Securities Regulation Daily Wrap Up, CLEARANCE AND SETTLEMENT—Del. Ch.: No obligation for sellers of clearing firm to indemnify buyers for firm’s losses, (Nov 10, 2025)

By Rebecca E. Hoffman, J.D.

The clearing firm’s procedures or lack thereof were not to blame for the loss, the court concluded, even though the firm could have acted to alleviate the loss.

Buyers of a clearing firm (Clearing) failed to show that the merger agreement entitled them to indemnification for Clearing’s subsequent $15.2 million loss, the Delaware Chancery Court ruled. In a letter to the parties the same day, Chancellor Kathaleen St. Jude McCormick indicated that the sellers would be awarded fees and costs associated with litigating their motion to enforce a subpoena for documents from the parties’ FINRA arbitration (Legent Group, LLC v. Axos Financial, Inc., No. 2020-0405 (Del. Ch. Nov. 7, 2025)).

The court explained that after conducting due diligence, the sellers purchased Clearing. The parties’ merger agreement contained a provision stating that the sellers would indemnify the buyers for losses that come about because a warranty or representation in Article III of the agreement fails.

Squeezed. Scott Reynolds, a principal at one of the clearing firm’s introducing broker-dealers (IBDs) that would “trade away,” or use other entities to execute trades, “got caught in what is called a ‘short squeeze’—a situation where a trader must close their short position on a security in response to a sudden and unexpected increase in the security’s price.” Reynolds did not close the position and the losses to Clearing grew to $16.6 million, of which the IBD covered $1.4 million. Although Clearing could have intervened, it relied on Reynolds’s assurances. FINRA investigated this occurrence and officially warned Clearing that its risk-management system was lacking.

The buyers sought indemnification, claiming that the sellers breached the merger agreement. They neglected to pay their outstanding notes. Meanwhile, a FINRA arbitration panel concluded that Clearing had relied on Reynolds’s promise to close the short position, and thus Reynolds was responsible for the loss. The sellers brought the instant action, seeking a declaratory judgment that they were not obligated to indemnify the buyers.

Legal compliance representation. The buyers argued that a representation in the agreement that Clearing had complied with “all applicable Laws and Orders” was not true, because FINRA rules require firms to have risk management systems in place that are “‘reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules.’” Their expert testified that Clearing’s systems lacked technological controls, and thus “Clearing was not setting or enforcing trade limits and had to rely on [the IBD’s] internal discretion in monitoring high-risk trades.” But the court agreed with the sellers’ expert witness, who said that having a mix of technology and manual human activity “allows clearing firms to adapt to risk events that appear in unexpected ways.”

The sellers also point to FINRA’s “Cautionary Action Letter,” which stated that Clearing failed to comply with rules regarding mandated controls. But FINRA’s letter is not a disciplinary action, is not meant to have legal effect, and cannot be used as proof that Clearing broke FINRA rules, the court explained. In addition, this letter, and an earlier letter that the sellers cite to, fall under a carve-out from the legal compliance representation in the agreement.

Counterparty breach representation. The buyers also failed to show the inaccuracy of another representation, which provides that no counterparty has defaulted on the contract. They argued that the contract with Reynolds’s IBD was in default when the merger closed, but the court said the contract was not “material,” as defined by the agreement.

The chancellor’s separate letter granted the sellers reasonable fees and costs that they incurred in enforcing a subpoena for documents related to the FINRA arbitration. The buyers argued that the documents were confidential, but some of them had been publicly filed. “Buyers’ arguments in motion practice concerning the FINRA documents,” where they repeatedly referred to all FINRA documents collectively as subject to a protective order, “elided key distinctions on which they now rely in a way that misled the court,” Chancellor McCormick wrote.

The case is No. 2020-0405.

Judge: McCormick, K.

Attorneys: Thomas E. Hanson, Jr. (Barnes & Thornburg LLP) for Legent Group, LLC, COR Advisors LLC, St. Cloud Capital Partners II, L.P., and Carlos P. Salas. Michael C. Heyden, Jr., (Gordon Rees Scully Mansukhani, LLP) for Axos Financial, Inc., Axos Clearing, Inc., Axos Securities, LLC, and Axos Clearing LLC.

Companies: Legent Group, LLC; COR Advisors LLC; St. Cloud Capital Partners II, L.P.; Axos Financial, Inc.; Axos Clearing, Inc.; Axos Securities, LLC; Axos Clearing LLC

LitigationEnforcement: BrokerDealers ClearanceSettlement FinancialIntermediaries MergersAcquisitions RiskManagement DelawareNews