1.   Liability Under Section 10(b) and Rule 10b-5

In Connolly, supra, an introducing broker's customers brought a class action against a clearing firm and others, asserting inter alia violations of Section 10(b) and Rule 10b-5. Specifically, the plaintiffs alleged that the clearing firm knew or in the exercise of reasonable diligence should have known of its introducing broker's manipulative activities. The court, holding that the plaintiffs had failed to state a claim for primary liability under Section 10(b) and Rule 10b-5, granted the clearing firm's Rule 12(b)(6) motion. The court observed that there was no specific allegation of direct violation by the clearing firm but that even if the plaintiffs had attempted to allege primary violations, that claim would fail: "It is well-established that a clearing firm . . . does not have a fiduciary relationship with the customers . . . of the introducing broker with which it has contracted to perform clearing services," id. at 9.

The Connolly court also emphasized that simply alleging that the clearing firm had compliance responsibility over the introducing broker without further demonstration of any duty owed, could not create a fiduciary duty where none otherwise existed, id. "Because plaintiffs have not adequately alleged a fiduciary relationship between SSC and themselves, SSC owed plaintiffs no duty of disclosure," id. at 10. Since SSC had no duty of disclosure, it could not be held primarily liable under Rule 10b-5 for non-disclosure.

Ross v. Bolton, 904 F.2d 819 (2d Cir. 1989) presents another Section 10(b) case. There, the customer's claims against his introducing and clearing brokers stemmed from the collapse of a stock in which the introducing broker was the primary market maker. The Second Circuit affirmed the District Court's dismissal of an amended complaint for failing to state a viable Section 10(b) and Rule 10b-5 aiding and abetting claim against the clearing broker. The complaint alleged that the clearing firm had recklessly disregarded the introducing broker's deteriorating net capital position and had attempted to dominate and control the introducing broker. Nonetheless, Ross was required to allege not only a primary securities law violation but further, that the clearing broker knew of the wrong and substantially assisted its perpetration, id. at 824. Since Ross had failed to allege any fiduciary duty of the clearing firm or that the firm had acted with actual intent, dismissal was warranted.

The failure of D. Blech & Co., Inc. several years ago spawned securities class actions and pretrial motions addressing claims against Blech's clearing broker. Shortly before Blech's collapse for net capital deficiencies, its clearing firm began to dishonor securities trades by Blech's alleged confederates. That resulted in precipitous price declines of stocks in which Blech had acted as an underwriter or principal market maker and consequently, market manipulation claims. In re Blech Securities Litigation, 928 F. Supp. 1279 (S.D.N.Y. 1996) ("Blech I"), focused inter alia on Rule 9(b) and 12(b)(6) motions filed by the clearing broker to rid itself of liability claims under Sections 10(b) and 20(a), RICO and common law fraud. Citing Ross, Dillon and Connolly, supra, the District Court determined that the complaint had failed to allege actionable, manipulative conduct by the clearing firm. Basically, the plaintiffs had alleged that the clearing firm knew that Blech was engaged in sham transactions, exerted pressure on Blech's principal to shore up Blech's capital position and through its compliance officer knew or should have known that Blech was "round tripping" thousands of shares of the issuers which Blech followed. The court commented: 

This alleged conduct, on its face, reflects no fraud, nor does it give rise to an inference of fraud. It reflects nothing more than the standard practice of clearing brokers to look first to the introducing broker's customer for payment and, in the event of non-payment, to inform the introducing broker . . . [T]he Complaint does not allege that Bear Stearns caused or directed trading by Blech & Co.'s customers or solicited or induced them to buy Blech securities at inflated prices. Nor are there any allegations that Bear Stearns did anything in an attempt to affect the price of such securities, id. at 1295.

Reiterating the general rule, the court emphasized that even if the clearing firm knew but failed to disclose a material fact regarding Blech's activities, none of the plaintiffs could have claimed to have been defrauded by that omission, since as a matter of law, a clearing broker owes no disclosure duty to the introducing broker's clients. Absent a duty to disclose, silence is not actionable under the federal securities laws, Basic, Inc. v. Levinson, 485 U.S. 224, 239 n. 17, 108 S. Ct. 978 (1988), 99 L. Ed.2d 194.

Blech I did not finish the story because the District Court granted the plaintiffs leave to amend their consolidated complaint. Blech III, supra, witnessed further attempts by the clearing firm to dismiss newly pleaded Section 10(b), Section 20(a) and common law fraud claims. The case illustrates the fact-intensive battle between litigants in clearing firm cases and well demonstrates that clearing firms are not always immune from liability exposure. The amended complaint asserted that Bear Stearns acted as a direct participant with Blech in an alleged manipulative scheme. The operative contention was that the clearing firm knew that the market prices of Blech-traded securities had to be maintained at an artificially inflated level for Blech to liquidate sufficient amounts thereof to eliminate its large debit balance with its clearing broker and correspondingly, reduce Bear Stearns' own exposure to loss. The plaintiffs asserted that Bear Stearns actually knew of Blech's fraudulent conduct and - going beyond mere performance of its routine clearing functions - directed and pressured Blech to engage in manipulative securities trades and funded contrived trades. Thus, the newly alleged conduct differed from that of the clearing broker in Dillon, supra, where a manipulation claim was dismissed, as there was no allegation that the clearing broker was making decisions regarding the introducing broker's client accounts. Accordingly, in Blech III, the District Court denied the clearing firm's motion to dismiss the newly pleaded Section 10(b) and common law fraud claims.