## Facts

- Louis S. Caiola, a sophisticated investor and major private-banking client of Citibank, conducted high-volume trading involving hundreds of millions of dollars, focusing on Philip Morris stock.
- To manage risk and margin demands, Citibank proposed a “synthetic trading” structure using equity swaps and cash-settled over-the-counter options tied to Philip Morris.
- The synthetic structure was marketed as providing economic exposure and hedging while limiting market “footprints” associated with large physical stock trades.
- Citibank personnel allegedly gave oral assurances in 1998 that the synthetic program would continue.
- Caiola alleged that after November 1998 Citibank changed its hedging approach to undisclosed physical trading while representing that it was still implementing the synthetic strategy.
- Caiola claimed Citibank misrepresented or failed to disclose material facts about how it was executing the strategy and about the resulting change in his risk exposure, causing significant lost profits.

## Issues

1. Whether Caiola adequately alleged he was a purchaser or seller of “securities” (including equity swaps and cash-settled OTC options) sufficient for standing under § 10(b) and Rule 10b-5.
2. Whether the complaint adequately pleaded material misrepresentations or omissions in connection with the alleged securities transactions.
3. Whether contractual non-reliance/disclaimer clauses defeated the federal securities fraud claims at the pleading stage.

## Decision

- The Second Circuit reversed the dismissal under Rule 12(b)(6) and remanded for further proceedings.
- The court held Caiola adequately alleged purchases and sales of securities, including derivative instruments whose value was derived from an underlying security.
- The court held the complaint sufficiently alleged material misrepresentations and omissions based on assurances about implementing a synthetic strategy and the alleged undisclosed change in hedging approach.
- The court declined to treat contractual non-reliance provisions as dispositive at the pleading stage, noting reliance is typically fact-intensive and the alleged misconduct included ongoing, post-agreement representations and omissions.

## Legal Principles

- The Exchange Act’s definition of “security” is construed broadly, and economic substance controls over formal labels.
- Derivative instruments may qualify as “securities” for § 10(b) purposes when their value is derived from an underlying security, including cash-settled options and swap-based exposures structured around the underlying stock.
- A plaintiff may satisfy the purchaser-seller requirement by alleging a series of derivative transactions that create, adjust, or unwind economic exposure to an underlying security.
- Allegations that a financial intermediary misrepresented or concealed a material change in how an agreed trading/hedging strategy was being executed can constitute actionable misstatements or omissions under Rule 10b-5.
- Contractual non-reliance clauses do not automatically bar § 10(b) claims at the motion-to-dismiss stage, particularly where the alleged fraud involves post-contract conduct and continuing misrepresentations or omissions.

## Conclusion

The Second Circuit reinstated the federal securities fraud claims, ruling that stock-linked synthetic derivatives can be “securities” under § 10(b), that alleged undisclosed changes in a promised trading strategy can be materially misleading, and that non-reliance clauses did not mandate dismissal on the pleadings.


Caiola v. Citibank, N.A., 295 F.3d 312 (2d Cir. 2002)