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Second Circuit Court Finds that Investors May Sue New York Stock Exchange for Failure to Enforce Market Integrity

December 20, 2007
Corporate Governance Newsletter

New York Stock Exchange, Inc. enjoys absolute immunity when it breaks its own rules – so long as it doesn’t talk about it, according to a recent appellate court ruling in an investor-led lawsuit. Plaintiffs alleged that the NYSE failed to enforce the Exchange’s rules prohibiting improper trading by its specialists. The suit also charged the Exchange with misleading investors about practices.

Although finding that the Exchange had immunity for its alleged failure to operate an honest market, the Second Circuit vacated the district court’s ruling that investors who purchased securities on the NYSE could not sue the Exchange for making false statements about the integrity of the market it operated.

In so doing, the Second Circuit limited the precedential effect of its prior decision in the Nortel Networks case, which was misinterpreted as holding that only issuers of securities may be liable for making false statements. In its opinion, the court acknowledged that Nortel does not in fact stand for the scheme-liability limitation that “would place beyond the reach of Rule 10(b)-5 false statements made by underwriters, brokers, bankers, and non-issuer sellers.”

“In short,” the appeals court concluded, “the district court incorrectly read Nortel [] to mean that an action under Rule 10(b)-5 for false statements . . . lies only against the issuer of the security, or that only statements about a security issuer are actionable.”

The court remanded the plaintiffs’ action to the district court for further proceedings against the NYSE on the claims based on the Exchange’s allegedly false statements.

In re NYSE Specialists Sec. Litig. (California Public Employees’ Ret. Sys. v. New York Stock Exchange, Inc.), No. 06-1038, Opinion (2d Cir. Sept. 18, 2007); Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Corp., 369 F.3d 27 (2d Cir. 2004).

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