United States District Court, E.D. Pennsylvania
I. STEPHEN RABIN, on behalf of himself and all others similarly situated, Plaintiff,
John Doe Market Makers, NASDAQ OMX PHLX LLC, and NASDAQ OMX GROUP, INC., Defendants.
Gerald Austin McHugh United States District Court Judge
Now before me in this purported securities class action are motions by two parties who wish to be appointed as lead plaintiff for a class of investors.
Plaintiff I. Stephen Rabin (“Rabin”) is an individual investor and filed the original Complaint in this action. He describes himself as “an attorney who actively invests in the options market and is familiar with securities markets.” Rabin’s Memorandum in Further Support of his Motion for Appointment as Lead Plaintiff at 10. Plaintiff Rabin’s Complaint alleges a complex conspiracy among certain market participants to use special market privileges to unfairly extract dividend payments from stocks. I will briefly summarize the extensive allegations in Rabin’s Complaint.
The Complaint focuses on alleged actions of certain “market makers.” A market maker is a dealer who plays a quasi-regulatory role in a market, promoting liquidity in the market by promising to be able to engage in transactions with other brokers or dealers at quoted prices. Complaint ¶ 1 n.1; 17 C.F.R. § 15c3-1(c)(8). Market makers enjoy certain privileges because of their quasi-regulatory status.
The Complaint alleges the market makers used these privileges to unfairly manipulate certain options trades. As Plaintiffs put it, “[a]n option is a contract to buy or sell a specific underlying security.” Complaint ¶ 15. A particular kind of option is called a “call;” it “gives the holder (the ‘buyer’) the right, but not the obligation, to buy 100 shares of the underlying security … at a specified price.” Complaint ¶ 19. An entity may both sell and buy options. An entity that has sold more than it has bought has taken a “short” position; the reverse is a “long” position. Complaint ¶ 20. Sellers receive a premium fee for writing and selling an option. Complaint ¶ 21.
When a party exercises an option to acquire the security to which the option relates, she sends a notice to the Options Clearing Corporation (OCC). Complaint ¶ 24. The OCC randomly selects a broker/dealer that wrote the kind of option being exercised and assigns to the broker/dealer the obligation to satisfy the option. If a party has exercised an option and become an owner of a security within a certain minimum amount of time before that security pays a dividend, the party will receive the dividend.
According to the Complaint, some percentage of options holders regularly fail to exercise their options. Those options are not assigned by the OCC, and therefore some sellers are not required to deliver the security on which the unassigned option is based. Complaint ¶ 27. An option seller who does not have to deliver a security because the option was not assigned can collect a dividend paid by that security. The Complaint avers, “[t]he measure of these unexercised options is the contract’s ‘open interest.’ ” Complaint ¶ 27.
Certain market makers, the Complaint alleges, have used privileges provided by their status, such as the ability to simultaneously buy and sell the same numbers of options, to unfairly win a large share of the open interest. These market makers have allegedly executed transactions with each other buying and selling large numbers of options in matched trades. The trades are many times larger than the rest of the pool of outstanding options, and because of their disproportionate size, the large trades make it likely that the market makers will be assigned by the OCC most of the “open interest” and collect most of the security’s dividend while exposing themselves to little or no risk. Complaint ¶ 28.
Plaintiff Rabin argues that this practice injures “retail investors” such as himself who had also purchased options because their share of the “open interest” is diminished by the market makers’ large matched trades. Rabin argues that the market makers have violated federal securities laws and that the retail investors injured by the trades are a class entitled to relief.
Rabin filed a Complaint alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 as well as unjust enrichment. The Private Securities Litigation Reform Act (PSLRA) required Rabin, after filing the Complaint, to publicize a notice of the action and afford other potential members of the purported class the opportunity to file their own motions to be appointed as lead plaintiff. 15 U.S.C. § 78u-4; Manual for Complex Litigation (Fourth) § 31.3 (2004). In this case, only one other party filed such a motion: Freshwater Global Alpha Fund, L.P. (“Freshwater”). Freshwater is an institutional investor. Plaintiff Rabin has also filed a motion to be appointed as lead plaintiff for the class action. Both parties have also asked the court to appoint their current counsel as lead counsel for the class.
The Third Circuit has explained that the PSLRA “establishes a two-step process for appointing a lead plaintiff: the court first identifies the presumptive lead plaintiff, and then determines whether any member of the putative class has rebutted the ...