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Monthly Archives: October 2015

Class Action Mismatch: Securities Class Action Jurisprudence and High-Frequency Trading Manipulation

Tara E. Levens, Too Fast, Too Frequent? High-Frequency Trading and Securities Class Actions, 82 U. Chi. L. Rev. 1511 (2015).

For faculty members with retirement savings in TIAA-CREF or brokerage accounts, market events of summer 2015 might prompt the conclusion that August is the cruelest month of all. Along with millions of other small investors, academics throughout the United States could only watch helplessly as volatile markets took shareholders on a daily roller-coaster ride resulting in devalued accounts.

In the wake of the 2008 market crash, small investors have become increasingly educated about the structural and institutional drivers of extreme market volatility: automatic, computerized trading techniques over which the small, individual stakeholder has little knowledge or control. Most prominent among these market innovations has been the advent of computerized, high-frequency trading (HFT), driven by mathematical algorithms.

In her thoughtful and innovative comment, Too Fast, Too Frequent? High-Frequency Trading and Securities Class Actions, Tara E. Levens explores the interesting question whether the prevalence of HFT techniques resulting in massive financial losses to small-stake investors will open the door to new securities class actions. Her general conclusion is that current legal theories undergirding various types of securities law violations are mismatched with the harms induced by HFT. Consequently, Levens attempts to formulate a jurisprudence for new securities class actions based on the unique injuries resulting from HFT manipulation. In essence, Levens’ task is a riff on the theme of fitting new wine into old bottles.

Levens first describes the types of investor harms addressed under current securities laws, most notably liability for fraudulent misrepresentation under § 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934. She suggests that the harms induced by HFT are a poor fit for conventional securities fraud claims. Instead, she pivots to theories of open-market manipulation, which she believes better capture the factual basis for seeking relief.

She notes that plaintiffs may bring claims of open-market manipulation under § 10(b), although “such claims have received ‘curiously little attention’ from plaintiffs, prosecutors, and the courts.” (Pp. 1514–15.) She further suggests that plaintiffs might bring claims of open-market manipulation under § 9 of the Act, but such actions require a showing of specific intent. Because of the difficulty in pursuing relief under § 9, Levens indicates that plaintiffs and prosecutors rarely rely on this provision when bringing manipulation proceedings.

To provide context for her recommendations, Levens analyzes developments in securities class litigation, focusing on the Supreme Court’s elaboration of the fraud-on-the-market presumption that relieves plaintiffs of the necessity to show individual reliance in fraud cases. She suggests that the Court’s 2014 Halliburton decision changed the landscape of securities-fraud class litigation by enhancing the role of expert witness “impact studies” used to demonstrate the effect of an alleged fraud or misrepresentation on a stock’s price, which may determine whether the fraud-on-the-market presumption applies. However, she refrains from concluding whether the increased use of impact studies will benefit either plaintiffs or defendants, or result in more or fewer class certification approvals.

Against this doctrinal backdrop, Levens discusses in great technical detail what constitutes high frequency trading, a subset of algorithmic trading. She explains two types of HFT: market-making activities and more aggressive strategies such as statistical arbitrage. Levens’ article provides an intelligible, accessible account of HFT for less-knowledgeable readers. She concludes by surveying the heated debate over the effects of high frequency trading on market efficiency.

Levens highlights exactly how novel the problem of HFT is on the legal landscape. She notes that the SEC has yet to promulgate formal rules or regulations relating to HFT. According to Levens, the SEC increased its enforcement efforts after the Flash Crash of May 2010, but studies are inconclusive whether HFT or other factors triggered that market collapse. The SEC brought its first market manipulation case against an HFT firm only in October 2014. That action was pursued under Rule 10b-5 and the alleged perpetrator agreed to pay a fine and to cease and desist from further violations of the securities laws.

Levens believes that the spread of HFT and consequent market collapses has set the stage for a resurgence of the open-market manipulation theory. She suggests that plaintiffs who wish to bring claims against HFT firms might succeed by combining various theories of open-market manipulation with the fraud-on-the-market presumption; this hybrid strategy allows plaintiffs to avoid the more stringent intent requirements of § 9, while also availing themselves of the liberal fraud-on-the-market presumption to avoid potentially difficult reliance issues. Levens notes that the fraud-on-the market presumption generally has not been available to plaintiffs alleging market manipulation claims, but she contends that in some situations courts have held otherwise.

Finally, Levens addresses whether high-frequency traders ought to have a private right of action to redress their own injuries, something no commentator has addressed. While noting that traders do not represent the most sympathetic group of claimants, she indicates that traders also may suffer losses from HFT. Analyzing this problem, Levens concludes that HFT traders most likely will have a very difficult time satisfying the requirements for certifying a class action under Fed. R. Civ. P. 23, showing loss causation, or proving reliance.

As Levens correctly points out, HFT issues are likely to continue to surface in litigation, presenting litigants and courts with an array of novel legal problems. She concludes that “regardless of whether high-frequency traders come to court as plaintiffs or defendants, the advent of HFT marks a changed circumstance that the securities-litigation bar will have to wrestle with in the near future.” (P. 1557.)

Levens, the incoming Editor-in-Chief of the University of Chicago Law Review, has produced an impressively sophisticated piece. She has identified a set of emerging legal issues and grappled with existing doctrine as applied to new problems. Even if her hybrid approach proves unsound, she is to be commended for undertaking such an ambitious, challenging topic and, in the best tradition of young scholarship, thinking outside the box.

Cite as: Linda S. Mullenix, Class Action Mismatch: Securities Class Action Jurisprudence and High-Frequency Trading Manipulation, JOTWELL (October 19, 2015) (reviewing Tara E. Levens, Too Fast, Too Frequent? High-Frequency Trading and Securities Class Actions, 82 U. Chi. L. Rev. 1511 (2015)), https://courtslaw.jotwell.com/class-action-mismatch-securities-class-action-jurisprudence-and-high-frequency-trading-manipulation/.

Controversial Supreme Court Appointments – A Blockbuster in the Foreign Films Category?

Often we like scholarship lots because it reflects new or interesting perspectives on familiar subjects. Sometimes, though, the story itself is so thought-provoking that a good telling is all that is needed to make the article worth commending to Courts Law readers.

Such is the case with Hugo Cyr’s article, which chronicles the highly charged engagement between the Supreme Court of Canada and the Canadian Government (the Executive, comprised of members of the ruling political party) over the fundamental requirements for their respective legitimacy. Everyone seems to agree that the incidents recounted were “unfortunate” in that they provoked strong expressions of differences in what has historically been regarded as a relationship to be managed tactfully. Yet the events exposed many intriguing issues about how best to conduct this critical relationship to promote the continuity and flexibility needed to serve well the interests of the public.

It is hoped that this brief summary will, like the fast-paced trailers that preview a movie’s highlights, whet the appetites of JOTWELL readers to press “watch” in the link above and follow the entire story. But, first, a word or two of background – much like the lines that appear by way of explanation in the first scene of the movie:

Like the Supreme Court of the United States, the Supreme Court of Canada serves a range of important constitutional roles, including as arbiter of federal relations. Indeed, so trusted has it become in that role that its unusual jurisdiction to render advisory opinions on the constitutionality of proposed legislation has been invoked on a number of occasions in recent years to provide perspective on potentially controversial political initiatives.

The implications of the Court’s many sensitive roles for judicial appointments – both for who is selected and for the appointment process – will be obvious to U.S. readers. The academic discussion and political commentary on the judicial appointment process in Canada has developed more slowly than in the U.S.; it has become more prevalent with the advent and interpretation of the Charter of Rights and Freedoms, although there is not yet any formal approval process.

Still, there has long been acknowledgement of the need for judges to be representative of Canada’s juridical diversity. The Supreme Court Act makes provision for three of its nine judges to be appointed from Québec. Customarily (i.e., not by law), the remaining six judges include three from Ontario, two from the provinces to the west and one from the provinces to the east. Since the Court is a court of general appellate jurisdiction, the inclusion of three members from Québec ensures that the Court, which may sit in panels of five, seven or nine, could arrange its sittings so that a majority of the panel deciding an appeal from Québec or having important implications for Québec-federal relations would be from that province.

As a practical matter, the Court operates in a much more collegial way than this would suggest. Many of the judges are functionally bilingual; they typically include young lawyers trained in Québec among their law clerks; and from time to time it even happens that Québec judges take the lead in writing majority or unanimous judgments on issues of the common law.

With the scene set, the drama begins with the need to appoint a successor for one of the retiring Québec judges. The incumbent Government, known for emphasizing expedience over politesse, conducted a process that did not ease these concerns by selecting a member, who was from Québec, of the Federal Court of Canada (a lower federal court).

Unfortunately, it is not clear that Supreme Court Act permits this. The provision for appointing judges from Québec sits within the larger context of the provision establishing the basic requirements for eligibility for appointment. To be eligible, a person must be either a current or former member of a superior court of a province, or a lawyer who has been a member of the profession for at least ten years. The language of the provision for appointing judges from Québec appears to add an additional requirement–that the appointee must be a current member of the Québec judiciary or the profession. Federal Court judges are neither. (Judges from Québec have been appointed without this qualification in the past, but not as one of the three Québec judges.)

Aware of the problem, the Government obtained advance opinions from well-respected past members of the Supreme Court and announced Marc Nadon’s appointment. In the course of the following week, he was interviewed by an ad hoc committee of parliamentarians to answer general questions about himself and his career and he was sworn in. His appointment was challenged immediately in the Federal Court, and the Supreme Court announced that he would not participate in matters for the time being. Later that month, the Québec National Assembly adopted a unanimous motion rejecting the appointment as deplorable unilateralism depriving Québec of its guaranteed “répresentation” on the Court.

These events are just the fast-paced opening scene of a fascinating story. The plot thickens as the Government attempts to sideline this opposition by introducing legislative amendments to correct the problem after the fact and by seeking an advisory opinion from the Supreme Court to bless its actions. There is considerable character development as the majority of the Supreme Court interprets its legislation as invalidating the Government’s appointment and goes on to pronounce the proposed legislation also constitutionally invalid. The drama continues as the Court offers the view that its composition and “essential features” are, or have become, entrenched and would require formal constitutional amendment to be modified. (In Canada, a constitutional amendment would be virtually impossible.)

The story’s ending necessarily remains open. But Professor Cyr astutely identifies the uneasy sense in which the Government’s bold action provoked a strong response from the Supreme Court that may have jeopardized the flexibility required to maintain good working relations between the Judiciary and the Executive. Such “cooperative federalism” has served Canada well in the past and may be much in demand to meet the challenges ahead in a changing world. Though the progress of this relationship is inevitably shaped by the specifics of Canadian law and politics, stories like this can be of larger comparative interest to those whose passion is Courts law.

Cite as: Janet Walker, Controversial Supreme Court Appointments – A Blockbuster in the Foreign Films Category?, JOTWELL (October 5, 2015) (reviewing Hugo Cyr, The Bungling of Justice Nadon’s Appointment to the Supreme Court of Canada, 67 Sup. Ct. L. Rev. 73 (2014)), https://courtslaw.jotwell.com/controversial-supreme-court-appointments-a-blockbuster-in-the-foreign-films-category/.