United States: Southern District Of New York Dismisses Securities Class Action Against Brokerage Firm For Failure To Adequately Allege Material Misrepresentations And Scienter

On August 10, 2018, Judge Kimba M. Wood of the United States District Court for the Southern District of New York dismissed a putative securities class action against foreign exchange trading company FXCM Inc. (“FXCM” or the “Company”) and its CEO.  Ret. Bd. of the Policemen’s Annuity and Benefit Fund of Chicago v. FXCM, No. 15-cv-03599 (S.D.N.Y. Aug. 10, 2018).  Plaintiff alleged that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 by making material misstatements and omissions concerning certain risks associated with the Company’s business model.  The Court held that the alleged misrepresentations were inactionable “puffery,” too vague to be actionable, or were not misleading because the alleged risks were adequately disclosed when the Company’s disclosures were viewed as a whole.  The Court also held that plaintiff had failed to allege a strong inference of scienter.

FXCM is a brokerage firm that provides access to the FX market.  According to the complaint, the Company eschewed the “principal model” adopted by most retail brokerage firms, under which the broker takes the opposite side of its customers’ trades, in favor of an “agency model” under which the Company served as an intermediary between customers and banks.  The Company allegedly had a “no debit policy” under which customers could take long, highly-leveraged currency positions and the Company would be responsible for covering all losses beyond the amount of collateral in the customers’ accounts.  In January 2015, the Swiss National Bank announced it would de-peg the Swiss Franc from the Euro, triggering a sharp devaluation of the Euro in relation to the Franc.  Plaintiff alleged that, as a result of this devaluation, many of the Company’s customers suffered losses well above their collateral, leading to $276 million in losses for the Company.  According to plaintiff, to avoid regulatory default, the Company agreed to a “punitive” financing agreement with an outside investment company and, as a result, the Company’s stock price dropped from $14.87 to $1.60 within one week.

The Court first considered plaintiff’s allegations that the Company made misleading statements about its agency model and the risks the Company faced from its “no debit policy,” liquidity, and risk factors.  Plaintiff had alleged that the Company misrepresented that, because under the agency model the Company did not take the opposite side of its customers’ trades, this “reduced [the Company’s] risk” and the Company was “not exposed to the market risk of a position moving up or down in value.”  The Court held that the Company’s statements were either nonactionable puffery or were not misleading in the context in which they were made because the Company’s model was clear to investors.  The Court similarly dismissed plaintiff’s argument that the Company had not disclosed the “no debit policy,” finding that the Company’s 10-K, when reviewed as a whole, “plainly disclose[d] that FXCM could be exposed to liability in the event that a customer’s losses exceed[] the amount of cash in their account.”  Similarly, statements in the Company’s Form 10-K that it had a “fairly conservative margin policy,” “maintained a sustainable pool of liquidity,” and “maintained excess regulatory capital” were held to be inactionable statements, as the Court found them to be the types of general statements on which investors are unlikely to rely.

The Court then considered whether plaintiff had adequately alleged scienter.  Plaintiff had alleged that:  the Company’s CEO knew that the Company was exposed to a $2.2 billion open position on the Euro-Swiss Franc pair and knew there was a risk the pair would be de-pegged; the CEO tried to cover up the extent of the loss by claiming the open position was $1 billion rather than $2.2 billion; and the CEO blamed the loss on the failure of banks to provide pricing and liquidity.  The Court concluded that these allegations did not create a strong inference of scienter, noting that while the CEO allegedly knew about the $2.2 billion open position and was aware of extreme price movement in other currencies, plaintiff had failed to allege that the CEO perceived the risk that the Euro-Swiss Franc would be de-pegged as a serious possibility at the time.  The Court also found that statements to which plaintiff pointed to support the inference of a cover up were not contradictory and did not lend themselves to an inference of scienter.  The Court added that the CEO’s alleged understanding of the agency model was insufficient to establish a strong inference of scienter given the Court’s determination that the Company sufficiently disclosed in its Form 10-K that it was exposed to risk from customer losses exceeding collateral.  The CEO was also allegedly aware that other companies had raised margin requirements with respect to the Euro-Swiss Franc pair, but the Court noted that this indicated “nothing more than a different business judgment.” 

Finding that plaintiff failed to adequately plead material misstatements and scienter, the Court dismissed plaintiff’s claims under Sections 10(b) and Rule 10b-5 without addressing defendants’ loss causation argument.  The Court also dismissed plaintiff’s Section 20(a) control person liability claim because plaintiff failed to adequately allege a primary violation by the Company.


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