Seventh Circuit Reverses Dismissal of Collusive Trading Scheme
Susan M. Greenwood | Bloomberg Law
The U.S. Court of Appeals for the Seventh Circuit reversed and remanded a district court decision dismissing claims that AnchorBank, FSB (AnchorBank) employee Clark Hofer engaged in a collusive trading scheme in violation of Sections 9(a) and 10(b) of the Securities Exchange Act of 1934 (Exchange Act).
Gaming AnchorBank’s 401(k) Plan
As the Seventh Circuit explained, AnchorBank’s 401(k) Plan (Plan) allowed employees to invest in the AnchorBank Unitized Fund (Fund). The Fund, administered by Plumb Trust Company (Trustee), holds both cash and AnchorBank stock and is required to maintain a “cash-to-stock ratio” of 5 to 11 percent. Accordingly, as AnchorBank employees purchased and sold Fund units, the Trustee purchased and sold AnchorBank stock to maintain the proper ratio. AnchorBank, the Fund, and the Trustee (collectively, Plaintiffs) allege that Hofer and certain co-conspirators coordinated trades in the Fund by first selling Fund units, necessitating a cash payout from the Fund. The Trustee then would sell AnchorBank stock to return the Fund’s cash reserves to the required 5 to 11 percent balance. Because the co-conspirators sold a large volume of Fund units, the Trustee’s correspondingly high volume sale of AnchorBank stock—in relation to normal daily trading of the stock—depressed AnchorBank’s share price. Hofer and his co-conspirators then, allegedly, purchased Fund units. In response, the Trustee purchased large volumes of AnchorBank stock, raising the stock price so that the co-conspirators could repeat the cycle.
Hofer allegedly masterminded 36 trades, which, the Court said, often represented the entirety of the Fund’s daily trading activity. In addition, the co-conspirators amassed 72 percent of the Fund’s units as a result of their trades and increased the value of their holdings by up to 270 percent, without contributing any additional monies to their Plan accounts. At the same time, however, their activities allegedly caused the value of Fund units to fall almost 95 percent in value, from $11 per share to $0.49 per share.
Reviewing the complaint de novo, the Seventh Circuit held that Plaintiffs adequately alleged claims for securities fraud and market manipulation. It explained that Plaintiffs met the requirements of Federal Rule of Civil Procedure 8 simply by stating that the Trustee demanded judgment and damages under the Federal Securities laws on behalf of Plan participants, based on Hofer’s investment in the Fund through the Plan. As for Federal Rule of Civil Procedure 9(b), “[t]he complaint painted a sufficiently detailed picture of the alleged scheme” to set forth the “‘who, what, when, where, and how’ of the fraud.”
Turning to the specific elements for claims under Sections 9(a) and 10(b) of the Exchange Act, the Seventh Circuit held that Plaintiffs pled these claims with sufficient particularity. In particular, the Court noted that (1) the Trustee relied on Hofer’s manipulation of the price of Fund units and AnchorBank stock when it purchased and sold AnchorBank stock to maintain the Fund’s requisite cash to stock ratios, and (2) other Plan participants relied on the manipulated prices when making their own investment decisions. As to intent, the Seventh Circuit held that “[t]he inference of scienter that is raised in the complaint remains strong in light of the competing, plausible explanations offered by Hofer, such as that he was simply following the rudimentary investment strategy of buying low and selling high.”
Finally, the Court held that Plaintiffs’ allegations describing the effect of Hofer’s purported scheme on the price of Fund units and AnchorBank stock met the pleading requirement for loss causation. While the Seventh Circuit noted that (1) the Trustee had discretion over when to purchase and sell AnchorBank stock and (2) a general economic downturn could have influenced the decline in AnchorBank’s stock price, it concluded that “we do not require that a plaintiff plead that all of its loss is necessarily attributed to the actions of the defendants, only that it plead that the defendant is at least one plausible cause of the economic loss.” (emphasis in original).
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