Citadel Securities LLC et al v. Chicago Board Options Exchange, Inc. et al

Filing 59

MEMORANDUM Opinion and Order: For the reasons stated in the Memorandum Opinion and Order, defendants Chicago Board Options Exchange, Inc., International Securities Exchange, LLC, NASDAQ PHLX, LLC, NYSE ARCA, Inc. and NYSE MKT, LLC,'s motion to dismiss [doc. 49 ] is granted. Civil case terminated. Signed by the Honorable Robert W. Gettleman on 10/23/2018. Mailed notice (cn).

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
CITADEL SECURITIES LLC, RONIN CAPITAL )
LLC, SUSQUEHANNA SECURITIES and
)
SUSQUEHANNA INVESTMENT GROUP,
)
)
Plaintiffs,
)
)
v.
)
)
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),
)
)
Defendants.
)

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 Apayment for order
flow@ (APFOF@) or Amarketing fee@ programs established by each defendant. Defendants
removed the case to this court under 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 (AExchange Act@), 15 U.S.C. ' 78 et seq., and defendants= duty under that

Act to follow those rules. The court agreed with defendants and denied plaintiffs’ motion to
remand. Citadel Securities, LLC v. Chicago Board Options Exchange, 2017 WL 118419 (N.D.
Ill. Jan. 12, 2017). Defendants have now moved to dismiss for lack of jurisdiction and/or failure
to state a claim. For the reasons described below, that motion is granted.
BACKGROUND
Defendants are all National Securities Exchanges registered with the Securities Exchange
Commission (ASEC@) that operate as self regulatory organizations (ASROs@). 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 Aprovide 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 Aprogram@ 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 Aorder flow@ to a market, thereby increasing liquidity and benefitting investors.
Defendants have adopted rules creating the PFOF programs under which defendants imposed
fees Adesigned to ensure that market makers that may trade with customers on the Exchange[s]
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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 Acustomer,@ but not trades made
for proprietary Ahouse 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 Acustomer orders@ instead of
Aproprietary 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, (the “first complaint”)Illinois, on May 22, 2013, alleging that
defendants charged PFOF fees Ain violation of their own rules.@ The first complaint alleged that
the amount of allowable fees Ais set forth in fee schedules that are noticed, published and
approved by the SEC,@ that defendants= activity Aviolates their own rules and/or fee schedules,@
that plaintiffs Asuffered 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 Aare required to comply with their rules and fee schedules.@
Defendants removed the first complaint to this court. One month later plaintiffs
voluntarily dismissed it. That same day plaintiffs filed a new complaint (the “second
complaint”), again in the Circuit Court of Cook County, Illinois. That complaint attempted to
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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 APFOF@ Program.@ Instead of
seeking a declaration that defendants Aare required to comply with their own rules,@ the
complaint sought a declaration that defendants many not Acharge PFOF fees on orders that are
not part of the Exchanges= PFOF Programs.@
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. 2015).
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 A[SEC] does not have
jurisdiction over the market makers= petition pursuant to its Rules of Practice,@ and that the
A[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.
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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 ASEC
opinion@). On September 13, 2016, defendant Chicago Board Options Exchange filed a petition
for review of the SEC opinion with the Seventh Circuit. Plaintiffs and NASDAQ both moved
and were granted leave to intervene.
The Seventh Circuit affirmed the SEC’s decision, agreeing that § 19(h)(1) of the
Exchange Act permits the SEC to take regulatory action against an exchange when “in its
opinion such action is necessary or appropriate in the public interest, for protection of investors,
or otherwise in furtherance of the purpose of the [Exchange Act],” but did not provide a
jurisdiction over “law suits initiated by and between private parties.” Chicago Board Options
Exchange v. Securities and Exchange Commission, 889 F.3d 837, 839, 842 (7th Cir. 2018).
DISCUSSION
Plaintiffs’ current complaint asserts six state law claims. Count I seeks a declaration that
defendants cannot charge PFOF fees for orders that are not part of the PFOF program. Count II
seeks an accounting of the fees allegedly improperly charged. Count III alleges a breach of
contract, Count IV is a claim for promissory estoppel, and Counts V and VI assert claims for
restitution and rescission. Defendants have moved to dismiss all the claims arguing that:
(1) the court lacks subject matter jurisdiction; (2) the claims are preempted by the Exchange Act;
(3) defendants are absolutely immune from all claims based on the challenged conduct; (4) the
claims are barred by defendants’ rules; and (5) the claims fail to state claims under state law.
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Because the court agrees that defendants’ claims are either preempted by the Exchange Act or
defendants are completely immune from suit based on the alleged conduct, it need not reach
defendants’ other arguments.
Despite plaintiffs’ efforts to artfully draft their claims, this court has already held, and the
Seventh Circuit has agreed, that plaintiffs’ complaint “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 § 78(s)(g)(1) of the Exchange Act.” Citadel
Securities, 2017 WL 118419 at *4; Citadel Securities v. Chicago Board Options Exchange, 809
F.3d 694, 699 (7th Cir. 2015) (“We agree with the district court that plaintiffs seek to enforce
defendants’ own rules promulgated under the Exchange Act.”).
In In re Series 7, 548 F.3d at 111, the District of Columbia Circuit addressed the issue of
“whether common law causes of action can be alleged against a Self-Regulatory Organization
(“SRO”) for the negligent performance of its duties under the [Exchange Act].” After
recognizing that there is no implied right of action under that Act, the court stated, “[w]hether
analyzed under preemption doctrine or a theory of regulatory immunity, the result is the same:
plaintiffs cannot raise a common law complaint against [an SRO] based on duties arising under
the Exchange Act. Id. at 113.
In In re Series 7, the plaintiffs sued the National Association of Securities Dealers
(“NASD”), an SRO, alleging that the NSAD had misreported the scores of the Series 7 Exam of
a large number of applicants. Plaintiffs brought a nation-wide class action for breach of
contract, negligence and negligent misrepresentation. The district court dismissed, noting that
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the plaintiffs sought remedies for negligent performance of an SRO’s regulatory duties that
Congress did not provide. In affirming, the DC Circuit first addressed preemption, and noted
that several other circuits, although not explicitly relying on preemption, had held that common
law claims based on an SRO’s breach of its duties under the Exchange Act were inconsistent
with Congress’s intent under that act. Id. at 113-14 (citing Barbara v. New York Stock
Exchange, Inc., 99 F.3d 49 (2d Cir. 1996); Desiderio v. NASD, 191 F.3d 198 (2d Cir. 1999);
Sparta Surgical Corp. v. NASD, 159 F.3d 1209, 1215 (9th Cir. 1998) (abrogated on other
grounds by Merrill Lynch, Pierce, Fenner & Smith v. Manning, __ U.S. __ 136 S.Ct. 1562
(2016)); MM&S Fin., Inc. v. NASD, 364 F.3d 908, 912 (8th Cir. 2004) (holding that a private
breach of contract claim against an SRO would vitiate Congress’s intent not to allow private
rights of action against self-regulatory organizations for violating their own rules). After
reviewing these cases, the court noted that “[t]hough not always explicitly identifying the
underlying premise, courts have consistently found Congress’s intent under the Exchange Act
precludes common law causes of action, and we agree with our sister circuits.” Id. at 308.
The court then addressed immunity, indicating that “[w]hen an SRO acts under the aegis
of the Exchange Act’s delegated authority, it is absolutely immune from suit for the improper
performance of regulatory, adjudicatory or prosecutorial duties delegated by the SEC.” Id.
The upshot of this is that common law claims against an SRO for violating its own rules are
either preempted or barred by immunity, or both.
Plaintiff acknowledges that SROs are immune from suit for claims alleging violations of
their regulatory functions, but argue that the PFOF rules are operational, not regulatory. Citing
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City of Providence v. Bats Global Markets, Inc., 878 F.3d 36, 48 (2d 2017), plaintiffs argue that
“when an exchange engages in conduct to operate its own market that is distinct from its
oversight role, it is acting as a regulated entity—not a regulator. Although the latter warrants
immunity the former does not.” (Emphasis in original.)
The court agrees that SROs are entitled to immunity only for actions taken in their
regulatory role. The court disagrees with plaintiffs, however, that enforcing PFOF fees is not
regulatory. The claims in City of Providence were that the exchanges had engaged in
manipulative or deceptive conduct in violation of § 10(b) of the Exchange Act. The court
concluded that the defendant exchanges were not immune because the plaintiffs had not alleged
that the exchanges “inadequately responded to, monitored or policed their members’ actions.”
Id at 48.
In the instant case, that is precisely what plaintiffs do claim. They do not claim that
defendants charged fees on orders that were properly marked as “house orders.” Instead, they
allege that fees were charged on “house orders” that were improperly marked by its members as
“customer orders.” Properly read, plaintiffs claim is that defendants failed to monitor their
members to ensure proper marking. Indeed, in their brief in opposition to the motion to dismiss,
plaintiffs make clear that they are alleging “willful misconduct and gross negligence on the part
of the exchanges” in connection with those duties. Monitoring their members to ensure
compliance with rules designed to promote fair distribution of the costs of attracting order flow
as a result of the SEC’s decision to promote the listing of options on more than one exchange
(Citadel Securities, 808 F.3d at 697-98) is undoubtedly regulatory in nature. Thus, the court
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concludes that application of the PFOF fees falls within the exchanges’ broad regulatory
function. Consequently, defendants are immune from plaintiffs’ claims.
CONCLUSION
For the reasons stated above defendants’ motion to dismiss [doc. 49] is granted.
ENTER:

October 23, 2018

__________________________________________
Robert W. Gettleman
United States District Judge

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