Citadel Securities LLC et al v. Chicago Board Options Exchange, Inc. et al
Memorandum Opinion and Order signed by the Honorable Robert W. Gettleman on 1/12/2017: Plaintiffs' motion to remand 18 is denied. Mailed notice (gds)
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
CITADEL SECURITIES LLC, RONIN CAPITAL, )
LLC, SUSQUEHANNA SECURITIES and
SUSQUEHANNA INVESTMENT GROUP,
CHICAGO BOARD OPTIONS EXCHANGE,
INC., INTERNATIONAL SECURITIES
EXCHANGE, LLC, NASDAQ PHLX LLC (f/k/a )
Philadelphia Stock Exchange, Inc.), NYSE ARCA, )
INC. (f/k/a Pacific Exchange, Inc.), NYSE MKT )
LLC (f/k/a NYSE Amex LLC, f/k/a American
Stock Exchange LLC),
Case No. 16 C 9747
Judge Robert W. Gettleman
MEMORANDUM OPINION AND ORDER
Plaintiffs Citadel Securities LLC, Ronin Capital, LLC, Susquehanna Securities and
Susquehanna Investment Group sued defendants Chicago Board Options Exchange, Inc.,
International Securities Exchange, LLC, NASDAQ PHLX, LLC, NYSE ARCA, Inc. and NYSE
MKT, LLC in the Circuit Court of Cook County, Illinois, seeking to recover fees allegedly
improperly charged to and paid by plaintiffs to defendants under certain “payment for order
flow” (“PFOF”) or “marketing fee” programs established by each defendant. Defendants have
removed the case to this court pursuant to 28 U.S.C. § 1441(a), asserting original and exclusive
jurisdiction under 28 U.S.C. § 1331 and/or 15 U.S.C. § 78aa because, according to defendants,
the action alleges and seeks relief based on violations of rules promulgated under the Securities
Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78 et seq., and defendants’ duty under that
Act to follow those rules. Plaintiffs have moved to remand, arguing that they have alleged
violations of state law only, leaving this court without subject matter jurisdiction. For the
reasons described below, the motion is denied.
Defendants are all National Securities Exchanges registered with the Securities Exchange
Commission (“SEC”) that operate as self regulatory organizations (“SROs”). As SROs,
defendants are part of a comprehensive system adopted by Congress for regulating the securities
markets. See In re Series 7 Broker Qualification Exam Scoring Litig., 548 F.3d 110, 114 (D.C.
Cir. 2008). The Exchange Act authorizes and requires defendants to adopt rules governing the
conduct and administration of the exchanges and their members. See 15 U.S.C. §§ 78f(b),
78s(b). These rules must “provide for the equitable allocation of reasonable dues, fees, and other
charges among its members and issuers and other persons using its facilities.” 15 U.S.C. §
78f(b)(4). The SEC has broad authority to amend the SROs’ rules. 15 U.S.C. § 78s(c).
Plaintiffs are market maker member firms of defendant exchanges. Plaintiffs allege that
during the period in question each defendant exchange ran a “program” under which that
exchange collected PFOF fees. PFOF is an arrangement by which a broker receives payment
from a market maker in exchange for sending order flow to them. The fees are imposed to
attract “order flow” to a market, thereby increasing liquidity and benefitting investors.
Defendants have adopted rules creating the PFOF programs under which defendants imposed
fees “designed to insure that market makers that may trade with customers on the Exchange[s]
contribute to the cost of attracting order flow.” See SEC Concept Release, A Competitive
Developments in the Options Markets, 69 Fed. Reg. 6124, 6129 (Feb. 9, 2004). Defendants
impose PFOF fees on a market maker when a trade is made for a “customer,” but not trades
made for proprietary “house trades,” where a firm trades on its own behalf. Plaintiffs allege that
over a multi-year period defendants improperly charged PFOF fees on millions of orders not
subject to those fees. According to the complaint, those fees were charged as a result of at least
two member broker-dealer firms incorrectly marking plaintiffs’ orders as “customer orders”
instead of “proprietary orders.” The complaint alleges that defendants entered into stipulations
under which the broker dealers paid penalties. In the instant action, plaintiffs seek restitution or
recovery from defendants of all fees allegedly mischarged.
This is not the first time plaintiffs have brought these claims. They initially filed suit in
the Circuit Court of Cook County, Illinois, on May 22, 2013, alleging that defendants charged
PFOF fees “in violation of their own rules.” That original complaint alleged that the amount of
allowable fees “is set forth in fee schedules that are noticed, published and approved by the
SEC,” that defendants’ activity “violates their own rules and/or fee schedules,” that plaintiffs
“suffered harm because the [defendants] overcharged PFOF fees in violation of SEC-approved
fee schedules,” and that a dispute existed between the parties as to whether defendants “are
required to comply with their rules and fee schedules.”
Defendants removed the original complaint to this court. One month later plaintiffs
voluntarily dismissed it. That same day plaintiffs filed a new complaint, again in the Circuit
Court of Cook County, Illinois. That complaint attempted to eliminate all reference to any
violation by defendants of their own rules, replacing them with allegations that defendants
charged fees that were not part of the “PFOF” Program.” Instead of seeking a declaration that
defendants “are required to comply with their own rules,” the complaint sought a declaration that
defendants many not “charge PFOF fees on orders that are not part of the Exchanges’ PFOF
Defendants again removed the case to this court. Plaintiffs moved to remand, which the
court denied. Citadel Securities, LLC v. Chicago Board Options Exchange, Inc., 2013 WL
11319427 (N.D. Ill. Dec. 11, 2013). The court then granted defendants’ motion to dismiss for
lack of subject matter jurisdiction based on plaintiffs having failed to exhaust their
administrative remedies before the SEC. Citadel Securities, LLC v. Chicago Board Options
Exchange, 2014 WL 11370439 (N.D. Ill. Aug. 4, 2014). The Seventh Circuit affirmed both
decisions. Citadel Securities, LLC v. Chicago Board Options Exchange, 808 F.3d 694 (7th Cir.
Plaintiffs then brought a petition for administrative remedy before the SEC, requesting
that the SEC order defendants to pay plaintiffs’ damages in an amount equal to the PFOF fees
that plaintiffs claim were improperly charged. Plaintiffs did not identify any basis for the SEC’s
jurisdiction in their petition, and in fact expressly stated that the “[SEC] does not have
jurisdiction over the market makers’ petition pursuant to its Rules of Practice,” and that the
“[SEC] has no statutory authority to exercise jurisdiction over this matter.” Defendants asserted
that the SEC had jurisdiction under § 19(h)(1) of the Exchange Act, which authorizes the SEC to
institute proceedings to determine whether an SRO has violated any of its own rules and to take
appropriate remedial action.
On July 15, 2016, the SEC issued an opinion explaining why it disagreed with the
Seventh Circuit’s opinion that the SEC had jurisdiction, and dismissed plaintiffs’ petition. In re
Petition of Citadel Securities, LLC, et al., 2016 WL 3853760 (July 15, 2016) (the “SEC
opinion”). On September 13, 2016, defendant Chicago Board Options Exchange filed a petition
for review of the SEC opinion with the Seventh Circuit. CBOE v. SEC, No. 16-3423. Plaintiffs
and NASDAQ both moved and were granted leave to intervene. That matter remains pending in
the Seventh Circuit. The day after CBOE initiated its appeal of the SEC opinion, plaintiffs filed
the instant action. The instant complaint appears to be, with some minor irrelevant differences,
the same complaint which this court dismissed previously.
Plaintiffs’ complaint asserts six state law claims. A state claim can be removed to federal
court only if the federal court has original jurisdiction unless Congress provides otherwise. 28
U.S.C. § 1441(a); Rivet v. Regions Bank of Louisiana, 522 U.S. 470, 474 (1998). “The presence
or absence of federal-question jurisdiction is governed by the ‘well-pleaded complaint rule,’
which provides that federal jurisdiction exists only when a federal question is presented on the
face of plaintiff’s properly pleaded complaint.” Id. at 475 (quoting Caterpillar, Inc. v. Williams,
482 U.S. 386, 392 (1987)). For proper removal, a right or immunity created by the Constitution
or laws of the United States must be an essential element of the plaintiff’s claim, Gully v. First
Nat’l Bank in Meridian, 299 U.S. 109 (1936), and a case may not be removed on the basis of a
federal defense even if both parties admit that the defense is the only question truly at issue.
Rivet, 522 U.S. at 475.
An “independent corollary” to the well-pleaded complaint rule is the principle that “a
plaintiff may not defeat removal by omitting necessary federal questions.” Id. (quoting
Franchise Tax Board of Cal. v. Construction Laborers Vacation Trust for Southern Cal., 463
U.S. 1, 22 (1983)). If a court concludes that a plaintiff has “artfully pleaded” to omit necessary
federal questions, it may uphold removal despite the absence of a federal question on the face of
the complaint. Rivet, 522 U.S. at 475. The artful pleading doctrine allows removal where
federal law completely preempts a plaintiff’s state law claim, id., and where the plaintiff’s state
law claims “implicate significant federal issues.” Grable & Sons Metal Products, Inc. v. Darue
Engineering and Manufacturing, 545 U.S. 308, 312 (2005).
Defendants’ removal is based on 28 U.S.C. § 1331 (federal question), and the Exchange
Act’s exclusive jurisdiction provision, 15 U.S.C. § 78a(a) (“§ 27"), which provides:
The district courts of the United States . . . shall have exclusive jurisdiction of
violations of this Chapter or the rules and regulations thereunder, and of suits in
equity and actions at law brought to enforce any liability or duty created by this
Chapter or the rules and regulations thereunder.
Plaintiffs’ motion to remand argues that they have brought state law claims only, and that
those claims do not implicate any federal issues. Defendants counter by arguing, as they did in
the previous action, that despite plaintiffs’ artful pleading, the complaint alleges that defendants
violated their own rules by charging fees not authorized by their own fee schedules.
As an initial matter, defendants argue that this court’s assertion of jurisdiction in the
previous action, and the Seventh Circuit’s affirmance, whether as law of the case or as a matter
of precedent, controls the instant decision. Plaintiffs respond that the SEC’s determination that it
lacks jurisdiction and, more importantly, the Supreme Court’s recent decision in Merrill Lynch,
Pierce, Fenner & Smith, Inc. v. Manning, ___ U.S. ___, 136 S.Ct. 1562 (2016), interpreting the
breadth of the Exchange Act’s exclusive jurisdiction provision, compels a different result.
The court disagrees with both positions. First, the SEC opinion is obviously not binding
on this court, particularly since it is on review by the Seventh Circuit and, in any event, the
decision means simply that plaintiffs have exhausted any potential administrative remedies. The
Seventh Circuit’s decision, if unaffected by Merrill Lynch would, of course, be binding on the
court and compel a denial of remand. Thus, the only issue is whether Merrill Lynch alters the
decision reached by both this court and the Seventh Circuit, that plaintiffs’ complaint raises
claims that support federal subject matter jurisdiction. As discussed below, although Merrill
Lynch may alter the analysis, the outcome remains the same.
In Merrill Lynch, the plaintiff sued Merrill Lynch and other financial institutions in New
Jersey state court alleging that the defendants engaged in “naked short sales” of Escala stock,
driving the price of the stock down and causing a loss to the plaintiff, who had held over 2
million shares. The complaint alleged that the defendants’ actions violated the New Jersey
Racketeering Influenced Corrupt Organization Act (“RICO”), New Jersey Criminal Code, New
Jersey Uniform Securities Law, and New Jersey common law of negligence, unjust enrichment,
and interference with contractual relations. The complaint specifically referred to the SEC’s
Regulation SHO, which regulates short sales, identifying Merrill Lynch’s past violations of that
regulation and suggesting that it had done so again, in addition to violating state law. Merrill
Lynch, 136 S.Ct. at 1566-67.
Merrill Lynch removed the case to the federal district court asserting federal jurisdiction
under both the general federal question statute, 28 U.S.C. § 1331, which grants district courts
jurisdiction of “all civil actions arising under” federal law, and under § 27 of the Exchange Act.
The plaintiff moved to remand arguing that neither statute supported subject matter jurisdiction.
Id. at 1567. The district court denied the motion, but certified the question for immediate appeal.
The Third Circuit reversed and ordered remand to the state court, concluding that the
general federal question statute, 1331, did not confer jurisdiction because all of the plaintiff’s
claims were “brought under state law” and none “necessarily raised” a federal issue. Id. (citing
Manning v. Merrill Lynch, Pierce, Fenner & Smith, 772 F.3d 158, 161-66 (2014)). Next, the
court held that § 27's exclusive jurisdiction provision covers only those cases involving the
Exchange Act that would satisfy the “arising under” test of § 1331. Id. Because the court had
already concluded that the district court lacked jurisdiction under § 1331, it concluded that there
was no jurisdiction under § 27.
Merrill Lynch sought Supreme Court review of the Third Circuit’s decision that
jurisdiction under § 27 was limited to those cases “arising under” the Exchange Act.
Recognizing a circuit split as to the breadth of § 27, the Court granted certiorari and affirmed the
Third Circuit, concluding that the “arising under” test used to determine federal jurisdiction
under § 1331 is the appropriate test. Thus, it concluded that Section 27 provides exclusive
jurisdiction of the same class of cases as “arise under” the Exchange Act for purposes of §
1331.” Id. at 1575. Because Merrill Lynch had not challenged the Third Circuit’s decision that
there was no jurisdiction under § 1331, the Court concluded that there was also no jurisdiction
under § 27.
The upshot of this is that the determination of whether plaintiffs’ state law claims fall
within § 27's exclusive jurisdiction provision, as held by both this court and the Seventh Circuit,
requires a determination whether their claims “arise under” the Exchange Act. Because neither
this court nor the Seventh Circuit performed that analysis, and because Merrill Lynch
specifically abrogated Sparta Surgical Corp. v. National Association of Securities Dealers, Inc.,
149 F.3d 330 (9th Cir. 1998), a case on which the Seventh Circuit relied, further analysis is
The “arising under” test is satisfied in either of two circumstances. “Most directly, and
most often, federal jurisdiction attaches when federal law creates the cause of action asserted.”
Merrill Lynch, 136 S.Ct. at 1569. “But even when ‘a claim finds its origins’ in state law, there is
a special and small category of cases in which arising under jurisdiction still lies.” Id. (quoting
Gunn v. Minton, 568 U.S. __, 133 S.Ct. 1059, 1064 (2013). A federal court has jurisdiction of a
state-law claim if it “‘necessarily raise[s] a stated federal issue, actually disputed and substantial,
which a federal forum may entertain without disturbing any congressionally approved balance’
of federal and state power.” Id. (quoting Grable, 545 U.S. at 314)). This description covers
cases in which a state-law cause of action “is brought to enforce a duty created by the Exchange
Act because the claim’s very success depends on giving effect to a federal requirement.” Id.
Applying this test, the court concludes, as it did before, that it has jurisdiction over
plaintiffs’ claims. First, both this court and the Seventh Circuit have already held that plaintiffs’
complaint, although artfully drafted, alleges that defendants violated their own rules, which are
established and approved by the SEC as part of its regulatory function, and with which
defendants are bound to comply under § 78s(g)(1) of the Exchange Act. The complaint thus
raises a federal question, resolution of which is necessary to plaintiffs’ claims. Plaintiffs’
attempt to avoid this conclusion by characterizing their case as simply needing to “prove that the
[defendants] took money from them to which [defendants] were not entitled.” But, to show that
defendants were not entitled to the fees, plaintiffs must show that defendants violated their own
rules. Absent such a violation, defendants were entitled to assess and keep the fees. Thus,
plaintiffs’ claims necessarily implicate a federal issue.
Second, that federal issue is “actually disputed.” Indeed, it is the central point of the
dispute. Plaintiffs simply cannot win without showing that defendants violated their own rules.
The federal issue is also substantial. The substantiality inquiry examines the importance
of the issue to the federal system as a whole, rather than the importance of the issues to the
parties. Gunn, 133 S.Ct. at 1066 (2013). “[I] is not enough that the federal issue be significant
to the particular parties in the immediate suit; that will always be true when the state claim
‘necessarily raises’ a disputed federal issue . . ..” Id. (emphasis in original). In the instant case,
defendants play a central role in the national system of securities markets. “National Security
Exchanges . . . are critical components of the National Market System, which provides the
foundation for investor confidence in the integrity and stability of the United States capital
markets.” NASDAQ OMX Group, Inc. v. UBS Securities, LLC, 770 F.3d 1010, 1024 (2d Cir.
2014). Thus, the court concludes that whether defendants complied with their own rules and
obligations that are designed to ensure that market makers that may trade with customers on the
exchanges contribute to the cost of attracting that order flow, is “sufficiently significant to the
development of a uniform body of federal securities regulation to satisfy the requirement of
importance to the federal system as a whole.” Id.
Additionally, as defendants argue, lack of federal jurisdiction would threaten uniformity.
See Grable, 545 U.S. at 312 (federal forum offers uniformity on federal issues). Subjecting
defendants’ obligations under their PFOF Programs to differing state contract law would be
inconsistent with a national market system.
Finally, the issues raised are capable of resolution in federal court without disturbing the
federal-state balance approved by Congress. The states have no particular interest in resolving
matters involving violations of rules approved by the SEC, unlike for example, in Gunn, when
the Court noted that states have a “special responsibility for maintaining standards among
members of the licensed professions.” Gunn, 133 S.Ct. at 1068. Indeed, the fact that Congress
has determined that jurisdiction should lie exclusively in federal courts for alleged violations of
the Exchange Act and of the rules and regulations promulgated thereunder, is a strong signal that
exercising federal jurisdiction over state claims that necessarily raise such allegations will not
upset the congressionally approved federal-state balance of power. See NASDAQ, 770 F.3d
Consequently, the court concludes that plaintiffs’ claims, although couched in state law
terms, arise under the Exchange Act and jurisdiction in federal court is proper. Plaintiffs’
motion to remand is denied.
For the reasons described above, plaintiffs’ motion to remand (Doc. 18) is denied. This
matter remains set for a report on status on February 9, 2017, at 9:00 a.m.
January 12, 2017
Robert W. Gettleman
United States District Judge
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