Second Circuit Holds That Allegations Of Direct Fraudulent Representations Are Necessary For Market Manipulation Claims Under Section 10(b) And Rule 10b-5


In Fezzani v. Bear, Stearns & Co., Inc., No. 09-4414-cv, 2013 WL 1876534 (2d Cir. May 7, 2013), a 2-1 majority of a panel of the United States Court of Appeals for the Second Circuit held that plaintiffs' failure to plead direct misrepresentations from defendant to plaintiffs was fatal to their market manipulation claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. This is the first decision from a Court of Appeals applying the strict limitations on the scope of primary liability set in recent decisions by the Supreme Court to claims involving market manipulation.

From 1992 through 1996, a now-defunct broker-dealer, A.R. Baron ("Baron"), executed a "pump and dump" scheme involving high pressure "cold calls" to potential customers, aimed at inducing the customers to purchase securities in initial public offerings of small, unknown companies with negligible profits. Baron's salespeople would represent deceptively that such stocks were part of an active, rising market in which prices were fairly set by arms-length transactions. In reality, the "market" was a result of a series of artificial trades arranged by Baron to generate the façade of a rising market. These practices defrauded customers out of millions of dollars, and eventually led to the criminal convictions of a number of its former officers, directors and key employees.

Plaintiffs, a group of individual investors, alleged that Baron and its clearing broker, Bear, Stearns & Co, Inc. ("Bear Stearns"), falsely represented the market surrounding the securities at issue, and that defendant Isaac R. Dweck ("Dweck") enabled Baron, through short-term cash infusions and financing, to "park" securities in his accounts, for which he was rewarded with ownership in companies on a preferential basis and returns on the parking arrangements. Plaintiffs also alleged that Dweck's providing of funds to Baron prolonged Baron's fraudulent activity. Plaintiffs made no claim for recovery from Dweck for damages caused by the parking of specific securities, but instead sought to impose liability on Dweck for all of Baron's deceptive activities; in other words, plaintiffs made no attempt to connect particular trades to Dweck's parking.

The United States District Court for the Southern District of New York held that the plaintiffs' broad allegations that Dweck was...

To continue reading