Tuesday, December 15, 2015

Panel Upholds Dismissal of Suit Alleging Exchanges Overcharged Firms

By Kevin Kulling, J.D.

The Seventh Circuit Court of Appeals has upheld the dismissal of a lawsuit brought by Citadel Securities, LLC and other market makers against several options exchanges, including the Chicago Board Options Exchange (CBOE). In the suit, Citadel claimed it was overcharged millions of dollars over a seven-year period under the exchanges’ “payment for order flow” programs. The court said that Citadel had not exhausted all available administrative remedies before turning to the courts for relief (Citadel Securities, LLC, v. Chicago Board Options Exchange, Inc., December 11, 2015, Flaum, J.)

Market makers’ complaint. Citadel along with three other specialist firms brought the lawsuit against CBOE and four other options exchanges, alleging that the exchanges had improperly assessed fees for options trades between January 2004 and June 2011. The fees are known as “payment for order flow” (PFOF).

According to the complaint, one of the exchange members, not identified in the complaint, had mismarked requests to buy and sell options as originating with public customers, when they were not. Although such orders should not have been subject to the fees, the firms were assessed fees totaling millions of dollars. Citadel sought to recover what it said were improperly assessed fees.

District court ruling. In granting CBOE’s motion to dismiss, the district court said that the Exchange Act provided a comprehensive administrative review process for decisions rendered by exchanges. Final rulings issued by an exchange are subject to administrative review by the SEC, and if an aggrieved party is dissatisfied with the SEC’s determination, the court said, they can obtain further review from a federal appellate court. Ultimately, the district court concluded that Citadel had failed to demonstrate that they exhausted or did not have a meaningful administrative remedy.

Issues on appeal. Citadel argued that because the exchanges acted outside of their regulatory function and solely in their private capacity as for profit entities, there was no need for exhaustion of remedies before the SEC. Citadel also argued that “exhaustion” was not required because the SEC cannot provide adequate relief.

The Seventh Circuit said, however, that “given that the plain language of the Exchange Act calls for SEC review of plaintiffs’ allegations of improper PFOF fees, the district court did not abuse its discretion in holding that plaintiffs are required to exhaust administrative remedies.”

Additionally, Citadel had not clearly shown that the SEC’s administrative procedure is futile or inadequate to prevent irreparable injury. “While there is no obvious path to the monetary compensation plaintiffs seek, it is impossible to say whether relief is available since plaintiffs have made no attempt to bring the matter before the SEC.”

Remand issue. Citadel also argued that removal of the case to federal court was improper because there was no federal regulatory interest at issue. The Seventh Circuit held that the district court’s denial of plaintiff’s motion to remand was proper. The court said that removal was proper based on federal law that gives district courts exclusive jurisdiction on matters such as Citadel’s allegations that the exchange violated its own rules, which is governed by the Exchange Act and establishes that federal courts have exclusive jurisdiction over actions seeking to interpret and enforce compliance with exchange rules or the Act itself.

The case is Nos. 14‐2912 and 14‐3071.

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