Antitrust Law Daily Wrap Up, ANTITRUST—N.D. Ill.: Court tosses claims that CME gave high-frequency traders unfair advantage, (Dec 4, 2015)

By Kevin Kulling, J.D.

A federal district court in Chicago has dismissed a class action suit brought by three commodity futures traders who alleged that the CME Group, Inc. gave high frequency traders on their exchanges an illegal advantage by allowing them to see price and market data before other market participants and to use the information to execute trades before other traders. The court also dismissed the traders’ claims alleging violations of federal antitrust laws (Braman v. The CME Group, Inc., December 3, 2015, Blakey, J.).

Allegations of the complaint. In April 2014, three commodity futures traders filed the class action against CME and its subsidiary, the Chicago Board of Trade (CBOT), alleging that the exchanges facilitated “hyper scalping” by high-frequency traders (HFTs) by allowing them to see price and market data before other market participants and to use this data to execute trades before other traders. The traders also alleged that the exchanges had entered into “clandestine contracts” with HFTs, knowing that the activities would adversely affect all other individuals and entities that traded the exchanges’ futures contracts.

According to the second amended complaint, sometime after January 1, 2005, the exchange defendants began to allow certain HFTs to exploit a structural advantage known only to the exchange defendants that existed at the CME called the “latency loophole.” That advantage, when coupled with receiving price information faster than all the other customers, allowed these select firms to exploit the order flow of all the other customers and users of the exchange defendants trading markets, according to the complaint. The traders contended that the latency loophole, or latency gap, was a gap in time between when a HFT with direct market access could see that it made a trade and at what price and when the rest of the world was made aware of the trade.

The traders claimed that the exchanges violated the Commodity Exchange Act (CEA) and Commodity Futures Trading Commission (CFTC) rules when they created a marketplace “fraught with manipulation and clandestine, surreptitious trading that caused the prices of futures contracts to be artificial and that defendants perpetrated a fraud on the marketplace and intentionally concealed the activities of a select class of market participants.” The complaint alleged that the exchanges continuously refused and were unwilling to enforce CEA and CFTC rules and regulations.

Antitrust claims. In their complaint, the traders alleged violations of Sections 1 and 2 of the Sherman Act with respect to transaction prices and commissions. The traders claimed that the exchanges “entered, made and performed a web of agreements in unreasonable restraint of trade with numerous HFTs and other preferred clients” and their profit making activities were “anticompetitive.” The complaint alleged that the clandestine incentive agreements, offered to HFTs in high volume markets and not offered to the plaintiff traders, “anti-competitively” disadvantaged the traders, in multiple ways, including the burdens of having to pay higher costs to transact and having to transact in a “market in which wash trades or other high volume, manipulative trading practices move prices on an absolute level and periodically disconnected price trends and patterns from market new or other legitimate stimuli.”

The complaint also alleged that the exchanges violated the Sherman Act by offering and making rebate payments to HFTs and by attempting and conspiring to monopolize.

The court found that the complaint failed to state a Sherman Act claim because there was a lack of an allegation regarding any restraint on trade, let alone an unreasonable restraint on trade.

The court noted that the agreements between the exchanges and the HFTs, if anything, promote trade (at least amongst the HFTs). The court also said that the traders did not allege that the occurrence of high frequency trading on the exchanges unreasonably restrained trading by regular investors, or that the exchanges endeavored in any way to fix prices.

“Plaintiffs have not alleged that defendants unreasonably restrained trade, in fact they allege that defendants encouraged trade through the use of the incentive agreements, nor have they alleged that the defendants violated the antitrust laws by creating barriers to entry or otherwise attempting to create a monopoly.”

The court made a point of noting that its “task is not to adjudicate the fairness or appropriateness of high frequency trading,” but only to decide whether the traders stated a claim for which relief may be granted. In the end, the court held that they had not.

Motion to dismiss. The exchanges argued in their motion to dismiss that the complaint failed to state a claim, including a failure to allege elements of a private right of action under the CEA.

The court agreed that the traders could not pursue a private right of action for false information although Section 9 of the CEA makes it unlawful for any person to make any false or misleading statement of a material fact to the Commission. However, the traders had not alleged that any statements were made to the Commission.

The court dismissed other claims brought by the traders, including their allegations that false information disseminated by the exchanges contributed to manipulation. The court held that the traders’ allegations did not meet the pleading requirements that an artificial price existed, the exchanges caused the artificial price, or that the exchanges specifically intended to cause the artificial price. The court said that even if, as the traders allege, the exchanges created a two tiered marketplace, the existence of the marketplace itself was not alleged to have caused price fluctuations, artificiality or losses. The court noted that it was the HFTs’ trades that would have caused any manipulation of prices, artificiality and any losses.

The court also held that the complaint failed to state a claim for aiding and abetting manipulation. The complaint failed to allege that the defendants had knowledge of any violation on the part of HFTs. The court noted that the plaintiffs had not alleged that any particular HFTs violated the CEA or that the exchanges knew about any particular violation of the Act. Merely alleging that defendants knowingly encouraged and incentivized HFTs to transact business on their exchanges did not state a claim for relief under the CEA, the court said.

The court also tossed the common law fraud claim, saying that the traders did not allege a false statement of material fact, and they have failed to plead fraud with the degree of particularity, including the who what where when and how of the fraud.

The case is No. 14 C 2646.

Attorneys: Christopher Lovell (Lovell Stewart Halebian Jacobson LLP) for William C. Braman. Albert Lee Hogan, III (Skadden, Arps, Slate, Meagher & Flom LLP) for The Board of Trade of the City of Chicago, The CME Group, Inc. and The CME Exchange, Inc.

Companies: The Board of Trade of the City of Chicago; The CME Group, Inc.; The CME Exchange, Inc.

Cases: Antitrust IllinoisNews