Facts
- Plaintiffs were options market makers on the Chicago Board Options Exchange who filled orders in Chrysler Corporation call options.
- Prudential Securities, Inc., a brokerage firm, bought large quantities of Chrysler call options from plaintiffs in mid-April 1988, including options with strike prices well above the market price.
- On May 7, 1988, Chrysler announced a merger with Daimler-Benz AG; Chrysler’s stock price rose about 30% over the next three days.
- Plaintiffs alleged Prudential earned over $10 million from the pre-announcement options positions.
- Plaintiffs claimed Prudential’s trading was “economically irrational” absent material nonpublic information and alleged Prudential traded as a tippee based on an unlawful tip from insiders at Chrysler and/or Daimler-Benz.
- Plaintiffs sued under § 10(b) of the Securities Exchange Act and SEC Rule 10b-5 and added an Illinois common-law negligence claim.
- Prudential moved to dismiss under Rule 12(b)(6), arguing the complaint failed to meet Rule 9(b) and the PSLRA’s heightened pleading standards for fraud-based securities claims.
Issues
- Whether allegations of suspicious, highly profitable options trading, without identifying a tipper, tippee recipient, or specific tip content, plausibly stated an insider-trading claim under § 10(b) and Rule 10b-5 and satisfied Rule 9(b) and the PSLRA.
- Whether Illinois law recognizes a negligence claim by exchange market makers against a broker for alleged insider-trading-type conduct absent a cognizable duty running from the broker to the market makers.
Decision
- The court granted Prudential’s motion to dismiss.
- The federal securities claims were dismissed for failure to plead insider trading with the particularity required by Rule 9(b) and the PSLRA, including insufficient allegations supporting scienter.
- The Illinois negligence claim was dismissed for failure to allege a cognizable duty owed by Prudential to the market makers (and as an improper effort to restate the securities-fraud theory as negligence).
Legal Principles
- Insider-trading claims brought under § 10(b) and Rule 10b-5 are subject to Rule 9(b)’s particularity requirement and the PSLRA’s requirements to plead, with particularity, facts supporting a strong inference of the required state of mind.
- A plausible tipping-based insider-trading theory generally requires well-pleaded facts showing a breach of duty by an insider, disclosure of material nonpublic information for personal benefit, and the tippee’s knowing trading on that information.
- Unusual trading patterns and large profits, standing alone, do not satisfy heightened federal pleading standards where the complaint lacks specific facts identifying the tipper, the recipient, the information conveyed, and why the inference of unlawful knowledge is strong rather than speculative.
- Under Illinois negligence law, a plaintiff must plead a duty owed by the defendant to the plaintiff; brokers executing exchange trades generally do not owe a generalized duty of care to professional, arm’s-length counterparties to protect them from informational disadvantages.
Conclusion
The court dismissed market makers’ federal insider-trading claims because the complaint relied primarily on post hoc inferences from profitable trades and failed to plead specific facts about any tip, tipper, or knowing misuse of material nonpublic information as required by Rule 9(b) and the PSLRA, and it dismissed the state negligence claim for lack of a cognizable duty owed by the broker to exchange counterparties.