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Mill Bridge V, Inc. v. Benton

December 3, 2009

MILL BRIDGE V, INC. AS SUCCESSOR TO VAN DER MOOLEN OPTIONS USA, LLC C/O VAN DER MOOLEN SPECIALISTS, LLC, PLAINTIFF,
v.
I. ISABELLE BENTON, BENTON PARTNERS II, LLP, JAMES KENKELEN, A TRANSFEREE, AND EILEEN WHITE, A TRANSFEREE, DEFENDANTS.



The opinion of the court was delivered by: Buckwalter, S.J.

MEMORANDUM

Currently pending before the Court is the Motion of Defendants Benton Partners II, LLP and I. Isabelle Benton to Dismiss the Second Amended Complaint. For the following reasons, the Motion is granted in part and denied in part.

I. FACTUAL AND PROCEDURAL HISTORY

A. Factual Background

1. History and Facts About the Philadelphia Stock Exchange

According to the facts set forth in the Second Amended Complaint, the Philadelphia Stock Exchange, Inc. ("PHLX") was founded in 1790 and, since then, has continuously conducted business in the city of Philadelphia. (Sec. Am. Compl. ¶ 15.) The PHLX is registered under section 78f of the Exchange Act as a self-regulatory organization ("SRO") and, as such, is overseen by the Securities and Exchange Commission ("SEC"). (Id. ¶¶ 17-18.) In addition to the federally promulgated rules and regulations, the PHLX also operates under its own set of rules and has an elected and appointed governing body. (Id. ¶ 21.) The PHLX officials include a chair, two vice-chairs, and members of the governing board, who are responsible for the general operation of the PHLX. (Id. ¶¶ 23, 25.) In addition, the Board designates members and non-members to serve on Standing Committees, such as Executive, Finance, Business Conduct, Floor Procedure, and Options. (Id. ¶ 24.)

Through January 20, 2004, the PHLX was operated as a not-for-profit mutual association incorporated in Delaware. (Id. ¶ 16.) There were 505 seats on the PHLX, with one of the seats owned by the PHLX itself. (Id.) Those who owned a "seat" on the PHLX effectively owned an equity interest in the association and maintained the right to trade on the PHLX floor. (Id.) On January 21, 2004, the PHLX was "demutualized," such that it became a for-profit Delaware corporation owned by its stock holders. (Id.) Each of the other 504 seats was exchanged for, or converted into, one hundred shares of Class A PHLX stock. (Id.) Those owning Class A stock were entitled to a "special dividend" under certain contingencies. (Id.) Demutualization had no effect on the PHLX's status as an SRO, and the SEC approved the required rule changes for PHLX to operate as a for-profit stock corporation. (Id. ¶ 17.) From January 21, 2004 through December 31, 2006, all transactions in PHLX stock were required to be done in units of 100 shares. (Id. ¶ 26.)

Prior to demutualization, the best bids for and offers of PHLX were public, with the person or entity making the bid or offer identified. (Id. ¶ 27.) Any change in seat ownership was publicly posted and listed in the next PHLX bulletin. (Id.) After demutualization, however, and until approximately December 1, 2004,*fn1 the only way to obtain an indication of interest to buy or sell PHLX stock was to contact the Shareholder Services Department. (Id. ¶ 28.) Unless the inquiring person was listed as a qualified investor with Shareholder Services, no information regarding bids was given. (Id.) If a stock transaction was to be consummated, the Shareholder Services Department acted as an intermediary and revealed the parties' identities at that juncture. (Id.)

2. Relevant Events in PHLX's History

In 1997, Meyer (Sandy) Frucher joined the PHLX board. (Id. ¶ 29(a).) By June of 1998, Frucher became the Board Chair and PHLX CEO, remaining in that position during all times relevant to the allegations of the Second Amended Complaint. (Id. ¶ 29(b).) Throughout his tenure, the PHLX continuously searched for new ways to obtain an influx of capital. (Id. ¶ 29(c),(d).) At some point in 2001, Frucher assembled a team consisting of Norman Steisel, Robert Gerard, and the PHLX outside financial advisor, Keefe, Bruyette & Wood, Inc. ("KBW") to demutualize the PHLX and seek out strategic partnerships or investors to provide the needed capital. (Id. ¶ 38.)

Beginning in July 2001, KBW pursued sales of PHLX assets and performed a series of valuations of and for the PHLX, at which time it valued PHLX assets for purposes of sale. (Id. ¶¶ 32-33.) During an October 2002 Board meeting, KBW informed the PHLX Board of Governors that the PHLX had a value of between $250 and $350 million. (Id. ¶ 34.) KBW also explained that the PHLX's structure as a not-for-profit mutual association restricted its ability to enter into deals with "strategic investors" and that demutualization was a necessary course. (Id. ¶ 35.) This information was purportedly obtained from a transaction known as the "Kwok Li deal," in which another business sought to enter into a profit-making arrangement with the PHLX. (Id.) Notably, seat owners on the PHLX were repeatedly told of PHLX's financial problems, but were never told of the value the PHLX could have with the entry of strategic investor. (Id. ¶ 37.)

Frucher thereafter developed a plan for demutualization that was presented to the Board in December 2002. (Id. ¶ 29(e).) On February 12, 2003, Frucher published an official memo to the PHLX community on various issues that had arisen in connection with the demutualization, including the future equity interest of management and the voting rights of members and seat owners. (Id. ¶ 29(f).) Subsequently, on October 22, 2003, the PHLX Board issued an "Informational Memorandum on Demutualization" ( the "Info Memo"). (Id. ¶ 29(g).) This document contained, in part, an advisory letter from KBW, and represented that the survival of the PHLX was in jeopardy unless the PHLX received an infusion of capital. (Id.) Further, it indicated that the value to a seat owner of an ownership interest in the PHLX would be less than zero if a seat owner opted out of demutualization in lieu of a state law appraisal of his or her rights. (Id.)

In the fall of 2004, PHLX conducted talks with Citadel, who expressed interest as a potential strategic partner in the PHLX. (Id. ¶ 29(h).) Throughout the remainder of the fall season, the PHLX publicized statements that it had been advised to seek bankruptcy counsel. (Id. ¶ 29(I).) By November of 2004, PHLX began serious negotiations with Archipelago Holdings ("Arca"). (Id. ¶ 29(j).) Arca and PHLX entered into a confidentiality agreement, on December 3, 2004, to allow the parties to exchange information for purposes of negotiations. (Id.) Arca ultimately offered to purchase the PHLX for $50 million, to be paid through a combination of cash and Arca stock. (Id.) On April 21, 2005, however, the PHLX announced that it rejected the possible sale to Arca to pursue other options. (Id. ¶ 29(k).)

Subsequently, on August 16, 2005, Interactive Brokers Group (Timber Hill) sent a letter to Frucher offering to pay $20,000,000 for a non-dilutable twenty percent equity interest in the PHLX. (Id. ¶ 29(l).) Ultimately, on September 22, 2005, the PHLX issued a tender offer to buy up to 167 blocks of 100 shares at $900 per share from the original Class A shareholders, effectively offering to retire stock from these shareholders at the same price they would have received had the Arca deal been consummated. (Id. ¶ 29(m).) During these relevant transactions, the PHLX Board used KBW as its financial advisor and Wilkie, Farr & Gallagher ("WFG") as its legal counsel. (Id. ¶ 30.)

3. Background of Plaintiff Mill Bridge V, Inc.

Van der Moolen Options U.S.A., LLC ("VDM") was a Delaware limited liability company that, in part, conducted business as a specialist on the options floor of the PHLX. (Id. ¶ 9.) At the close of 2003, VDM terminated its options business on the PHLX floor and ended its membership in the PHLX. (Id. ¶ 10.) Before doing so, VDM entered into negotiations to sell its PHLX operations to Defendant I. Isabelle Benton, during which time VDM provided Benton with non-public information. (Id. ¶ 11.) The negotiations ended without a deal being consummated. (Id.)

When the PHLX was demutualized in January of 2004, VDM received 600 shares of Class A PHLX stock in exchange for its six PHLX seats. (Id. ¶ 12.) In December 2004, VDM sold these 600 shares to Benton's company, Defendant Benton Partners II, LLP ("BPII"). (Id. ¶ 12.) Subsequently, on August 22, 2005, pursuant to provisions of the Delaware General Corporation Law, VDM merged with, and into, Plaintiff Mill Bridge V, Inc. ("Mill Bridge V"). (Id. ¶ 13.) The merger agreement provided that all of the property, rights, and privileges of VDM vested in plaintiff Mill Bridge V. (Id. ¶ 14.)

4. Details of the Alleged Insider Trading Transaction

Defendant Benton became a member of the PHLX Board of Governors in the spring of 2003 and, at all relevant times, also served on the Executive Committee, the Business Conduct Committee, and the Demutualization Advisory Group. (Id. ¶ 40.) As part of the Demutualization Advisory Group, Benton was involved in the preparation and assembly of the Info Memo distributed in October 2003. (Id. ¶ 41.) According to the Second Amended Complaint, the Info Memo, aside from making the aforementioned affirmative representations about the state of the PHLX, did not include information pertaining to: (1) the existence and content of valuations performed of the PHLX, including the Kwok Li deal; (2) the "extant plans" to realize the value of the PHLX or assets of the PHLX in separate transactions; and (3) the prior relationships that Robert Gerard, WFG, and KBW had with the PHLX. (Id. ¶ 44.)

In mid-November 2004, BPII placed an "indication of interest" to acquire PHLX stock. (Id. ¶ 49.) On December 1, 2004, BPII made its first purchase of PHLX stock from former seat owner and current stockholder Richard Feinberg. During the negotiations, BPII did not disclose any information such as the underlying value of the PHLX and PHLX's current efforts to enter into deals. (Id. ¶ 50.)

VDM contacted Shareholder Services on December 1, 2004 in order to sell its Class A PHLX stock. (Id. ¶ 52.) Rather than informing VDM of the then-pending bids and advising VDM to post an "indication of interest" to sell, Shareholder Services, through its director Robert Kreszswick, directly contacted Defendant Benton and informed her that VDM wished to sell its stock. (Id.) Benton thereafter made contact with Janet Bennett, VDM's representative in Philadelphia, to indicate her interest in buying VDM's PHLX shares. (Id.) According to Plaintiff, there were several bids for 100 shares each then pending on the books of Shareholder Services: (1) Daniel Carrigan having bid $10,000 on November 12, 2004; (2)William F. Rooney having bid $14,500 on November 12, 2004 for 100 shares and increasing his bid to $18,750 on November 30, 2004; (3) Richard A. Kirslis having bid $16,600 on November 23, 2004 for 100 shares; and (4) Scott Ruden having bid $17,000 on November 30, 2004. (Id. ¶ 53.)*fn2

"As a result of VDM being informed that BPII was the sole bidder at the relevant time," VDM did not learn of other bids and how much had been paid for PHLX stock on other sales within the preceding thirty days, even though Shareholder Services had begun to show both bids and offers of stock on its website. (Id. ¶ 56.) Ultimately, VDM sold all 600 shares of PHLX stock to BPII for $13,000 per 100 shares. (Id. ¶¶ 56, 65.) The stock purchase was marked private. (Id. ¶ 57.)

During the December 15, 2004 meeting of the PHLX Board, a "freeze" was imposed on all PHLX stock transactions by PHLX Board members. (Id. ¶ 51.) From the date of January 2004 demutualization up until the December 15, 2004 freeze, BPII purchased approximately one half of all PHLX stock that was sold between the day of demutualization and the "freeze." (Id.)

5. Related Litigation

The demutualization and subsequent sale of PHLX led to a number of civil lawsuits, one of which was brought directly against Defendants Benton and BPII. Specifically, on September 5, 2005, Steven Mirow, current Plaintiff's counsel, filed a complaint on behalf of Richard Feinberg asserting insider trading claims against BPII and Benton. Compl., Feinberg v. Benton, Civ. A. No. 05-4847 (E.D. Pa. Sep. 9, 2005) ("Feinberg Complaint"); see also Feinberg v. Benton, No. CIV.A.05-4847, 2007 WL 4355408 (E.D. Pa. Dec. 13, 2007) (denying summary judgment). The Feinberg Complaint claimed violation of Rule 10b-5 and control person liability against the defendants in connection with a November 30, 2004 sale by Feinberg to BPII of 100 shares of PHLX stock. The case proceeded to a non-jury trial. On July 2, 2008, the Court entered judgment for the defendants on all claims.

B. Procedural History

On June 16, 2008, Mill Bridge V, LLC ("Mill Bridge LLC"), represented by Steven Mirow, brought suit against BPII and Benton claiming a violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b-5, 17 C.F.R. § 240.10b-5; seeking rescission under section 29(b) of the Securities Exchange Act, 15 U.S.C. § 78cc(b), and alleging control person liability under section 20(a) of the Exchange Act, 15 U.S.C. § 78t. The Complaint alleged that BPII bought 600 shares of PHLX stock from VDM on December 10, 2004, without disclosing material non-public information and that Mill Bridge LLC was the successor in interest to VDM. Defendants moved to dismiss the complaint on various grounds and, in lieu of a response, the plaintiff asked for additional time to obtain documents from VDM in the Netherlands and determine if Mill Bridge LLC was the proper plaintiff. This Court dismissed the complaint without prejudice and allotted a set period of time in which to file an amended complaint.

Plaintiff's counsel filed a new pleading entitled "First Amended Complaint" on October 20, 2008. This document was brought on behalf of current Plaintiff Mill Bridge V, Inc. and raised the identical claims. Defendants again moved to dismiss. On April 30, 2009, the Court dismissed the First Amended Complaint and ordered Plaintiff to file, within twenty days, a new complaint that complied with the following directives: (1) "Plaintiff, when addressing its insider trading claim (Count I), shall specify, in accordance with Fed.R.Civ.P. Rule 9(b), the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-4b, and appropriate case law, each alleged material misstatement or omission, and offer all specific, relevant facts that explain why each was misleading;" and (2) "As to Count III, Plaintiff shall set forth the specific provision of the Philadelphia Stock Exchange's Code of Conduct that was allegedly violated by Defendant Isabelle Benton." Order, Mill Bridge V, Inc. v. Benton, Civ. A. No. 08-2806 (E.D. Pa. Apr. 30, 2009).

Plaintiff filed the current Second Amended Complaint on May 20, 2009, adding Defendants James Kenkelen and Eileen White as transferees of some of the 600 shares of PHLX stock. The Second Amended Complaint re-asserted the three causes of action from the prior iterations of the document, and added a new claim under the Pennsylvania Securities Act, 70 Pa.C.S. §§ 1-401(a), 501(a). On June 4, 2009, Defendants moved to dismiss the Second Amended Complaint, Plaintiff responded, and both parties filed supplemental briefs. The Court now turns to a discussion of the Motion.

II. STANDARDS OF REVIEW

A. General Standard of Review Under Rule 12(b)(6)

Under Rule 12(b)(6), a defendant bears the burden of demonstrating that the plaintiff has not stated a claim upon which relief can be granted. FED. R. CIV. P. 12(b)(6); see also Hedges v. United States, 404 F.3d 744, 750 (3d Cir. 2005). In Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007), the United States Supreme Court recognized that "a plaintiff's obligation to provide the 'grounds' of his 'entitle[ment] to relief' requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Id. at 555. Following the basic dictates of Twombly, the Supreme Court, in Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009), subsequently defined a two-pronged approach to a court's review of a motion to dismiss. "First, the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions. Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice." Id. at 1949. Thus, although "Rule 8 marks a notable and generous departure from the hyper-technical, code-pleading regime of a prior era . . . it does not unlock the doors of discovery for a plaintiff armed with nothing more than conclusions." Id. at 1950. Second, the Supreme Court emphasized that "only a complaint that states a plausible claim for relief survives a motion to dismiss." Id. "Determining whether a complaint states a plausible claim for relief will . . . be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense." Id. Where the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged, but not shown an entitlement to relief.

Id.; see also McTernan v. City of York, Pa., 577 F.3d 521, 530-31 (3d Cir. 2009).

Notwithstanding these new dictates, the basic tenets of the Rule 12(b)(6) standard of review have remained static. DeFebo v. Andersen Windows, Inc., No. CIV.A.09-2993, 2009 WL 4268553, at *4 (E.D. Pa. Nov. 23, 2009); Spence v. Brownsville Area Sch. Dist., No. CIV.A.08-626, 2008 WL 2779079, at *2 (W.D. Pa. Jul. 15, 2008). The general rules of pleading still require only a short and plain statement of the claim showing that the pleader is entitled to relief and need not contain detailed factual allegations. Phillips v. County of Allegheny, 515 F.3d 224, 233 (3d Cir. 2008). Further, the court must "accept all factual allegations in the complaint as true and view them in the light most favorable to the plaintiff." Buck v. Hampton Twp. Sch. Dist., 452 F.3d 256, 260 (3d Cir. 2006). Finally, the court must "determine whether, under any reasonable reading of the complaint, the plaintiff may be entitled to relief." Pinkerton v. Roche Holdings Ltd., 292 F.3d 361, 374 n.7 (3d Cir. 2002).

B. Heightened Pleading Standard for section 10(b) and Rule 10b-5 Claims

While the above-defined Rule 12(b)(6) standard applies generally to all motions to dismiss, Plaintiff's claims under Section 10(b) and Rule 10b-5 carry additional and more stringent pleading requirements. Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") prohibits the use of fraudulent schemes or devices in connection with the purchase or sale of securities. 15 U.S.C. § 78j(b) (2000). "Pursuant to this statutory authority, the [SEC has] promulgated Rule 10b-5, which creates a private cause of action for investors harmed by materially false or misleading statements." In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 275 (3d Cir. 2006). Rule 10b-5 prohibits, in connection with the purchase or sale of securities, the making of "any untrue statement of a material fact" or the omission of "a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading."

17 C.F.R. § 240.10b-5 (1951).

To state a claim under section 10(b) and Rule 10b-5, a plaintiff must allege: (1) a material misrepresentation or omission; (2) scienter; (3) a connection with the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation. Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005); In re Suprema, 438 F.3d at 275. In assessing the sufficiency of section 10(b) pleadings, the court "accept[s] all factual allegations in the complaint as true," and "consider[s] the complaint in its entirety, as well as . . . sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322-23 (2007).

Because Section 10(b) claims sound in fraud, however, plaintiffs must satisfy the heightened pleading standard of Federal Rules of Civil Procedure 9(b). Rule 9(b) requires that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." FED. R. CIV. P. 9(b). This heightened pleading standard "'give[s] defendants notice of the claims against them, provide[s] an increased measure of protection for their reputations, and reduce[s] the number of frivolous suits brought solely to extract settlements.'" Key Equity Investors, Inc. v. Sel-Leb Mktg., Inc., 248 Fed. Appx. 780, 784 n.5 (3d Cir. 1997) (quoting In re Suprema, 438 F.3d at 270). The standard is "relaxed somewhat where the factual information is peculiarly within the defendant's knowledge or control." See In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1418 (3d Cir. 1996).

In addition to the requirements of Rule 9(b), a securities fraud plaintiff must also meet the heightened pleading standard of the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4. The PSLRA was enacted to reduce the number of frivolous "'strike suits' aimed at achieving quick settlements," and established specific pleading mandates for several of the 10b-5 elements. In re Campbell Soup Sec. Litig., 145 F. Supp. 2d 574, 584-85 (D.N.J. 2001). As to the first element, the PSLRA requires that a complaint set forth "each statement alleged to be misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information or belief, the complaint shall state with particularity all facts on which that belief is formed." See 15 U.S.C. § 78u-4(b)(1); see also Key Equity Investors, 246 Fed. Appx at 784; In re Alpharma Inc. Sec. Litig., 372 F.3d 137, 147 (3d Cir. 2004). In other words, the complaint should set out the "who, what, when, where and how" of the events at issue. In re Alphapharma, 372 F.3d at 148 (quotations omitted).

As to the second element of scienter, a plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. (quoting 15 U.S.C. § 78u-4(b)(2)). To do so, the complaint may allege: (1) "facts to show that defendants had both motive and opportunity to commit fraud," or (2) "facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Id. (quotations omitted). The United States Supreme Court has emphasized that a complaint gives rise to a "strong inference" of scienter "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Tellabs, 551 U.S. at 324.

In Cal. Pub. Employees' Ret. Sys v. Chubb Corp., 394 F.3d 126 (3d Cir. 2009), the Third Circuit Court of Appeals summarized the interplay between the three standards established by Rule 12(b)(6), Rule 9(b), and the PSLRA, as follows:

"[U]nless plaintiffs in securities fraud actions allege facts supporting their contentions of fraud with the requisite particularity mandated by Rule 9(b) and the Reform Act [PSLRA], they may not benefit from inferences flowing from vague or unspecific allegations -- inferences that may arguably have been justified under a traditional Rule 12(b)(6) analysis." . . . . In other words, pursuant to this 'modified' Rule 12(b)(6) analysis, 'catch-all' or 'blanket' assertions that do not comply with the particularity requirements are disregarded.

Id. (internal citations omitted). If a complaint fails to meet the stringent pleadings requirements for sustaining a § 10(b) claim, the "appropriate sanction . . . is dismissal." Id. (citing 15 U.S.C. § 78u-4(b)(3)(A)); see also In re Rockefeller Ctr. Props., Inc. Sec. Litig., 311 F.3d 198, 224 (3d Cir. 2002).

III. DISCUSSION

Defendants now move to dismiss the entirety of the Second Amended Complaint on various grounds. First, Defendants seek dismissal of Plaintiff's two claims under Section 29(b) of the Exchange Act. Second, Defendants allege that the Rule 10b-5 claim is inadequately pled. Third, Defendants assert that the section 20(a) control person liability claim against Defendant Benton cannot stand. Finally, Defendants aver that Plaintiff's claims under the Pennsylvania Securities Act fail on multiple grounds. The Court addresses each argument individually.

A. Claim Under Section 29(b) of the Securities Exchange Act (Counts IV and V)

Counts IV and V of the Second Amended Complaint seek rescission of the December 2004 trade between VDM and BPII pursuant to section 29(b) of the Securities Exchange Act. Rule 29(b) states, in pertinent part:

Every contract made in violation of any provision of this chapter or of any rule or regulation thereunder, . . . [or] the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of this chapter or any rule or regulation thereunder, shall be void.

15 U.S.C. § 78cc(b) (1990). "Section 29(b) itself does not define a substantive violation of the securities laws; rather, it is the vehicle through which private parties may rescind contracts that were made or performed in violation of other substantive provisions." Berckeley Inv. Group, Ltd. v. Colkitt, 455 F.3d 195, 205 (3d Cir. 2006). Plaintiffs invoking section 29(b) to void an Agreement must establish that the contract they seek to void involved or will involve a prohibited transaction, that they are in contractual privity with respect to the disputed transaction, and that they are in the class of persons that the securities acts were designed to protect. Id. (citing Reg'l Props., Inc. v. Fin. and Real Estate Consulting Co., 678 F.2d 552, 559 (5th Cir. 1982)).

Plaintiff now relies on the PHLX Code of Conduct to satisfy the prohibited transaction element of section 29(b) claim. Specifically, he asserts the PHLX Code of Conduct in effect at the time relevant to this case required a "covered person" -- i.e., one who was in possession of material information of the PHLX -- to inform the PHLX Board when he or she wished to engage in any transaction connected to the PHLX. The Board had to then given approval for that "covered person" to proceed on that transaction. (Sec. Am. Compl. ¶¶ 83-105.) Because Defendant Benton, as a member of the PHLX Board and thus a "covered person," never obtained clearance from the PHLX Board to engage in her proposed PHLX stock transaction, Plaintiff claims that she violated the PHLX Code of Conduct. (Id. ¶¶ 100-103.) According to Plaintiff, this failure "to comply with a rule or regulation made under the Securities Exchange Act in forming the contract of sale at issue herein provides the basis for Plaintiff to rescind said sale pursuant to Section 29(b) of the Act." (Id. ¶ 104.)

Prior to addressing the viability of Plaintiff's claim, some background discussion of the PHLX's self-promulgated regulations is helpful. In 1997, the PHLX adopted a written code of conduct ("PHLX 1997 Code of Conduct") that addressed, among other matters, dealings or transactions by "covered persons," which included members of the PHLX Board, PHLX officers, and members of PHLX committees or groups -- all of whom had access to material, non-public information. (Sec. Am. Compl. ¶ 84.) This Code was approved by the SEC as PHLX Rule 708. Order Granting Approval to Proposed Rule Change Relating to Amendments to Certificate of Incorporation and By-laws, Release No. 34-38960, 62 Fed. Reg. 45904-1 (Aug. 29, 1997).

Subsequently, on June 21, 2002, the PHLX filed with the SEC a proposed rule change to adopt a Seat Transaction Policy for Governors, Committee Members, and Associated Member Organizations. (Sec. Am. Compl. ¶ 85); Order Approving Proposed Rule Change by the Philadelphia Stock Exchange, Inc. to Adopt a Seat Transaction Policy and Add Supplementary Material to PHLX Rule 708, Release No. 34-47389, 68 Fed. Reg. 9107-01 (Feb. 27, 2003). Under the Policy, "before a Covered Person or their associated member organization could purchase or sell a Seat, the Covered Person [had to] notify the Exchange, in writing, which [would] convene the Special Committee on Governor and Committee Member Seat Transactions ('Special Committee')." (Pl.'s Resp. Mot. Dismiss, Ex. 1.) Thereafter, the Special Committee would review the proposed seat transaction to determine if the covered person had any material confidential information and, if so, the Committee was empowered to take steps to protect the information from inappropriate disclosure. (Id.) This Policy also amended the previously-adopted PHLX Rule 708 -- entitled "Acts Detrimental to the Interest and Welfare of the Exchange" -- to make clear to Covered Persons that any violation of the Seat Transaction Policy constituted an act detrimental to the Exchange and was in violation of PHLX Rule 708. (Sec, Am. Compl. ¶ 86); Release No. 34-47389, 68 Fed. Reg. 9107-01. Via Release issued on February 27, 2003, the SEC again approved this proposed rule change. Release No. 34-47389, 68 Fed. Reg. 9107-01.

On May 20, 2004, subsequent to demutualization and the elimination of seats, the PHLX filed with the SEC another proposed rule change, this time seeking to rescind Commentary .01(f) to the previous Exchange Rule 708, which corresponded to the PHLX Code of Conduct policy statement on seat transactions. (Sec. Am. Comp. ¶ 91.) This commentary stated that:

[a] member, member organization, or person associated with or employed by a member or member organization shall not engage in acts detrimental to the interest or welfare of the Exchange. . . . . .01 Acts which could be deemed detrimental to the interest or welfare of ...


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