Short Seller's Price Fixing Claims Against “Prime Brokers” Barred

This posting was written by Jeffrey May, Editor of CCH Trade Regulation Reporter.

The federal securities law preempted a claim against large financial institutions that served as “prime brokers” in short sale transactions for artificially inflating fees imposed on short sellers in violation of the antitrust laws, the U.S. Court of Appeals in New York City has ruled.

Dismissal of the antitrust claim with prejudice (2007-2 Trade Cases ¶75,988), on the ground of implied preclusion of the antitrust laws by the securities laws, was affirmed.

A short seller profits from borrowing stocks that it believes will drop in price from a prime broker, selling them on the open market, and then purchasing replacement securities to return to the broker. The broker charges the short seller a borrowing fee.

A complaining short seller alleged that since 2000 prime brokers charged artificially inflated borrowing fees by agreeing on which securities to designate arbitrarily as hard-to-borrow and setting minimum borrowing fees for these securities.

Applying the reasoning of the U.S. Supreme Court's 2007 decision in Credit Suisse Securities (USA) LLC v. Billing, 2007-1 Trade Cases ¶75,738, the Second Circuit ruled that the short seller's price fixing claims were barred.

In Credit Suisse, the Supreme Court ruled that federal securities law implicitly precluded application of the antitrust law to the underwriters’ alleged anticompetitive conduct. The Court articulated four considerations that bear upon whether “the securities laws are ‘clearly incompatible’ with the application of the antitrust laws” in a particular context:

(1) Location within the heartland of securities regulations;
(2) SEC authority to regulate;
(3) Ongoing SEC regulation; and
(4) Conflict between the two regimes.

All four Billing considerations weighed in favor of implied preclusion, it was decided. The appellate court concluded that (1) short selling was squarely within the heartland of the securities business and (2) the Securities Exchange Commission not only had authority to regulate the role of the prime brokers in short selling and the borrowing fees charged by prime brokers under Sec. 10(a) of the Securities Exchange Act of 1934, but the agency exercised its authority to regulate the role of the prime brokers in short selling.

Lastly, the court concluded that antitrust liability would create actual and potential conflicts with the securities regime. Antitrust liability would inhibit the brokers from engaging in other
conduct that the SEC currently permits and that benefits the efficient functioning of the short selling market. There was a potential conflict because, in the future, the SEC might decide to regulate the borrowing fees charged by brokers.

Details of the December 3 decision, In re Short Sale Antitrust Litigation, 08-0420-cv, appears at 2009-2 Trade Cases ¶76,822..