperly conflates market manipulation claims with pure misrepresentation claims, and it is incorrect to hold only the person who communicates a misrepresentation liable for acts of manipulation.

Rehearing. The court began by rejecting the appellants’ argument that the summary order was inconsistent with its decision in Levitt v. J.P. Morgan, noting that the issue of clearing-broker liability in that case pertained only to considering certification of a class. In fact, the court stated, Levitt favorably cited the district court’s opinion (which was affirmed).

Moreover, the court noted, district courts have distinguished between cases concerning clearing brokers’ liability for others’ activities when providing normal clearing services and cases where a plaintiff alleges that a clearing broker has “shed its role as clearing broker and assumed direct control of the introducing firm’s operations and its manipulative scheme.” The court found that the complaint failed to allege facts regarding such control on the part of the defendants in relation to manipulating prices. The facts alleged have not shown that Bear Stearns directed the fraud or instructed Baron or Dweck to set up sham transactions, the court concluded.

SEC amicus brief. According to the SEC, the Second Circuit’s opinion held that, in all manipulation cases, liability attaches only to persons who communicate a misrepresentation. The SEC opined that, in fact, “[t]he essence of manipulation is not a misrepresentation, but market activity—the buying and selling of shares—that itself creates a ‘false pricing signal,’” such as parking.

The court noted that its opinion did not require that reliance on communications by a defendant must be shown in every manipulation case and agreed that a showing of reliance may be based on “market activity” intended to mislead investors. However, the court stated, in this case, there is no claim that the parking transactions, and their purported prices, were ever reported in a market or could have sent a “signal” to a market. Moreover, the court stated, the complaint “lump[s] together sales of securities that Dweck did not park with those of securities he did park,” and, as such, it has not met applicable particularity requirements.

Partial dissent. According to the dissenting opinion, the treatment of the parked and unparked securities together did not justify dismissing the complaint. The parking of certain securities helped to sustain the manipulation of all of the securities, the opinion explained. In addition, the opinion stated, the majority’s objection to the complaint for not alleging that the prices used in the parking transactions were reported in a market misunderstands the function of parking schemes: to conceal rather than disclose price information.

The case is No. 09-4414-cv.

Attorneys: Max Folkenflik (Folkenflik & McGerity) for Mohammed Fezzani. Michael Schissel (Arnold & Porter LLP) for Bear Stearns & Co. Inc. and Bear Stearns Securities Corp.

Companies: Bear Stearns & Co. Inc.; Bear Stearns Securities Corp.

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