Monday, December 07, 2009

2nd Circuit Upholds Short Sale Antitrust Preemption

By James Hamilton, J.D., LL.M.

A 2nd Circuit panel affirmed (In re Short Sale Antitrust Litigation) a decision by the U.S. District Court for the Southern District of New York that an antitrust claim against several brokerage firms involved in short selling was preempted by the securities laws. The class members acted as sellers in short-sale securities transactions and alleged that the brokerage firms conspired to charge short sellers artificially inflated fees in connection with securities borrowing for the sales in violation the antitrust laws. In determining that the antitrust claim was preempted, the appellate court applied the analysis used by the U.S. Supreme Court in its 2007 decision, Credit Suisse Securities (USA) LLC v. Billing.

The 2nd Circuit found that, within the short sale context at issue, antitrust laws were clearly incompatible with the securities laws because short selling is an area of conduct squarely within the area of securities regulations, the SEC has clear and adequate authority to regulate the area and is engaged in active and ongoing regulation and there is a serious conflict between the antitrust and securities regulatory regimes.

The appellate panel found that the Commission had sufficient regulatory authority under Exchange Act Section 10(a). The plaintiff, referring to the legislative history of that provision, argued that Section 10(a) was intended only to regulate the manipulation of share price through short selling. However, according to the appeals panel, "nothing in the wording of Section 10(a) so limits its reach and the SEC has interpreted Section 10(a) as a grant of `plenary authority' to regulate short sales."

Regulation SHO and the SEC's recent short sale roundtable evidenced the agency's ongoing regulation of short sales. While conceding that the roundtable and the regulation did not focus specifically on the regulation of borrowing fees, the court found that "it is enough for this purpose that the SEC’s ongoing regulation is focused on the role of the prime brokers in short selling."

Finally, the court found that actual and potential conflicts existed between the antitrust and securities regulatory schemes. An actual conflict existed because antitrust liability would inhibit brokers from engaging in other conduct that the SEC currently permits and that benefits the efficient functioning of the short selling market. There was also a potential conflict because the SEC in the future may decide to regulate the borrowing fees charged by brokers.