On March 31, 2023, Judge Paul Crotty of the United States District Court for the Southern District of New York dismissed certain coordinated putative securities class actions asserting claims under the Securities Exchange Act of 1934 against two prime brokers after the collapse of a client family office affected stock prices of various publicly traded companies. Chew King Tan v. Goldman Sachs Grp. Inc., No. 21-cv-8413, slip op. (S.D.N.Y. Mar. 31, 2023). Plaintiffs alleged that defendants engaged in insider trading by using their knowledge of the family office's financial condition to sell shares of certain companies in which the family office held concentrated interests before the price of those shares collapsed. The Court held that plaintiffs failed to establish insider trading either on a theory that defendants misappropriated material non-public information or on a tipper/tippee theory. However, the Court granted plaintiffs leave to file an amended complaint.
Plaintiffs' allegations arose from the family office's use of total return swaps ("TRS") with various counterparties, including defendants, through which the family office was able to amass extremely concentrated positions in certain issuers without actually holding those shares on its books and, therefore, without having to publicly disclose its positions. Id. at 3. Instead, defendants held the shares that were the subject of the TRS and also purchased additional shares of the same issuers as a hedge. Id. When the price of certain shares declined, the family office was unable to cover its losses and allegedly notified certain counterparties, including defendants, in an unsuccessful effort to forestall the counterparties' declaring the family office to be in default under their agreements. Id. at 6. Defendants then terminated their agreements, issued notices of default, and executed large block trades in connection with terminating the swaps and executing the associated hedges. That allegedly created further downward pressure on certain of the issuers' stock prices. Id.
Plaintiffs first alleged that defendants breached a duty to the family office by misappropriating material non-public information ("MNPI") regarding the family office's imminent financial collapse. For purposes of the motion to dismiss, defendants did not dispute that they possessed MNPI and traded upon it; rather, they argued only that there was no breach of fiduciary duty. Id. at 10–11. The Court explained that it did not need to decide whether defendants owed a duty of confidentiality to the family office because, even if they did, plaintiffs had "failed to allege a deceptive or manipulative device ... by which [d]efendants committed a fraud upon the [family office]." Id. at 12. The Court noted in this regard that a large amount of the stock at issue was TRS-related collateral that defendants had a contractual right to sell. Id. at 13. As for the remainder—the shares held as hedges—the Court held that plaintiffs failed to point to a single trade where defendants did not disclose the trade to the family office. Id. Moreover, the Court determined that when defendants issued default notices, the family office "was assuredly on notice that [defendants] intended to trade on the MNPI." Id. at 15.
The Court also rejected plaintiffs' alternative theory of insider trading based on tipper/tippee liability. Although the Court determined that it was "plausible" that the family office should be deemed an insider because of the level of control it had over certain stocks (which amounted to the possession of MNPI regarding the price of those stocks), the Court held that plaintiffs' theory failed because plaintiffs did "not even attempt to allege that [the family office] shared this information to seek a personal benefit [for itself]." Id. at 17. The Court noted that, in fact, the complaint alleged that the family office expected defendants not to trade on the information but to refrain from trading. Id. at 18.
The Court further held that plaintiffs' claims under Section 20A and 20(a) of the Exchange Act were deficient not only for failure to allege a primary violation, but for other reasons as well. With respect to Section 20A, the Court held that plaintiffs failed to allege that they themselves traded "contemporaneously" with defendants and, in fact, alleged that they only purchased shares before the alleged insider trading. Id. at 19. Further, the Court explained that Section 20(a) control-person liability requires that plaintiffs show "a primary violation by the controlled person and control of the primary violator by the targeted defendant." Id. at 20-21 (emphasis in original). The Court held that plaintiffs failed to allege any specific employee of defendants traded on MNPI and that they did not connect their generalized allegations that "[defendants] as entities conducted these schemes" to any employees named in the complaint. Id. at 21 (emphasis in original).
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