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: Jim Hamilton's World of Securities Regulation

By Jim Hamilton

9th Circuit: State Claims Against Clearing Agencies Preempted

A 9th Circuit panel found that the federal securities laws preempted state law fraud claims against Depository Trust and Clearing Corp., Depository Trust Co. and the National Securities Clearing Corp. The claims arose from the stock borrow program created by NSCC to deal electronically with temporary short term fails-to-deliver. As alleged by an issuer, the stock borrow program facilitated naked short selling and artificially depressed the price of its stock by creating more electronic shares in the marketplace than were reflected in paper stock certificates.

Under the stock borrow program approved by the SEC, NSCC settles fail-to-deliver transactions by electronically ?borrowing? the requisite number of shares of the undelivered stock from one of its members who is willing to lend the shares, and then delivering the ?borrowed? shares to the purchaser. NSCC guarantees the transactions it processes by assuming the obligation of sellers to deliver shares to buyers. The buyer is credited with the shares and generally unaware that there has been a fail-to-deliver.

The appeals court found that Congress did not intend to preempt the entire field of regulating the clearing and settlement of securities transactions. So-called "field preemption" was inapplicable because "an examination of the statutory framework of the Exchange Act does not reveal the comprehensiveness necessary to infer that Congress intended" for federal regulation to completely occupy the field. However, the court concluded that "conflict preemption" applied because the state claims to either the existence or the operation of the program "would conflict with Congressional directive, as set forth under Section 17A."

The SEC previously expressed its support for such a conclusion in an amicus brief filed in similar litigation. In 2006, the SEC asserted that the

plaintiffs? theory of liability would open up any Commission-approved SRO rule to challenges under similar theories, namely that the Commission erred in approving the rule because it misapprehended the rule?s consequences, and that the SRO then committed state-law fraud by failing to disclose the facts that establish the Commission?s error. Of course, any state law that created this result would make uniform regulation impossible, and would impermissibly stand as an obstacle to the accomplishment and execution of the full purpose and objectives of Congress in creating the Exchange Act?s self-regulatory regime, including the portion of that regime applicable to registered clearing agencies under Section 17A.

Whistler Investments, Inc. v. The Depository Trust and Clearing Corp (9th Circuit) (opinion in full text)

Full post as published by Jim Hamilton's World of Securities Regulation on August 25, 2008 (boomark / email).