1

Filed 11/13/14

CERTIFIED FOR PARTIAL PUBLICATION*

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

FIRST APPELLATE DISTRICT

DIVISION ONE

OVERSTOCK.COM, INC. et al.,

Plaintiffs and Appellants, 

v.

GOLDMAN SACHS & CO. et al.,

Defendants and Respondents.

 A135682

 (San Francisco City & County

 Super. Ct. No. CGC-07-460147)

I. INTRODUCTION

Often, it is the federal courts, applying federal law, that wrestle with claims of 

cross-state securities fraud involving a nationally-listed stock. Here, plaintiffs of various 

states allege defendants, securities firms headquartered on the East Coast, violated

California and New Jersey law through their involvement in massive naked short selling 

of Overstock shares. The trial court sustained demurrers to plaintiffs’ New Jersey 

Racketeer Influence and Corrupt Organizations (RICO) claim without leave to amend 

and subsequently granted summary judgment on plaintiffs’ California market 

manipulation claims. 

We affirm the dismissal of the belatedly raised New Jersey RICO claim. We also 

affirm the summary judgment as to three of the four defendants, but reverse as to Merrill 

Lynch Professional Clearing Corporation. The evidence, although slight, raises a triable 

issue this firm effected a series of transactions in California and did so for the purpose of 

 

*

Pursuant to California Rules of Court, rules 8.1105(b) and 8.1110, this opinion 

is certified for publication with the exception of part III(A), III(B)(4)(d)(ii)–(iv) and

III(B)(4)(e).
2

inducing others to trade in the manipulated stock. In reaching this disposition, we 

conclude Corporations Code section 25400, subdivision (b), reaches not only beneficial 

sellers and buyers of stock, but also can reach firms that execute, clear and settle trades. 

However, as we further explain, such firms face liability in a private action for damages 

only if they engage in conduct beyond aiding and abetting securities fraud, such that they 

are a primary actor in the manipulative trading. 

II. FACTUAL AND PROCEDURAL BACKGROUND

Plaintiffs are Overstock.Com, Inc., an online retailer, and seven of its investors. In 

their Fourth Amended Complaint, plaintiffs alleged defendants intentionally depressed 

the price of Overstock stock by effecting “naked short sales”—that is, sales of shares the 

brokerage houses and their clients never actually owned or borrowed. This practice, and 

specifically perpetuating the naked short positions by means of exotic trading schemes, 

allegedly increased the apparent supply of the stock, lead to a “pile on” of further short 

sales, and thereby decreased the stock’s value—including the value of shares plaintiffs 

sold. Plaintiffs claimed defendants’ conduct violated Corporations Code sections 25400

and 25500,

1 Business and Professions Code sections 17200 and 17500,2

and New 

Jersey’s RICO statute (N.J. Stat. 2C:41-2(c)–(d)). To put plaintiffs’ allegations and the 

nature of the evidence proffered during the summary judgment proceedings in context, 

we start with an overview of how securities transactions unfold, naked short sales, and 

the Security and Exchange Commission’s (SEC) efforts to prohibit abusive short selling.

A. Steps in a Securities Transaction

Securities transactions involve a number of steps. These include, among others,

executing a trade order, clearing a trade, and settling a trade. (See generally Henry F. 

Minnerop, Clearing Arrangements (2003) 58 Bus. Law. 917, 919 (Minnerop); 17 C.F.R. 

§ 240.11a2–2(T) (2014).)

 

1 All further statutory references are to the California Corporations Code unless 

otherwise indicated.

2

Plaintiffs have not pursued their Business and Profession Code claims on appeal. 

Accordingly, we do not mention them further.
3

Execution is the process of reaching agreement on the terms of a transaction. This 

includes, for a buyer, not only finding the best price, but also choosing the right seller

given the size of the order, the nature of the security being traded, and the costs and fees 

associated with the trade. (See Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc.

(3d Cir. 1998) 135 F.3d 266, 270 & fn. 2.) Execution can be accomplished manually or 

automatically by computer. (See Domestic Securities, Inc. v. S.E.C. (D.C. Cir. 2003) 

333 F.3d 239, 243 [in the NASDAQ marketplace, buyers and sellers can automatically 

execute trades against quoted prices].) 

Upon execution, “the actual transaction has only begun. Thereafter, several steps 

must be taken to complete the course of dealing. These steps are typically the 

responsibility of a clearing agency” associated with a given stock exchange. (Bradford 

Nat. Clearing Corp. v. Securities and Exchange Commission (D.C. Cir. 1978) 590 F.2d 

1085, 1091, fn. 2 (Bradford).) “The clearing agency has three functions. First, the 

agency ‘compares’ submissions of the seller’s broker with those of the buyer’s to make 

sure that there is a common understanding of the terms of the trade. Following this 

process, the resulting ‘compared trade’ is ‘cleared.’ Most simply, this amounts to the 

clearing agency advising the selling and buying brokers, respectively, of their delivery 

and payment obligations.” (Ibid.) 

“The final, ‘settlement,’ stage in the process involves the delivery of securities 

certificates to the purchasing broker and the payment of money to the selling broker. 

Modernization of this task has led to storage of most stock certificates in a depository 

affiliated with the clearing agency. Thus, ‘delivery’ amounts to a bookkeeping entry that 

removes the security from one account and places it in another.” (Bradford, supra, 

590 F.2d at p. 1091, fn. 2; see also Norman S. Poser, The Stock Exchanges of the United 

States and Europe: Automation, Globalization, and Consolidation (2001) 22 U. Pa. J. 

Int’l Econ. L. 497, 514.)

Some firms, known as clearing firms, specialize in postexecution, “back office” 

clearing and settling of trades in conjunction with the appropriate clearing agency, in 

which the clearing firm is a “participant.” Such firms may provide these services to 
4

“introducing” brokerage firms on a fee-for-service basis.3(Dillon v. Militano (S.D.N.Y.

1990) 731 F.Supp. 634, 636–637; Douglas M. Branson, Nibbling at the Edges—

Regulation of Short Selling: Policing Fails to Deliver and Restoration of an Uptick Rule

(2009) 65 Bus. Law. 67, 91; see also 15 U.S.C. § 78c(a)(23)–(24) [defining clearing 

agency and participant].) Their services tend to include extending credit in margin 

accounts; providing written confirmation of executed orders to customers; receiving or 

delivering funds or securities from or to customers; maintaining books and records that 

reflect transactions, including rendering monthly or periodic statements of account to 

customers; providing custody of funds and securities in customer accounts; clearing and 

settling transactions effected in customer accounts. (Minnerop, supra, 58 Bus. Law. at 

p. 919.)

B. The Parties

Overstock sold shares in May and December 2006 through public offerings 

arranged by a San Francisco firm, W.R. Hambrecht + Co. The other seven plaintiffs are 

individuals who sold Overstock shares in 2004, 2005, and 2006. 

There are four defendants, two related “Goldman” entities and two related 

“Merrill” entities. Their ordinary activities can be understood with reference to the stages 

in a securities transaction discussed above.

Goldman, Sachs & Co. (hereinafter Goldman Brokerage) executes, clears, and 

settles securities transactions. Its operations are centered in New Jersey and New York. 

In some cases, Goldman Brokerage performs execution, clearance, and settlement for a 

single transaction. In other cases, its clients execute elsewhere and Goldman Brokerage 

provides only clearance and settlement services. Goldman Brokerage also houses a 

 

3

“Introducing” brokerage firms may, on their own, open accounts, provide 

investment advice, and take customer orders, but they hire clearing firms “to provide 

processing and administrative services in connection with securities transactions ordered 

by introducing firms for the account of their customers.” (Minnerop, supra, 58 Bus. 

Law. at p. 918.) These, typically smaller, brokerage firms “uniformly retain all customer 

contact functions . . . and frequently execute their customers’ and their own orders 

themselves . . . , while out-sourcing” the components of the trades. (Id. at p. 919.)
5

securities lending department which procures and supplies stock associated with certain 

transactions, including, as explained below, short sales. In this case, Goldman 

Brokerage’s execution of certain client trades and its own purchase of certain securities in 

connection with its securities lending business are primarily at issue.

Goldman Sachs Execution & Clearing, L.P. (hereinafter Goldman Clearing) 

likewise executes, clears, and settles securities transactions. It is an SEC-registered 

broker-dealer and a member of the National Securities Clearing Corporation. It is 

headquartered in New Jersey and has significant operations there, and in New York and 

Chicago. It offers its clearing services to other SEC-registered broker-dealers, hedge 

funds, and institutions. In this case, Goldman Clearing’s clearing and settlement services 

are primarily at issue.

Merrill Lynch, Pierce Fenner & Smith Inc. (hereinafter Merrill Brokerage), like its 

Goldman Brokerage counterpart, provides various investment services and runs a stock 

lending department that borrows and lends securities. This department conducts its 

borrowing, lending, and related transactional activity in New York and Illinois. As with 

Goldman Brokerage, it is Merrill Brokerage’s trade execution and lending operations

connected to naked short sales that are primarily at issue.

Merrill Lynch Professional Clearing Corp. (hereinafter Merrill Clearing), like its 

Goldman Clearing counterpart, provides various investment services and is an SECregistered broker-dealer and a member of the National Securities Clearing Corporation. 

Merrill Clearing is a wholly-owned subsidiary of Merrill Brokerage. It is headquartered 

in New York and has a substantial presence in New Jersey and Illinois. It also has a San 

Francisco customer service office. Merrill Clearing offers only limited execution 

services, and most Merrill Clearing clients execute their own trades. Merrill Clearing 

uses Merrill Brokerage to procure stocks needed to settle (or close out) a transaction. As 

with Goldman Clearing, Merrill Clearing’s clearing and settlement operations are 

primarily at issue here.
6

C. “Naked” Short Selling

In a short sale, the seller sells stock the seller does not own. It is a bet against the 

stock. In an ordinary short sale, the seller borrows stock from a lender (such as a 

brokerage firm’s lending department), sells this stock to a buyer at the going price, and 

then purchases replacement stock—hopefully at a lower price—to return to the lender. 

Lenders typically charge a borrow fee for lending shares to sell short. The seller profits if 

the stock price falls enough to cover all costs and fees associated with the sale, including 

borrowing the stock. Otherwise, if the stock price rises or does not fall enough to cover 

the costs and fees, the short seller suffers a loss. If the short seller never delivers the 

stock to the buyer, a “fail to deliver” occurs. The sale nonetheless appears on the seller’s 

and buyer’s books, and is then termed a “naked” short sale. 

Stocks that are “hard-to-borrow” (also called “negative rebate” stocks) can 

command high borrow fees, given their scarcity and desirability for short selling. During 

the 2005 and 2006 timeframe, Overstock was a particularly hard-to-borrow security, and 

shares of the company commanded a negative rebate of up to 35 percent of its value on 

an annualized basis. Thus, any trader hoping to profit from selling short would ordinarily 

need to recoup the borrow fees through a significant decline in the price of the security. 

In naked short sales, however, there is no borrowing and thus no borrow fee, and it is 

significantly easier to make a profit.

Short selling, itself, is lawful. (GFL Advantage Fund, Ltd. v. Colkitt (3d Cir. 

2001) 272 F.3d 189, 207 (GFL). Even short sales resulting in fails to deliver are not 

necessarily nefarious and occasionally occur in the regular press of market activity. 

(Cohen v. Stevanovich (S.D.N.Y. 2010) 722 F.Supp.2d 416, 424–425 (Cohen) 

[“allegations of failures to deliver, without more, are insufficient to state a claim for 

market manipulation”].) In Cohen, the alleged naked short selling activity was 

untethered to any “distort[tion to] the price” of the stock at issue and so did not constitute 

“ ‘willful conduct designed to deceive or defraud investors’ with regard to market 

activity.” (Id. at p. 425.) Similarly, in Sullivan & Long, Inc. v. Scattered Corp. (7th Cir. 

1995) 47 F.3d 857, 864, the short selling of more shares than could be obtained could not 
7

be viewed as manipulative when, under the peculiar circumstances, the selling drove the 

stock down to the correct market price, given the terms of a restructuring agreement. 

But there are situations in which intentional naked short selling can be employed 

to manipulate the market. (See Cohen, supra, 722 F.Supp.2d at pp. 424–425 [“fails to 

deliver can occur for a variety of legitimate reasons, and flexibility is necessary in order 

to ensure an orderly market and to facilitate liquidity,” but some fails may be “a potential 

problem” when “willfully combined with something more to create a false impression of 

how market participants value a security”]; Hyperdynamics Corp. v. Southridge Capital 

Management, LLC (2010) 305 Ga.App. 283, 288, fn. 8 [noting naked short sales could 

“depress the price of a target company’s shares”]; In re Adler, Coleman Clearing Corp.

(S.D.N.Y. 2007) 469 F.Supp.2d 112, 126 [“The Court is persuaded that the evidence 

sufficiently establishes that DiPrimo’s conduct, under Gurian’s control, amounted to 

concerted, naked short selling whose purpose was to drive down the price of Hanover 

House Stocks”]; Regulation SHO Proposed Release, SEC Rel. No. 34–48709, 68 

Fed.Reg. 62972, 62975; Amendments to Regulation SHO, 71 Fed. Reg. 41710-01

(Jul. 21, 2006) [“large and persistent fails to deliver . . . can be indicative of manipulative 

naked short selling, which could be used as a tool to drive down a company's stock price. 

The perception of such manipulative conduct also may undermine the confidence of 

investors.”].) Thus, in GFL, supra, 272 F.3d at pages 207–208, the Third Circuit 

suggested naked short selling would be actionable if it caused an “artificial depression” in 

price, by, for instance, “injection of inaccurate information” or “creation of a false 

impression of supply and demand,” such as by means of “ ‘matched buy and sell orders’ 

to ‘create a misleading appearance of active trading.’ ” 

D. Regulation SHO: Regulating Abusive Short Sales

The SEC began to focus on naked short selling and its potential abuses in 2003 

and 2004. (See Charles F. Walker, Colin D. Forbes, SEC Enforcement Actions and 

Issuer Litigation in the Context of A “Short Attack” (2013) 68 Bus. Law. 687, 691 

[relating history of SEC regulation of short sales, particularly through Regulation SHO].) 

It recognized manipulative short selling could pose problems for the markets and took 
8

“steps to restrict or prohibit it in various situations. See Regulation SHO Proposed 

Release, SEC Rel. No. 34–48709, 68 Fed.Reg. 62972, 62975–78 (Nov. 6, 2003); Short 

Sales, SEC Rel. No. 34–50103, 69 Fed.Reg. 48008, 48009 (Aug. 6, 2004); Amendments 

to Regulation SHO, SEC Rel. No. 34–56212, 72 Fed.Reg. 45544 (Aug. 7, 2007); 

Emergency Order, SEC Rel. No. 34–58166 (July 15, 2008).” (Pet Quarters, Inc. v. 

Depository Trust and Clearing Corp. (8th Cir. 2009) 559 F.3d 772, 776, fn. 3.)

In its 2003 proposal to regulate, the SEC warned: “Naked short selling can have a 

number of negative effects on the market, particularly when the fails to deliver persist for 

an extended period of time and result in a significantly large unfulfilled delivery 

obligation at the clearing agency where trades are settled. At times, the amount of fails to 

deliver may be greater than the total public float. In effect the naked short seller 

unilaterally converts a securities contract (which should settle in three days after the trade 

date) into an undated futures-type contract, which the buyer might not have agreed to or 

that would have been priced differently. The seller’s failure to deliver securities may also 

adversely affect certain rights of the buyer, such as the right to vote. More significantly, 

naked short sellers enjoy greater leverage than if they were required to borrow securities 

and deliver within a reasonable time period, and they may use this additional leverage to 

engage in trading activities that deliberately depress the price of a security.” (Regulation 

SHO Proposed Release, SEC Rel. No. 34–48709, 68 Fed.Reg. 62972, 62975, 

fn. omitted.)

The following year, in 2004, the SEC adopted Regulation SHO which imposes 

two requirements—“locate” and “delivery”—aimed at curtailing intentional naked short 

sales. (Electronic Trading Group, LLC v. Banc of America Securities LLC (2d Cir. 2009) 

588 F.3d 128, 135–136 (Electronic Trading), citing 17 C.F.R. § 242.203 (2014).) “The 

regulation first imposes “a ‘locate’ requirement . . . . See 17 C.F.R. § 242.203(b)(1)(i)–

(iii) (‘A broker or dealer may not accept a short sale order in an equity security from 

another person . . . unless the broker or dealer has: (i) [b]orrowed the security, or entered 

into a bona-fide arrangement to borrow the security; or (ii) [r]easonable grounds to 

believe that the security can be borrowed so that it can be delivered on the date delivery 
9

is due. . . .’). The Regulation SHO also imposes a ‘delivery’ requirement . . . . See 

17 C.F.R. § 242.203(b)(3) (with certain enumerated exceptions, ‘[i]f a participant of a 

registered clearing agency has a fail to deliver position . . . in a threshold security for 

thirteen consecutive settlement days, the participant shall immediately thereafter close

out the fail to deliver position by purchasing securities of like kind and quantity’).” 

(Electronic Trading, supra, 588 F.3d at pp. 135–136.) 

In other words, Regulation SHO requires brokers to have a reasonable belief they 

can “locate” the shares to be sold short and requires “participants”—i.e., clearing firms—

to “deliver” shares on a timely basis. Bona fide market makers’ trades, however, are 

exempt from the locate requirement.4 (17 C.F.R. § 242.203(b)(2)(iii) (2014).) Thus, 

market makers and their brokers, when engaged in legitimate trading, can commence a 

short sale without first worrying about whether they have ready access to the shares. The 

delivery requirement, in turn, only applies to “threshold securities,” meaning certain 

listed securities already suffering numerous fails to deliver (17 C.F.R. § 242.203(c)(6)

(2014)), and clearing firms can “reasonably” delegate the obligation to deliver shares to 

bona fide market maker clients. (17 C.F.R. 242.203(b)(3)(vi) (2014); see also Short 

 

4

“The term ‘market maker’ ” under Regulation SHO “means any specialist 

permitted to act as a dealer, any dealer acting in the capacity of block positioner, and any 

dealer who, with respect to a security, holds himself out (by entering quotations in an 

inter-dealer communications system or otherwise) as being willing to buy and sell such 

security for his own account on a regular or continuous basis.” (15 U.S.C. § 78c(a)(38); 

17 C.F.R. 242.203(c)(1) (2014).)

“Bona-fide market making does not include activity that is related to speculative 

selling strategies or investment purposes of the broker-dealer and is disproportionate to 

the usual market making patterns or practices of the broker-dealer in that security. In 

addition, where a market maker posts continually at or near the best offer, but does not 

also post at or near the best bid, the market maker’s activities would not generally qualify 

as bona-fide market making for purposes of the exception. Further, bona-fide market 

making does not include transactions whereby a market maker enters into an arrangement 

with another broker-dealer or customer in an attempt to use the market maker’s exception 

for the purpose of avoiding compliance with Rule 203(b)(1) [Regulation SHO] by the 

other broker-dealer or customer.” (Short Sales, S.E.C. Release No. 34-50103, available 

at 2004 WL 1697019, *13, fn. omitted.)
10

Sales, S.E.C. Release No. 34-50103, available at 2004 WL 1697019, *1, *16, *44.) 

Overstock, at all relevant times, was a threshold security. 

E. SEC and Exchange Actions Against Market Maker Clients of Defendants

Following the enactment of Regulation SHO, the SEC and several exchanges 

brought enforcement actions against a number of market participants for violating locate 

and delivery requirements, including two market maker clients of defendants, Steven 

Hazan and Scott Arenstein. While Hazan and Arenstein purported to be bona fide market 

makers, in fact, they were not. 

Hazan, a New York resident, was sanctioned in an August 2009, SEC order for 

violating both locate and delivery requirements. (In re the Matter of Hazan Capital 

Mgmt., LLC, SEC Release No. 60441 (Aug. 5, 2009) available at 2009 WL 2392842.) 

Among numerous other findings, the Commission found Hazan was not acting as a bona 

fide market maker and violated Regulation SHO when executing riskless and profitable 

“reverse conversion” trades and related “reset” trades. 

In the reverse conversion trades, Hazan would sell short a hard-to-borrow

threshold security to a counterparty. He would also buy from that counterparty a call 

option in the security and sell to that counterparty a put option in the security, such that 

he would eliminate all market risk associated with the short sale. Because all three 

components of the reverse conversion were priced interdependently, Hazan was assured

an “agreed-upon” profit. Meanwhile, the counterparty—for instance, a brokerage firm

such as Goldman Brokerage or Merrill Brokerage—was willing to pay this price to 

Hazan to “obtain” on its books shares of the hard-to-borrow threshold security, which it 

could lend for a profit until the put and call options expired. “Consequently” explained 

the SEC, “prime brokers created the demand for the reverse conversion to create 

inventory for stock loans on hard to borrow securities and options market makers like 

[Hazan] fed this demand.” 

Hazan employed additional nefarious trading practices to insure the short sale 

portions of the reverse conversions remained “naked” over time. Specifically, when 

alerted by clearing firms of his Regulation SHO obligation to deliver shares so settlement 
11

could occur, Hazan engaged in “sham reset transactions” that only gave the appearance of 

delivery, while actually perpetuating his undelivered short positions. Hazan would 

“obtain” the necessary shares for delivery by buying from another market maker who was

also selling short and who similarly never intended to deliver shares to Hazan. 

Meanwhile, Hazan would “pair” or hedge his new “purchase” with option trades, creating 

what the SEC called “married puts” or “buy-writes,” sometimes using “FLEX options.” 

Even though Hazan’s clearing firm—a firm such as Goldman Clearing or Merrill 

Clearing—would not receive actual delivery of the shares, it nevertheless would record 

the transactions as generating a “close out” and a new long position. There was also an 

appearance of delivery of the “purchased” shares back to the other market maker (who 

had never delivered them in the first place). In the end, Hazan would reestablish his 

previous short position, still naked, while succeeding in having the Regulation SHO 

thirteen-day delivery clock, in the clearing firms’ eyes, “reset” to day one. As settlement 

dates approached again and again, Hazan would repeat this process until the options on 

the original reverse conversion trade “expired or [were] assigned, thus” finally “closing 

out the short position and eliminating the synthetic long position that the short position 

had hedged.” 

Hazan pocketed over $3 million through his trading strategy. The SEC ordered 

him to disgorge it, enjoined him from further violations of Regulation SHO, censured his 

organization and barred him from association with any broker or dealer, with the right to 

re-apply for association after five years. The New York Stock Exchange (NYSE) issued 

a similar order regarding the same conduct. (Hearing Board Decisions NYSE AMEX 

LLC 09-AMEX-21 and 09-AMEX-22 (Aug. 4, 2009); NYSE ARCA, Inc. 09-ARCA-5 

and 09-ARCA-6 (Aug. 4, 2009).) NYSE Amex and NYSE Arca imposed $500,000 in 

penalties, and barred Hazan from membership and association with any member for 

seven years.

Arenstein was sanctioned in a June 2007 order issued by the American Stock 

Exchange (ASE). (In the Matter of Scott H. Arenstein (Jul. 20, 2007, AMEX case No. 

07-71.) He admitted engaging in the same reverse conversions and sham reset 
12

transactions as Hazan and made at least $1.4 million from his unlawful trades. The ASE 

ordered disgorgement, assessed a $3.6 million fine, and barred him from membership and 

associating with any member for five years. 

In 2011, Keystone, another purported market maker and a Goldman Clearing 

client, was sanctioned by the NASDAQ for engaging in the same kind of sham reset 

transactions. “[O]n the very same day [Keystone would be] ‘bought-in’ by Keystone’s 

clearing firm,” Keystone, on over fifty occasions would “negate[] the clearing firm’s buyin and contradict[] guidance provided by the Securities and Exchange commission 

requiring that [it] be a net purchaser of the open fail position in the security by selling 

near equivalent number of shares.” Keystone was required to disgorge $2 million in 

profits, pay a $500,000 fine, and suffer a censure and “three-month suspension in a 

supervisory capacity.” (John C. Pickford, Enforcement Counsel, NASDAQ OMX 

PHLX, notice of Disciplinary Action Against Keystone Trading Partners to Members, 

Member Organizations, Participants and Participant Organizations re FINRA Matter 

No. 2010022926 and Enforcement No. 2011-04, Jul. 7, 2011.) 

In short, there is no question Hazan, Arenstein and Keystone, purported market 

maker clients of defendants, engaged in abusive naked short selling and flagrant 

violations of the federal securities laws.

The SEC has continued to target abusive naked short selling, recently pursuing not 

only traders, but the firms that enabled their manipulative trading. The SEC pulled no 

punches in this regard in In the Matter of OptionsXpress, Inc. et al., in which it ruled the 

brokerage firm violated Regulation SHO in connection with sham reset transactions, 

similar to those just discussed, designed to avoid delivery: “Because [the firm] knew . . .

shares that were the subject of [a] buy were shares for [it’s client’s] account that were the 

subject of simultaneous deep-in-the-money calls, which would be exercised and assigned 

so that no shares were delivered to [the clearing agency], optionsXpress engaged in a 

sham close-out of its fail to deliver position. . . . [¶] . . . OptionsXpress did not close out 

its . . . fail to deliver positions by executing consecutive buy-write transactions and 

willfully violated Rules 204 and 204T. [¶] . . . [¶] . . . Feldman [the client] did not 
13

mislead those he dealt with at various clearing brokers who knew, directly or indirectly, 

that he was not going to the deliver securities if his calls were exercised and assigned; 

however, the market as a whole did not have this knowledge. See Wharf (Holdings) Ltd. 

v. United Int'l Holdings, Inc., 532 U.S. 588[, 596] (2001) (‘To sell an option while 

secretly intending not to permit the option’s exercise is misleading, because a buyer 

normally presumes good faith.’); Walling v. Beverly Enter., 476 F.2d 393, 396 (9th Cir. 

1973) (“Entering into a contract of sale with the secret reservation not to fully perform it 

is fraud cognizable under § 10(b).”); 37 Am. Jur. 2d Fraud and Deceit § 41 (2013) 

(‘[F]raud may consist of ... the creation of a false impression by words or acts . . . .)[, fns. 

omitted].” (In the Matter of OptionsXpress, Inc. et al., S.E.C. Release No. 490 (June 7, 

2013), available at 2013 WL 2471113, *72, *75.)5 

F. The Instant Lawsuit

1. Pleadings and Demurrer to New Jersey RICO Claim

Plaintiffs filed suit against Merrill Brokerage and Merrill Clearing, and Goldman 

Brokerage and Goldman Clearing in 2007, based largely on their suspected involvement 

in the Hazan and Arenstein trading schemes. Plaintiffs’ Third Amended Complaint, filed 

in April 2009, alleged several causes of action, including as relevant here, violations of 

California’s Corporate Securities Law (§§ 25000 et seq.). 

In December 2010, plaintiffs filed a motion for leave to file a Fourth Amended 

Complaint, seeking to add a cause of action under New Jersey’s RICO statute against the 

Merrill and Goldman defendants. According to plaintiffs, the new RICO claim was 

simply a new theory based on facts unearthed late in discovery on their California 

securities claims. 

 

5 While “SEC no-action letters constitute neither agency rule-making nor 

adjudication and thus are entitled to no deference beyond whatever persuasive value they 

might have” (Gryl ex rel. Shire Pharmaceuticals Group PLC v. Shire Pharmaceuticals 

Group PLC (2d Cir. 2002) 298 F.3d 136, 145), the “precedent value of SEC decisions has 

often been recognized by the courts in cases involving different parties” and “[c]itations 

to SEC decisions, assuming their precedent value without discussing it, are common.” 

(1 Bromberg & Lowenfels on Securities Fraud (2d ed. 2014)§ 1:5, italics added.)
14

Defendants, though wary of the new complaint, ultimately chose to acquiesce in 

its filing and entered into a stipulation with plaintiffs, which became an order of the trial 

court in January 2011. In the stipulation, the parties recited their conflicting positions on 

the motion for leave to amend (defendants believed the Fourth Amended Complaint was 

defective and prejudicial, while plaintiffs did not) and noted the court’s “tentative 

inclination,” expressed at a case management conference, “to address any issues of 

prejudice . . . by continuing the trial date.” The stipulation also expressly stated 

defendants were “not waiving, and expressly reserve[d], all rights to file in response to 

the Fourth Amended Complaint any and all pleadings, motions, and other responses on 

any grounds available under law or equity.” The complaint was deemed filed, and the 

trial date was continued for approximately three months, to December 5. 

As advertised, and as pertinent here, plaintiffs’ Fourth Amended Complaint realleged violations of sections 25400 and 25500 and additionally alleged a violation of 

New Jersey’s RICO statute (N.J. Stat. 2C:41-2(c)–(d)). 

Defendants demurred to the New Jersey RICO claim, arguing California law, not 

New Jersey law, should apply and, in any case, plaintiffs failed to state a claim under the 

New Jersey law. They did not ask the trial court to dismiss the new complaint based on 

prejudicial delay, but sought denial of further leave to amend on that ground. Ruling

from the bench on May 10, the trial court concluded the allegations about conduct in New 

Jersey were vague and conclusory, did not disclose whether actionable trade or 

commerce occurred in that state, and thus failed to state a claim.

The trial court also found such lack of detail in the pleadings so close to trial 

“pernicious to defendants.” However, rather than denying leave to amend outright, it 

allowed plaintiffs to submit a proposed Fifth Amended Complaint, stating it would 

consider granting leave based on the contents of the proposed pleading. Plaintiffs 

promptly submitted a proposed amended complaint with over 50 pages of additional 

allegations in support of their New Jersey RICO claim. 

After extensive briefing and a lengthy hearing, the trial court, on August 1, 2011, 

denied leave to file the proposed Fifth Amended Complaint. It cited two grounds: 
15

(1) granting leave to add the new RICO claim would prejudice defendants on the eve of 

trial; and (2) the RICO claim “would be futile because the facts as alleged . . . do not 

warrant the application of New Jersey RICO [law] to this case under California choiceof-law principles.” 

2. Summary Judgment on the Corporations Code and UCL Claims

Two weeks later, on August 19, 2011, the defendants moved for summary 

judgment on the remaining causes of action, including those based on California’s 

securities laws. 

Defendants advanced several arguments as to plaintiffs’ state-law securities 

claims: (1) no actionable conduct occurred in California, (2) defendants did not “effect” 

any stock transactions, (3) defendants’ conduct was not manipulative, (4) defendants did 

not act for the purpose of “inducing” others to trade in a manipulated stock, 

(5) defendants’ conduct did not cause any decline in Overstock’s share price and thus did 

not result in injury to plaintiffs, and (6) federal securities laws and regulations preempted 

the state-law claims. We do not discuss the parties’ extensive evidentiary showing here, 

but do so in the next section in discussing the merits of the motions. 

The trial court heard three days of argument on evidentiary objections to the 

documents filed in connection with the summary judgment motions and a full day of 

argument on the merits. In an order dated January 10, 2012, the court granted the 

motions. As to the state-law securities claims relevant here, the court ruled plaintiffs 

“failed to raise [any] triable issue of material fact supportive of finding that any act by 

any defendant foundational to liability, causation, or damages occurred in California.” 

The court declined to reach any of the other grounds for judgment defendants had urged. 

It issued a final, comprehensive order on April 11 and entered judgment the following 

day. 

III. DISCUSSION

On appeal, plaintiffs seek reversal of the dismissal of their New Jersey RICO 

claim and reversal of the summary judgment on their California Corporate Securities Law 

claims. 
16

A. New Jersey RICO Claim6

As recited above, in exchange for a three-month continuance of the trial date, 

defendants acquiesced to the filing of the Fourth Amended Complaint with plaintiffs’ 

newly asserted New Jersey RICO claim, while reserving the right to challenge the 

complaint by answer, motion, or otherwise. The trial court then employed a somewhat 

unusual, but not unprecedented, process to assess defendants’ demurrer to the New Jersey 

claim and determine whether to allow further amendment. It first sustained the demurrer, 

concluding plaintiffs failed to adequately allege actionable conduct in New Jersey. The 

court also worried the paucity of specifics prejudiced defendants given the impending 

trial date. It therefore solicited a proposed Fifth Amended Complaint and set a briefing 

schedule on leave to amend. After reviewing the proposed amended complaint, 

considering the supplemental briefing, and hearing further argument, the court denied 

leave to amend. It concluded the New Jersey RICO claim as fleshed out in the proposed 

amended complaint was so different from what had been previously alleged that belatedly 

injecting it into the litigation would be seriously prejudicial to the defendants. It also 

concluded choice of law principles prohibited application of New Jersey’s RICO law to 

defendants’ alleged conduct. 

 

6

The standard of review on appeal from a dismissal following the sustaining of a 

demurrer without leave to amend is well established: “A demurrer tests the legal 

sufficiency of the complaint, and the granting of leave to amend involves the trial court’s 

discretion. Therefore, an appellate court employs two separate standards of review on 

appeal.” (Roman v. County of Los Angeles (2000) 85 Cal.App.4th 316, 321.) “We 

review de novo the trial court’s order sustaining a demurrer. [Citation.] We assume the 

truth of all facts properly pleaded, and we accept as true all facts that may be implied or 

reasonably inferred from facts expressly alleged, unless they are contradicted by 

judicially noticed facts. [Citations.] . . . We give the complaint a reasonable 

interpretation and we read it in context. [Citation.] But we do not assume the truth of 

contentions, deductions or conclusions of fact or law. [Citation.] We will affirm an order 

sustaining a demurrer on any proper grounds, regardless of the basis for the trial court’s 

decision.” (Cansino v. Bank of America (2014) 224 Cal.App.4th 1462, 1468 (Cansino).)
17

1. Demurrer to Fourth Amended Complaint

Given how events unfolded, we first address whether the Fourth Amended 

Complaint, standing alone, adequately stated a New Jersey RICO claim. 

The trial court gave several reasons for concluding the pleading was lacking: 

Plaintiffs did not adequately allege trade or commerce in New Jersey, or conduct 

affecting trade or commerce in New Jersey. The allegations of conduct by alleged 

“enterprises” were vague and conclusory. Plaintiffs identified some, but not all, of the 

conspiring market makers. The conspiracy allegations were vague and conclusory. 

Lack of specificity, alone, was sufficient reason to sustain the demurrers. In New 

Jersey, it is “unlawful for any person employed by or associated with any enterprise 

engaged in or activities of which affect trade or commerce to conduct or participate, 

directly or indirectly, in the conduct of the enterprise’s affairs through a pattern of 

racketeering activity or collection of unlawful debt.” (N.J. Stat. Ann. § 2C:41-2(c).) To 

be liable, a defendant must have been “employed by or associated with a racketeering 

enterprise which engaged in trade or commerce in New Jersey or affected trade or 

commerce in New Jersey.” (State v. Casilla (2003) 362 N.J.Super. 554, 565.) As 

pertinent, “ ‘[r]acketeering activity’ means . . . any of the following crimes which are 

crimes under the laws of New Jersey or are equivalent crimes under the laws of any other 

jurisdiction: [¶] . . . [¶] (p) fraud in the offering, sale or purchase of securities.” (N.J. 

Stat. Ann. § 2C:41-1(a)(1)(p), italics added.) Thus, plaintiffs’ New Jersey RICO claim 

was predicated on fraudulent conduct. 

Claims under another state’s substantive law, if raised in a California forum, are 

subject to California’s procedures for judicial administration, including its pleading 

standards. (See Hambrecht & Quist Venture Partners v. American Medical Internat., 

Inc. (1995) 38 Cal.App.4th 1532, 1542, fn. 8; Gervase v. Superior Court (1995) 

31 Cal.App.4th 1218, 1229, fn. 6 [state pleading law applies to federal RICO claim, so

long as it does not impose undue barriers to bringing federal claim in state court].) 
18

Under California pleading rules, fraud must be pled with particularity.7 

(Quelimane Co. v. Stewart Title Guaranty Co. (1998) 19 Cal.4th 26, 47.) Thus, it is not 

enough to allege a defendant engaged in fraudulent conduct “ ‘to execute the aforesaid 

fraudulent scheme’ ” or in relation with such a scheme. (Sepulveda, supra, 

14 Cal.App.4th at p. 1716.) But that is all plaintiffs did in their Fourth Amended 

Complaint, alleging only “[i]n engaging in the actions described above, each of the RICO 

defendants engaged in a least two incidents of racketeering . . . by engaging in fraud in 

the offering, sale or purchase of securities.” 

While the pleading spoke broadly of a scheme in which defendants and market 

makers colluded to use conversions and other exotic trades to inflate the ostensible 

supply of Overstock shares and drive down their price—presumably the “actions 

described above”—the Fourth Amended Complaint did not assign any particular action to 

any particular act of alleged “fraud in the offering, sale or purchase of securities.” Nor 

did any portion of the complaint disclose a specific instance of allegedly fraudulent 

conduct.

8

 (See Goldrich v. Natural Y Surgical Specialties, Inc. (1994) 25 Cal.App.4th 

 

7

The same is true in New Jersey. (State, Dept. of Treasury, Div. of Inv. ex rel. 

McCormac v. Qwest Communications Intern., Inc. (N.J. Super. Ct. App. Div. 2006) 

387 N.J.Super. 469, 484.) 

Also, fraudulent conduct, as an underlying predicate act to a RICO offense, is 

distinguished from other elements of a RICO claim, such as the “existence of an 

enterprise” or a “ ‘pattern of racketeering activity,’ ” which need not be pleaded with the 

same level of specificity. Accordingly, Douglas v. Superior Court (1989) 

215 Cal.App.3d 155, 159, which plaintiffs cite, is inapposite. While that case addresses 

pleading a federal RICO claim, it does not address the requirements for pleading a 

predicate act grounded on fraudulent conduct. Indeed, the predicate acts mentioned, mail 

and wire fraud, must be pleaded with particularity in a RICO case. (People ex rel. 

Sepulveda v. Highland Fed. Savings & Loan (1993) 14 Cal.App.4th 1692, 1715–1716 

[applying federal RICO] (Sepulveda); see also Haroco, Inc. v. American Nat. Bank and 

Trust Co. of Chicago (7th Cir. 1984) 747 F.2d 384, 405 [“There can be little doubt that 

Fed.R.Civ.P. 9(b), which requires that allegations of fraud specify ‘with particularity’ the 

circumstances of the alleged fraud, applies to fraud allegations in civil RICO 

complaints.”].) 

8 Moreover, because the allegations of securities fraud were so vague, it was 

impossible for the trial court to make heads or tails of plaintiffs’ statement that “aspects 
19

772, 783 [“Even in a case involving numerous oft-repeated misrepresentations, the 

plaintiff must, at a minimum, set out a representative selection of the alleged 

misrepresentations sufficient to permit the trial court to ascertain whether the statements 

were material and otherwise actionable.”].) 

Accordingly, the trial court correctly concluded plaintiffs failed to plead their New 

Jersey RICO claim with the requisite specificity and properly sustained defendants’ 

demurrers. 

2. Denial of Leave to Amend

In Blank v. Kirwan, the Supreme Court stated with respect to an order denying 

leave to amend, “we decide whether there is a reasonable possibility that the defect can 

be cured by amendment: if it can be, the trial court has abused its discretion and we 

reverse; if not, there has been no abuse of discretion and we affirm.” (Blank v. Kirwan

(1985) 39 Cal.3d 311, 318 (Kirwan).) Plaintiffs read this language as establishing a rigid,

bright-line rule—that a trial court, following the sustaining of a demurrer, must always

allow an amendment that ostensibly cures a pleading defect, regardless of any other 

consideration, including how late in the litigation the amendment is offered and the 

degree of prejudice to the defense. We do not agree this is a fair reading of Kirwan or 

that the case forecloses the particular procedural process the court employed here to fully 

understand the nature of plaintiffs’ New Jersey RICO claim and to assess whether its 

belated injection into the case would be unduly prejudicial to the defense.

“When a demurrer is sustained, the court may grant leave to amend the pleading 

upon any terms as may be just.” (Code Civ. Proc., § 472a, subd. (c), italics added.) 

Accordingly, trial courts are statutorily imbued with wide discretion in the matter of 

amendment. (See Leader v. Health Industries of America, Inc. (2001) 89 Cal.App.4th 

603, 612 [“ ‘[A] litigant does not have a positive right to amend his pleading after a 

 

of the conduct at issue occurred in New Jersey and/or substantially affected trade or 

commerce in New Jersey.” Even though plaintiffs averred defendants “effected 

transactions at issue” and engaged in other conduct in New Jersey, plaintiffs did not link 

these broad descriptors with any particular predicate acts of fraud in New Jersey. 
20

demurrer thereto has been sustained. “His leave to amend afterward is always of grace, 

not of right.” ’ ”]; Whitson v. City of Long Beach (1962) 200 Cal.App.2d 486, 504 

[same].). It has long been recognized a court can take into account the number of 

amendments already allowed. (See Consolidated Concessions Co. v. McConnell (1919) 

40 Cal.App. 443, 446 [“there is a limit to which the patience of the trial court may be 

extended in the matter of allowing repeated attempts to amend a faulty pleading”].) And 

at least one case considering leave to amend following a demurrer explicitly recognized

the relevance of prejudice: “California courts have ‘a policy of great liberality in 

allowing amendments at any stage of the proceeding so as to dispose of cases upon their 

substantial merits where the authorization does not prejudice the substantial rights of 

others.’ ” (Douglas v. Superior Court, supra, 215 Cal.App.3d at p. 158, italics added.) 

In Kirwan, the Supreme Court addressed only the plaintiff’s many contentions he could 

amend to state a viable claim. No countervailing considerations, such as timing and 

prejudice, were raised, and the court had no occasion to, nor did it, consider any such 

matters. (Kirwan, supra, 39 Cal.3d at pp. 318–331.) 

Furthermore, countless cases involving motions for leave to amend outside of the 

demurrer context—motions that similarly implicate a trial court’s discretion (Code Civ. 

Proc., § 473, subd. (a))—routinely analyze prejudice. (E.g., Duchrow v. Forrest (2013) 

215 Cal.App.4th 1359, 1378; Magpali v. Farmers Group, Inc. (1996) 48 Cal.App.4th 

471, 486–488 [“It is apparent that adding the new cause of action would have changed 

the tenor and complexity of the complaint from its original focus on representations and 

demands made to Magpali by his superiors to an exploration of Farmers’ activities and 

practices in the entire Southern California area.”]; Estate of Murphy (1978) 

82 Cal.App.3d 304, 311 [“Where inexcusable delay and probable prejudice to the 

opposing party is indicated, the trial court’s exercise of discretion in denying a proposed 

amendment should not be disturbed.”].) 

In this case, the trial court was not considering pleadings filed at or near the outset 

of the litigation, the usual context in which a demurrer is interposed and where prejudice 

is not an issue. Rather, here, the court was dealing with a context equivalent to a motion 
21

for leave to amend, namely a request to file an amended pleading very late in the 

litigation. Indeed, the court expressed serious concern about prejudice at the time 

plaintiffs sought leave to file their Fourth Amended Complaint adding their new RICO 

claim. And on discerning the full magnitude of the claim proffered in the Fifth Amended 

Complaint, the court concluded it was not just “another theory” as they had represented 

in connection with their Fourth Amended Complaint. Rather, it was a fundamentally 

different and highly complex claim that could not fairly be injected into the case only two 

months before summary judgment motions were due and only six months before the 

already re-scheduled trial date. Under these circumstances, the court did not abuse its 

discretion in denying leave to amend.

Contrary to plaintiffs’ protestations, it is neither accurate nor fair to say the 

proposed Fifth Amended Complaint simply fleshed out the general allegations of the 

Fourth Amended Complaint and raised no specter of complexity not already apparent in 

that latter pleading. While the Fourth Amended Complaint focused on an alleged 

conspiracy between defendants, Hazan and Arenstein, and other unnamed “traders and 

market makers,” the Fifth Amended Complaint added allegations about several newlynamed market makers. While the Fourth Amended Complaint alleged five criminal 

enterprises, the proposed Fifth Amended complaint alleged ten. Although the Fourth 

Amended Complaint and proposed Fifth Amended Complaint both alleged a conspiracy 

to violate New Jersey’s RICO statute, the Fourth Amended Complaint only conclusorily 

pleaded each “defendant conspired,” while the proposed Fifth Amended Complaint, for 

the first time, alleged which defendants allegedly conspired with which market makers. 

And not only did the proposed Fifth Amended Complaint allege various iterations of 

conspiracies to violate New Jersey’s RICO statute between the defendants and Hazan and 

Arenstein, it also alleged conspiracies between the newly-named market makers and 

defendants.

In addition, the proposed Fifth Amended Complaint made manifest the New 

Jersey RICO claim was based on “conspiracy and indirect liability.” While secondary 

conspiracy liability is a feature of a New Jersey RICO claim (N.J. Stats. 2C:41-2(d); State 
22

v. Cagno (N.J. Super. Ct. App. Div. 2009) 409 N.J.Super. 552, 582), it is not, as 

discussed in the next section of this opinion, a feature of the California securities claims 

under sections 24500 and 25500 that had long been the principal claims in the case (see 

Kamen v. Lindly (2001) 94 Cal.App.4th 197 (Kamen); California Amplifier, Inc. v. RLI 

Ins. Co. (2001) 94 Cal.App.4th 102, 113 (California Amplifier) [noting “legislative 

decision to exclude aiders and abettors from . . . liability”]). Indeed, plaintiffs had 

repeatedly emphasized their California law claims did not hinge on the liability of the 

market makers, but depended solely on the defendants’ own primary conduct. Further, it 

was apparent from the proposed Fifth Amended Complaint there would be a focus on 

additional New Jersey laws governing defendants’ alleged predicate acts of racketeering. 

In short, with the proposed Fifth Amended Complaint, the trial court saw clearly 

the road ahead if a New Jersey RICO claim was belatedly added to the litigation and 

accurately observed that road looked “extremely complex.” The court did not abuse its 

discretion in denying leave to file the proposed pleading.9

 

9 We therefore need not, and do not, reach defendants’ additional challenges to 

the New Jersey RICO claim. 
23

B. California Corporate Securities Law Claim10

1. Sections 25400 and 25500

“Corporations Code section 25400, a part of the Corporate Securities Law of 1968 

(Corp. Code, § 25000 et seq.), provides that it is unlawful in this state to make false 

statements or engage in specified fraudulent transactions which affect the market for a 

security when done [for specified purposes].” (Diamond Multimedia Systems, Inc. v. 

Superior Court (1999) 19 Cal.4th 1036, 1040 (Diamond), footnote omitted.) “In short, it 

prohibits market manipulation.” (Ibid.) Section 25500, in turn, “creates a civil remedy 

for buyers or sellers of stock the price of which has been affected by the forms of market 

manipulation proscribed by section 25400.” (Ibid., footnotes omitted.) Sections 25400 

and 25500 “are patterned after and virtually identical to section 9 . . . of the Securities 

Exchange Act of 1934 (15 U.S.C. § 78i (SEA)).” (California Amplifier, supra,

94 Cal.App.4th at pp. 114–115.) Accordingly, California courts often look to federal law 

for guidance in interpreting the state statute. (Id. at p. 115; see 1 Marsh & Volk, Practice 

Under the Cal. Securities Law (1993) § 14.05[1]–[2], p. 14-60 to 14-61 (Marsh & Volk) 

[discussing relationship of federal and California laws].)

 

10 The standard of review of a summary judgment is also well established. 

(Global Hawk Insurance Company v. Le (2014) 225 Cal.App.4th 593, 600 (Global 

Hawk).) “ ‘Code of Civil Procedure section 437c, subdivision (c) provides that summary 

judgment is properly granted when there is no triable issue of material fact and the 

moving party is entitled to judgment as a matter of law.’ ” (Ibid.) A moving defendant 

can meet its initial burden by presenting evidence showing plaintiffs’ causes of action 

have no merit or are precluded by an affirmative defense. (Moua, Barker, Abernathy, 

LLP (2014) 228 Cal.App.4th 107, 112 (Moua); Code Civ. Proc., § 437c, subd. (p)(2).) If 

the defendant makes its initial showing, the burden shifts to plaintiffs to show a triable 

issue of material fact exists. (Global Hawk, at p. 600; Code Civ. Proc., § 437c, subd. 

(p)(2).) We review the trial court’s ruling de novo (Moua, at p. 112), construing “the 

evidence in the light most favorable to the opposition to the motion, and liberally 

constru[ing] the opposition’s evidence, while strictly scrutinizing the successful party’s 

evidence and resolving any evidentiary ambiguities in the opposition’s favor” (Dameron 

Hospital Assn. v. AAA Northern California, Nevada and Utah Insurance Exchange

(2014) 229 Cal.App.4th 549, 558). We will affirm a summary judgment if it is correct on 

any ground, as we review the judgment, not its rationale. (Moua, at p. 112.)
24

Section 25400, subdivisions (a) through (e), address different species of 

manipulative conduct “which were common during the so-called pool operations in the 

1920’s.” (Kamen, supra, 94 Cal.App.4th at p. 203.) “For instance, section 25400, 

subdivision (a) prohibits ‘wash sales,’ i.e., the entering of purchase and sale orders of 

equal amounts in order to create the appearance of active trading and raise or depress the 

price of a security. Subdivisions (c) and (e) deal with ‘tipster sheets’ where either a 

broker-dealer or other person engaged in the pool operations, or a third person employed 

by the principals, disseminates information that the price of a security will rise or fall 

because of the market operations of the pool.” (Ibid.; see 1 Marsh & Volk, supra,

§ 14.05[2], p. 14-61.)

“[T]he more general and fundamental prohibitions” of section 25400 are set forth 

in subdivisions (b) and (d). (1 Marsh & Volk, supra, § 14.05[2], p. 14-61.) Subdivision 

(b) makes it unlawful “[t]o effect, alone or with one or more other persons, a series of 

transactions in any security creating actual or apparent active trading in such security or 

raising or depressing the price of such security for the purpose of inducing the purchase 

or sale of the security by others.” (§ 25400, subd. (b).) “Subdivision (d) makes it 

unlawful . . . for sellers or buyers of stock to make false or misleading statements of 

material facts for the purpose of inducing a purchase or sale.” (Diamond, supra, 

19 Cal.4th at p. 1048.)

In this case, we are concerned with subdivision (b), which makes it unlawful “[t]o 

effect . . . a series of transactions” that create “actual or apparent active trading” raising 

or depressing the price of the security, for the “purpose of inducing the purchase or sale 

of such security by others.” (§ 25400, subd. (b).)11 Since “[a]lmost any conceivable 

 

11 Plaintiff’s Fourth Amended Complaint alleged violations of subdivisions (a) 

and (b). In their opening brief on appeal, plaintiffs, without providing a detailed analysis, 

continued to suggest defendants might face liability for violating subdivision (a)(1)’s 

prohibition against “effect[ing] any transaction in a security which involves no change in 

the beneficial ownership thereof.” Defendants, citing various SEC regulations and cases,

responded there was no evidence beneficial ownership was not changing hands in the 

trades at issue, and certainly no evidence of trades in which the same trader was buying 
25

series of transactions in a particular security would necessarily create either actual or 

apparent trading or raise or depress the price of the security to some extent, ” the “crucial 

question” is “intent.” (1 Marsh & Volk, supra, § 14.05[2][d]; California Amplifier, 

supra, 94 Cal.App.4th at pp. 110–111 [as “Marsh & Volk emphasizes,” liability under 

section 25400 “extends to everyone whose market trades are affected by the market 

manipulation”; “ ‘[i]n view of this potentially enormous and virtually unlimited 

liability,’ ” intention is “ ‘a necessary qualification of the defendant’s liability’ ”].)

Before examining the evidence presented in connection with the summary 

judgment motions as to the two brokerage firms and two clearing firms, we discuss two 

legal issues that are pivotal to the significance of the evidence. The first is the meaning 

of the term “[t]o effect” a series of transactions in a security. (§ 25400, subd. (b), 

emphasis added.) The second is the distinction between liability as a principal, and aider 

and abettor liability. (See California Amplifier, supra, 94 Cal.App.4th at p. 113 [a private 

civil action under sections 25400 and 25500 does not reach aiders and abettors].)

2. “Effecting” a Trade Under Section 25400 Is Not Limited to Beneficial Sellers 

and Buyers

Defendants contend section 25400, subdivision (b), reaches only the beneficial 

sellers and buyers of manipulated securities and does not reach entities that execute, clear 

and settle trades for clients. Thus, according to the defendant clearing firms, for example,

no section 25400, subdivision (b), claim can lie against them as a matter of law. Rather, 

any claim under this subdivision would have to be advanced against their former trader 

clients, such as Hazan and Arenstein, in whose name the manipulative trades were made 

and who have been punished by the SEC and major exchanges. 

Subdivision (b) could have been drafted to apply only to beneficial sellers and 

buyers. But it was not. Rather, this subdivision applies to “any person, directly or 

 

or selling to himself. Rather than respond to these points, plaintiffs, in reply, 

acknowledged “the trades were actual trades” and “real,” but argued even “real” trades 

can be manipulative under subdivision (b) if done for a prohibited purpose. We therefore 

conclude plaintiffs have abandoned any claim under subdivision (a), and pursue a claim 

only under section 24500, subdivision (b).
26

indirectly” who “effect[s], alone or with one or more other persons, a series of 

transactions.” (§ 25400, subd (b), italics added.) This is in stark contrast to other 

provisions of section 25400 that apply to narrower classes of persons. (§ 25400, subd. (a) 

[subdivision (a)(1) applies to those who “effect” transactions, while subdivision (a)(2) 

and (a)(3) apply only to those who “enter an order or orders”]; id., subds. (c), (d) [both 

applying only to “a broker-dealer or other person selling or offering for sale or 

purchasing or offering to purchase the security”].)

The verb “ ‘to effect’ means ‘to bring about; produce as a result; cause; 

accomplish.’ (Webster’s New World Dict. (3d college ed. 1988) p. 432.)” (People v. 

Brown (1991) 226 Cal.App.3d 1361, 1368.) A “Broker-dealer,” in turn, is defined under 

California’s securities law as “any person engaged in the business of effecting 

transactions in securities in this state for the account of others or for his own account.” 

(§ 25004, subd. (a), italics added.) Thus, the plain language of the securities laws 

contemplates those “effecting” a transaction can include someone other than the 

beneficial seller or buyer, and can include broker-dealers. 

Section 9 of the SEA, on which section 25400 was based, also uses the 

terminology “effect . . . a series of transactions” (15 U.S.C. § 78i(a)(2)), and that

terminology is construed broadly.

12

 (United States v. Weisscredit Banca Commerciale E 

D’Investimenti (S.D.N.Y. 1971) 325 F.Supp. 1384, 1393–1394.) The legislative history 

of the SEA shows “the term ‘effect’ as used in Section 9 of the 1934 Act (15 U.S.C. 

§ 78i) and other sections means ‘to (participate) in a transaction whether as principal, 

 

12 Section 9 provides in pertinent part: “It shall be unlawful for any person, 

directly or indirectly, by the use of the mails or any means or instrumentality of interstate 

commerce, or of any facility of any national securities exchange, or for any member of a 

national securities exchange—[¶] . . . [¶] (2) To effect, alone or with 1 or more other 

persons, a series of transactions in any security registered on a national securities 

exchange, any security not so registered, or in connection with any security-based swap 

or security-based swap agreement with respect to such security creating actual or 

apparent active trading in such security, or raising or depressing the price of such 

security, for the purpose of inducing the purchase or sale of such security by others.” 

(15 U.S.C. § 78i(a), italics added.)
27

agent, or both’. S.Rep. No. 972, 73d Cong.2d Sess. 17 (1934).” (Ibid., italics added; see 

also 8 Loss et al., Securities Regulation, (4th ed. 2012) p. 540; SEC Release No. 605 

(1936), available at 1936 WL 31604.) 

Moreover, reading section 9 to reach, as appropriate, agents of beneficial sellers 

and buyers also harmonizes the section with other provisions of the SEA and its 

regulations, which, like California’s definitional statute, speak of brokers “effecting” 

transactions by carrying out various agency and back-office functions, including clearing

and settlement. (See 15 U.S.C. § 78c(a)(4) [a broker “means any person engaged in the 

business of effecting transactions in securities for the account of others”]; id.

§ 78bb(e)(3)(C) [“a person provides brokerage and research services insofar as he . . . 

effects securities transactions and performs functions incidental thereto (such as 

clearance, settlement, and custody)”]; 17 C.F.R. § 240.11a2–2(T)(b) (2014) [“For 

purposes of this section, a member ‘effects’ a securities transaction when it performs any 

function in connection with the processing of that transaction, including, but not limited 

to, (1) transmission of an order for execution, (2) execution of the order, (3) clearance

and settlement of the transaction, and (4) arranging for the performance of any such 

function.”]13; see also S.E.C. v. Securities Investor Protection Corp. (D.D.C. 2012) 

872 F.Supp.2d 1, 9, fn. 8 [it is the clearing broker who “ ‘actually effectuates the 

trade’ ”].) 

We therefore conclude the word “effect” in section 25400, subdivision (b),

includes more than the activity of beneficial sellers and buyers, and can include

execution, clearing and settlement activities by brokerage and clearing firms.

 

13 Regarding this particular rule, the SEC stated it “uses the term ‘effect’ in the 

broad sense which the Commission believes that term has in Section 11(a) and other 

parts of the Act.” (Securities Transactions by Members of National Securities 

Exchanges, SEC Rel. No. 14563 (Mar. 14, 1978), available at 1978 WL 170833, at *10, 

italics added.) The purpose of “add[ing] to the rule a definition of the term ‘effect’ that 

includes all functions performed in causing a securities transaction to be transmitted, 

executed, cleared and settled” was “to eliminate any uncertainty as to the functions 

which are comprehended within the term ‘effect’ as used in Section 11(a) and the effect 

versus execute rule.” (Id. at *8, italics added.)
28

Kamen does not hold, contrary to what defendants maintain, that “effecting” a 

transaction refers only to beneficial sellers and buyers. Indeed, the case does not even 

consider the meaning of the term “effect” in subdivision (b). The complaint in Kamen 

“purport[ed] to state a cause of action under section 25400, subdivision (d).” (Kamen, 

supra, 94 Cal.App.4th at p. 202, italics added.) That subdivision, in contrast to 

subdivision (b), prohibits a “a broker-dealer or other person selling or offering for sale or 

purchasing or offering to purchase” a security from making any “false or misleading” 

statement “for the purpose of inducing the purchase or sale of such security by others.”

(§ 25400, subd. (d).) While the defendants in Kamen, a corporate officer and an 

accounting firm, were accused of making false statements about the company’s 

performance, neither sold or offered for sale any of the company’s shares. (Kamen, 

supra, 94 Cal.App.4th at p. 200.) Thus, neither was liable under the plain language of 

subdivision (d), which is strikingly different from the language of subdivision (b). 

(Kamen, at p. 206.) 

Defendants also point out the authors of Marsh & Volk were heavily involved in 

the drafting of the state securities laws, and their treatise states section 25400 generally 

reaches only those “engaged in market activity.” (Marsh & Volk, supra, § 14.05[4], 

p. 14-66.) The treatise then continues, “[s]ubdivision (a), dealing with matched orders, 

and subdivision (b), dealing with liability for a series of transactions manipulating the 

price of a security, by their very nature require that the defendant be a purchaser or seller, 

since the conduct prohibited is associated with a market transaction.” (Ibid.) We have no 

disagreement with Marsh & Volk’s general observation, as one can “engage in market 

activity” by executing, clearing and settling trades. However, for all the reasons we have 

discussed, we conclude Marsh & Volk’s second statement is unsupported and incorrect. 

In fact, the treatise provides no analysis on this point, let alone any discussion of either 

the statutory language or the like provisions of Section 9 of the SEA on which 

Corporations Code section 24500 was based. (See Diamond, supra, 19 Cal.4th at p. 1055

[the Marsh & Volk treatise cannot be invoked in favor of a statutory interpretation 

contrary to a statute’s plain language].)
29

3. Primary Versus Aider and Abettor Liability

Having concluded any person who “effect[s] a series of transactions” can include

not only beneficial sellers and buyers of shares, but also brokerage and clearing firms that

execute, clear and settle the trades, we next consider under what circumstances brokerage 

and clearing firms can incur liability, given the well-established rule that a private civil 

action under sections 25400 and 25500 does not reach aiders and abettors. Rather, only 

primary actors are subject to civil liability for damages. (Kamen, supra, 94 Cal.App.4th 

at p. 206, citing Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.

(1994) 511 U.S. 164, 179 (Central Bank) [holding no secondary liability under section 

10(b) of the SEA]; California Amplifier, supra, 94 Cal.App.4th at p. 113 [“To impose 

liability on persons who do not directly participate in a section 25400 violation would be 

contrary to the legislative decision to exclude aiders and abettors from section 25500 

liability.”]; compare §§ 25530–25536, 2540314 [authorizing enforcement actions by 

Commissioner of Corporations and allowing aider and abettor liability in such actions]).15

As did Kamen, we take guidance from Central Bank. The Supreme Court in 

Central Bank discussed section 10(b) of the SEA—and specifically its anti-fraud 

provision—and concluded: “The absence of . . . aiding and abetting liability does not 

mean that secondary actors in securities markets are always free from liability under the 

 

14 Section 25403, for example, provides: “Any person that knowingly provides 

substantial assistance to another person in violation of any provision of this division or 

any rule or order there under shall be deemed to be in violation of that provision, rule, or 

order to the same extent as the person to whom the assistance was provided.” (§ 25403, 

subd. (b).)

15 Aider and abettor liability is similarly limited under various federal securities 

laws. (Central Bank, supra, 511 U.S. at p. 183 [“various provisions of the [federal] 

securities laws prohibit aiding and abetting, although violations are remediable only in 

actions brought by the SEC,” citing, for example, “15 U.S.C. § 78o (b)(4)(E) (1988 ed. 

and Supp. IV) (SEC may proceed against brokers and dealers who aid and abet a 

violation of the securities laws); Insider Trading Sanctions Act of 1984, Pub.L. 98-376, 

98 Stat. 1264 (civil penalty provision added in 1984 applicable to those who aid and abet 

insider trading violations); 15 U.S.C. § 78u-2 (1988 ed., Supp. IV) (civil penalty 

provision added in 1990 applicable to brokers and dealers who aid and abet various 

violations of the Act)”].) 
30

securities Act. Any person or entity, including a lawyer, accountant, or bank, who 

employs a manipulative device or makes a material misstatement (or omission) on which 

a purchaser or seller of securities relies may be liable as a primary violator . . . , assuming 

all of the requirements for primary liability . . . are met. . . . . In any complex securities 

fraud . . . there are likely to be multiple violators . . . .” (Central Bank, supra, 511 U.S. at 

p. 191; see In re Enron Corp. Securities, Derivative & ERISA Litigation (S.D. Tex. 2002) 

235 F.Supp.2d 549, 582.)16 

Thus, section 10(b) liability has been imposed on brokerage and clearing firms 

when they have crossed the line from aider and abettor to primary violator. (E.g., Fox 

Intern. Relations v. Fiserv Securities, Inc. (E.D. Pa. 2007) 490 F.Supp.2d 590, 609 

[liability under section 10(b) possible when not engaging in mere ordinary clearing 

services]; In re Mutual Funds Inv. Litigation (D. Md. 2005) 384 F.Supp.2d 845, 857–858 

[“the trader defendants are alleged to have been involved in the [section 10(b)] fraudulent 

scheme from the outset and to have been at least one of its architects. Moreover, 

unquestionably it is the trader defendants who received the profits that were siphoned off 

from the mutual funds as a result of late trades and market timed transactions. These are 

not the activities of a mere aider and abettor but those of a primary participant in the 

unlawful conduct”]; In re Blech Securities Litigation (S.D.N.Y. 1997) 961 F.Supp. 569, 

 

16 As defendants point out, there are substantive differences between 

section 25400 and section 10(b) of the SEA—for instance, the focus in section 25400, 

subdivision (b), is on “effecting transactions” in manipulated securities, whereas 

section 10(b) broadly prohibits any person from the knowing use of deceptive practices in 

“connection with” the purchase or sale of a security. (15 U.S.C. § 78j(b).) However, that 

the conduct prohibited by section 10(b) may be broader, does not suggest the critical 

distinction between primary participants and aiders and abettors under that section is not 

helpful in defining these roles under California law. (Cf. Kamen, supra, 94 Cal.App.4th 

at p. 206, citing Central Bank, supra, 511 U.S. at p. 164.) Indeed, the basic approach to 

drawing the line between primary and secondary liability should generally operate

independently of particular substantive statutes. (See Freeman v. DirecTV, Inc. (9th Cir.

2006) 457 F.3d 1001, 1006, fn. 1 [“it is the Supreme Court’s approach to interpreting the 

statute, not the actual statute itself, that is significant . . . [t]hus, the fact that the court was 

interpreting a different act of Congress—the Securities Exchange Act—is 

inconsequential”].)
31

582–585 (Blech II)

17 [“Plaintiffs have remedied the defects of their previous complaint by 

adding sufficient allegations to give rise to an inference that [clearing firm] Bear Stearns 

had actual knowledge of Blech’s fraudulent conduct as well as a motive and opportunity 

for engaging in the scheme with Blech and his confederates”]; id. at p. 585 [“Bear 

Stearns is alleged to have conceived of and participated in the initiation and clearing of 

sham transactions aimed at affecting . . . the price of the Blech Securities”].)

In the Blech cases, Bear Stearns, a clearing firm, was accused of market 

manipulation under section 10(b) for directing and clearing trades of an introducing firm 

client, Blech. On the one hand, the trades were arguably legitimate efforts to reduce

Blech’s debt balance on Bear Stearns’ books; on the other, they were arguably known by 

Bear Stearns to be propping up the price of the traded securities. (Blech II, supra, 

961 F.Supp. at pp. 577–578; In re Blech Securities Litigation (S.D.N.Y., Oct. 17, 2002, 

No. 94 CIV.7696 RWS) 2002 WL 31356498, *1, *15 (Blech III).) In Blech II, the 

district court denied a motion to dismiss. While allegations Bear Stearns cleared or 

otherwise “engaged in” manipulative trades were insufficient to state a claim, as even 

knowingly processing the sham trades of others does not give rise to direct liability,

additional allegations Bear Stearns “directed” the sales and cleared the resulting trades to 

its pecuniary benefit, and did so knowing Blech’s fraudulent purpose, brought Bear 

Stearns into the realm of a primary violator. (Blech II, supra, 961 F.Supp. at pp. 584–

585.)

In Blech III, Bear Stearns moved for summary judgment. Evidence corroborated

the plaintiffs’ allegations of Bear Stearns’ orchestration of the trades and knowledge of 

the manipulation of the market. Not only did Bear Stearns direct trades, but it decided 

 

17 An earlier decision, In re Blech Securities Litigation (S.D.N.Y. 1996) 

928 F.Supp. 1279, is typically referred to as Blech I. At that point, the complaint did not 

yet sufficiently “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.” (Id. at 

p. 1295.)
32

with Blech who should be on the purchasing side of his sales.18 (Blech III, supra, 2002 

WL 31356498, at p. *11.) Indeed, the plaintiffs alleged “these demands forced parking 

and trading between Blech Accounts.” (Id. at p. *15, italics added.) Bear Stearns 

contended in turn, its “actions with respect to debit demands were simply consistent with 

its agreement . . . to serve as . . . clearing broker,” an agreement that, under NYSE Rule 

382, allocated back-office functions to Bear Stearns and compliance with rules and 

regulations to Blech as an introducing broker. (Blech III, at pp. *5–*6, *15.) 

The district court acknowledged “margin calls by a clearing broker or a failure to 

make margin calls, even with suspicion or knowledge of impropriety on the part of the 

initiating broker, is an appropriate and essential part of the securities business.” (Blech 

III, supra, 2002 WL 31356498, at p. *15.) The court concluded, however, “[a]n 

agreement to clear does not constitute an absolution from securities fraud” and concluded 

“[t]he contentions here go further.” (Ibid.) “[A] margin call made with knowledge that it 

will cause the initiating broker to commit a securities fraud which must be cleared by the 

clearing broker, constitutes direct action in connection with a contrivance to manipulate a 

security. Here that element of causality is at issue.” (Ibid.) 

In In re Mutual Funds Inv. Litigation, the district court also discussed clearing 

firm liability and allowed a SEA manipulation claim to proceed against two such firms 

when their activity extended beyond mere clearing services to providing clients with 

access to trading platforms that allowed for late trades and trades without time stamps. 

(In re Mutual Funds Inv. Litigation, supra, 384 F.Supp.2d at p. 862.) “These acts are 

‘manipulative or deceptive’ on their face, and by virtue of the trades they enabled, they 

 

18 “Bear Stearns supplied Blech with lists of accounts having unpaid trades so that 

Blech would know which accounts needed to sell to the . . . controlled accounts, and Bear 

Stearns and Blech directly discussed rebooking trades and switching trades around so that 

the Blech Trusts ended up buying stock from some accounts in which there were debits 

for unpaid trades. Shulman [of Bear Stearns] stated: ‘If we handle the liquidations and 

we don’t sell to him but we sell to the rest of the street, we have a concern that the 

outside world may perceive that his world is falling apart and the other market makers 

may pull their bids or significantly lower their bids.’ ” (Blech III, supra, 2002 WL 

31356498, at p. *11.)
33

affected the worth of mutual fund shares. Thus, they are the functional equivalent in the 

mutual fund industry of sham transactions that artificially affect market prices in more 

conventional contexts. [Citation.] Moreover, these alleged acts of deception, when 

considered with other allegations concerning the extent of Bank of America’s and Bear 

Stearns’ activities on behalf of late traders and high-volume market timers, imply that 

Bank of America and Bear Stearns did not merely assist in facilitating late trades and 

market timed transactions. Rather, it is reasonably inferable that they participated in 

initiating, instigating, and orchestrating the scheme. If discovery demonstrates this to be 

so, Bank of America and Bear Stearns face primary liability under Central Bank.” (Ibid.)

In contrast, clearing firms were absolved of liability in Fezzani v. Bear, Stearns & 

Co., Inc. (S.D.N.Y. 2004) 384 F.Supp.2d 618. The plaintiffs in that case alleged, much 

as in Blech, that Bear Stearns engaged in market manipulation under section 10(b) 

because it knew of a client’s, Baron’s, activities aimed at inflating stock prices and 

“provided financial support to Baron, and directed Baron at times to sell the manipulated 

securities to the public.” (Id. at pp. 628–629.) But in Fezzani, the allegations “d[id] not 

cross the threshold laid out in Blech III.” (Id. at p. 642.) “All the complaint alleges” is 

Bear Stearns “knew of Baron’s fraud and cleared the transactions that were fraudulently 

made”; there was no allegation Bear Stearns “contrived and agreed to fund” a 

manipulative scheme as in Blech. (Fezzani, at p. 642.)

Scone Investments, L.P. v. American Third Market Corp. (S.D.N.Y., Apr. 28, 

1998, No. 97 Civ. 3802 (SAS)) 1998 WL 205338, *1, *7–*8, also distinguished the Blech

cases. In Scone, a bank was “alleged to have directed that . . . securities be sold, not that 

the sale be effectuated by way of fraudulent misrepresentation. The Bank’s liquidation 

demand is a far cry from the ‘intimate’ ‘hands-on involvement’ and participation in ‘key 

decisions’ about the details of the sale which would render it a primary violator.” (Scone,

at pp. *8–*9; see Abrams, supra, 67 Brook. L. Rev. at p. 504.)

The Second Circuit recently addressed the “normal clearing services” standard in 

Levitt v. J.P. Morgan Securities, Inc. (2d Cir. 2013) 710 F.3d 454, 458–459, 466–468 

(Levitt), in reversing a class certification order. The circuit court concluded Bear Stearns
34

had no duty to disclose a known fraud to the plaintiffs, clients of an introducing firm, 

Sterling Foster, which had a clearing agreement with Bear Stearns making Sterling Foster 

responsible for monitoring its customers. The plaintiffs maintained Bear Stearns knew of 

Sterling Foster’s plan to manipulate the market for a soon-to-be-publicly-offered stock, 

ML Direct, by misusing insider shares supposedly subject to a lock-up agreement. They 

further alleged Bear Sterns nonetheless agreed to clear transactions in these shares, 

extended Sterling Foster unsecured credit, failed to cancel trades as required by an SEC 

regulation (Regulation T), and failed to disclose to purchasers Sterling Foster’s 400

percent profit in the underwriting. (Id. at pp. 462–465.) 

Levitt observed courts have grouped clearing firm activity into two categories: 

“First, in cases where a clearing broker was simply providing normal clearing services, 

district courts have declined to ‘impose . . . liability on the clearing broker for the 

transgressions of the introducing broker.’ [Citations.] The district courts have so held 

even if the clearing broker was alleged to have known that the introducing broker was 

committing fraud, [citation]; even if the clearing broker was alleged to have been clearing 

sham trades for the introducing broker, In re Blech, 961 F.Supp. at 584; and even if the 

clearing broker was alleged to have failed to enforce margin requirements against the 

introducing broker—thereby allowing the introducing broker’s fraud to continue—in 

violation of Federal Reserve and NYSE rules, [citation].” (Levitt, supra, 710 F.3d at 

p. 466.)

“In the second, much more limited category of cases, district courts have found 

plaintiffs’ allegations to be adequate—and so have permitted claims to proceed—where a 

clearing broker is alleged effectively to have shed its role as clearing broker and assumed 

direct control of the introducing firm’s operations and its manipulative scheme. . . . . 

Thus in Berwecky v. Bear, Stearns & Co., 197 F.R.D. 65 (S.D.N.Y.2000), the district 

court granted class certification in a suit brought by investors against clearing broker 

Bear Stearns for its role in the introducing firm . . . scheme to defraud investors. The 

Berwecky plaintiffs alleged that Bear Stearns ‘asserted control over [the introducing 

firm’s] trading operations by, inter alia, placing Bear, Stearns’ employees at Baron’s 
35

offices to observe Baron’s trading activities, approving or declining to execute certain 

trades, imposing restrictions on Baron’s inventory, and loaning funds to Baron.’ . . . 

[¶] Similarly, the district court in Blech [II], 961 F.Supp. 569, found that the ‘[c]omplaint 

crosse[d] the line dividing secondary liability from primary liability when it claim[ed] 

that Bear Stearns [the clearing broker] “directed” or “contrived” certain allegedly 

fraudulent trades.’ ” (Levitt, supra, 710 F.3d at pp. 466–467.)

Applying this dichotomy to the facts before it, Levitt concluded Bear Stearns did 

not have a duty to disclose Sterling Foster’s fraud because plaintiffs “failed to allege 

sufficiently direct involvement.” (Levitt, supra, 710 F.3d at p. 468.) “Certainly plaintiffs 

here do not allege that Bear Stearns, beyond merely acquiescing in the ML Direct 

scheme, went so far as to control and implement that scheme in the manner alleged, for 

example, in Berwecky.” (Ibid.) That “Bear Stearns allowed . . .’ . . . putatively sham or 

manipulative trades” was not “comparable to directing or instigating such trades.” (Id. at 

p. 469.) 

Thus, the threshold for primary liability on the part of clearing firms is high. They 

do not incur such liability when they provide “normal clearing services”—and that is so 

even when a firm knows the trader is committing fraud or knows it is clearing and 

settling sham trades. Rather, to qualify as a primary violator a clearing firm must “shed 

its role as clearing broker” and engage in conduct akin to “directing” the client’s 

manipulative trading, or “deciding with” the client how to engage in the unlawful trading, 

or intentionally providing a specialized tool for the client to engage in unlawful trading, 

or “initiating, instigating, and orchestrating” the client’s unlawful scheme,” or having 

“intimate” “hands-on involvement” and participating in “key decisions” about the 

“details” of the client’s unlawful trading, or assuming “direct control of” the client’s 

“operations and its manipulative scheme.” 

4. The Summary Judgment Evidence 

a. Goldman Brokerage

Goldman Brokerage was, itself, a purchaser of reversion conversions, and 

plaintiff’s expert, J. Marc Allaire, based on his review of Goldman documents, averred 
36

Goldman bought reverse conversions from Hazan and Arenstein. Allaire and other 

experts also opined, based on the pricing of these trades, Goldman Brokerage knew the 

short sale components of these complex trades would fail and continue to fail for the 

duration of the options components of the trades—in short, Goldman knew the trades 

were shams and created a “phony” supply of Overstock shares. Indeed, there is evidence 

Goldman Brokerage acted as Arenstein’s agent in executing conversion trades with itself, 

and acknowledged Arenstein could provide the firm a supply of shares it could not obtain 

“in the pits.” In an e-mail, for example, Goldman acknowledged such conversion trades 

“create inventory to allow customers to short.” In another email, it acknowledged a 

general goal of its Hedging Strategies Group was “to create supply and perpetuate selling 

in stocks with a large amount of short interest.” In sum, there is substantial evidence 

Goldman Brokerage was, itself, a beneficial purchaser of one species of the exotic trades

in which Hazan and Arenstein engaged to circumvent Regulation SHO. 

There is no evidence, however, raising a triable issue Goldman Brokerage’s own 

purchases, or its execution of Hazan’s or Arenstein’s or another clients’ sham trades in 

Overstock, were made in California. Hazan and Arenstein operated out of New York and 

New Jersey.

19

 Goldman Brokerage operated out of New York, New Jersey and Chicago. 

Further, plaintiffs did not rebut Goldman Brokerage’s evidence that any conversion 

trades were consummated on regional exchanges outside of California, such as the 

 

19 Although plaintiffs maintained one seller of conversions, Group One, had a 

California address, the company’s CEO swore in a 2004 SEC filing the firm, while a 

California entity, is headquartered in Chicago. There is no evidence Group One engaged 

in trading with Goldman Brokerage from any office in California as opposed to from its 

Illinois headquarters. The California address for Group One in some of Merrill 

Clearing’s trading records does not suffice to establish the location of trades or other 

interactions with Goldman Brokerage. Plaintiffs cited no deposition testimony or other 

evidence regarding the location of Group One or any trading history it had with Goldman 

Brokerage, in particular. Indeed, while plaintiffs’ expert stated Merrill Clearing’s “blue 

sheets show that Group One was located in San Francisco in 2005–2006,” the expert 

noticeably refrained from stating Group One conducted manipulative conversion trades 

with Goldman Brokerage in California.
37

Chicago Board Options Exchange, Midwest Stock Exchange, or Cincinnati Stock 

Exchange.20 

Accordingly, summary judgment was properly granted as to Goldman Brokerage.

b. Merrill Brokerage

There is a similar shortcoming in the evidence as to Merrill Brokerage. To begin 

with, there is no evidence Merrill Brokerage, in contrast to Goldman Brokerage, was, 

itself, a purchaser of reverse conversions in Overstock.

There is evidence Eugene McCambridge, a Merrill broker in Chicago, executed 

some trades in Overstock shares for Hazan and Arenstein. However, McCambridge 

could not identify which exchange he used for any given trade. He testified at deposition 

he would ordinarily route NASDAQ trades through “Arca or P-Coast.” But he was 

shown and testified specifically about trade tickets showing Overstock trades on the 

Midwest Stock Exchange in Chicago. The “blotters” (the paperwork showing the trades) 

also do not identify the exchange used for the trades. Thus, whether McCambridge 

executed any Overstock trades on the Pacific Exchange is pure speculation, insufficient 

to raise a triable issue Merrill Brokerage executed trades in Overstock in California. 

In addition, there is no evidence the trades McCambridge executed were of the 

exotic variety designed to avoid Regulation SHO’s delivery requirement. Plaintiffs’ 

experts purported to identify the alleged manipulative trading and they focused on 

Goldman Brokerage’s purchases of conversions and on the clearing firms’ activities. 

They made no reference to the trades McCambridge executed.

Accordingly, summary judgment was also properly granted as to Merrill 

Brokerage. 

 

20 While plaintiffs’ expert Allaire links the potentially California-based Pacific 

Exchange with the clearing firms and various sham reset trades, no linkage is made to 

Goldman Brokerage. The omission is striking. It is not enough, as Allaire states, that

Goldman Brokerage purchased conversions whose components were cleared by, for 

instance, Merrill Clearing, in a manner that links up with California. The question is 

what did Goldman Brokerage do in California. There is no evidence Goldman Brokerage 

did anything actionable in California. 
38

c. Goldman Clearing

Goldman Clearing did not have a clearing office in California, and there is no 

evidence this clearing firm did anything, in California or otherwise, beyond normal

clearing activity. There is no evidence Goldman Clearing directed, developed, or 

instigated—as opposed to acquiesced in—any strategy for repeatedly failing short sales, 

shirking delivery obligations, or clearing sham reset transactions. (See California 

Amplifier, supra, 94 Cal.App.4th at p. 113 [no aiding and abetting liability]; compare In 

re Mutual Funds Inv. Litigation, supra, 384 F.Supp.2d at p. 862, italics added

[“reasonably inferable that they participated in initiating, instigating, and orchestrating

the scheme”].) At best, there is evidence suggesting the firm was clearing purported 

market makers’ sham reset transactions, was aware short interest in Overstock was high, 

“noticed fails going up rather dramatically . . . at [Goldman Clearing],” and generally 

monitored client short sales in Overstock and gave clients notice of their regulatory 

obligations to “buy-in.” However, there is no evidence raising a triable issue the firm 

“shed its role as clearing broker and assumed direct control” of the scheme to evade 

federal securities laws. (Levitt, supra, 710 F.3d at pp. 466–467.) Indeed, the evidence 

pertaining to Goldman Clearing does not come close to that pertaining to Merrill Clearing

and to which we now turn.

 d. Merrill Clearing

Merrill Clearing, unlike Goldman Clearing, had an office in California and from 

that office provided clearing services to traders in Overstock shares, including Hazan and 

Arenstein. By February, 2005, Alan Cooper, the head of the office, was having “frequent 

interactions” with Hazan—approximately five-to-six times a week by telephone and email. Cooper, Hazan, and Merrill Clearing’s compliance department discussed 

Regulation SHO and, in general, a clearing firm’s responsibility to insure delivery and 

not to fail trades. At his deposition, Cooper claimed he and the compliance officer were 

not offering opinions on Regulation SHO, but simply explaining how Merrill Clearing 

would be implementing it. 
39

In one interaction, in mid-February, Hazan was upset that Merrill Clearing was 

automatically borrowing shares to insure delivery, when he expected it would not. In an 

internal e-mail, Cooper, based on a conversation with Hazan, relayed “the trader did not 

know we were going to be charging [fees to borrow] negatives” and if Merrill Clearing 

were to buy-in Hazan on the trade, Hazan would likely re-sell shares to “maintain his 

hedge.” Cooper asked if the buy-ins could be stopped. 

What Hazan, and in turn, Cooper, were complaining about was what Merrill 

termed the “flipping” of all trades for automatic delivery and settlement. This deprived 

legitimate market maker clients of Regulation SHO’s exemption from the locate 

requirement, and deprived the clearing firm of its right under the regulation to delegate 

delivery obligations to bona fide market maker clients. Hazan was not the only Merrill 

Clearing client complaining about it. Moreover, Merrill Clearing had had a “do not flip” 

practice for market maker clients in place prior to the time Hazan and Arenstein became 

clients, and the complained-about automatic “flipping” started with Merrill’s acquisition 

of another firm, Sage (for whom Cooper had worked), and its computer system which 

was not programmed to “hold back” market maker short sales. 

About a week later, Hazan sent Cooper an e-mail noting an interaction with 

Merrill Clearing’s compliance department concerning Regulation SHO, and then posing

several questions: Did a clearing firm need to pay to borrow a stock if it’s “being held 

for less than 10 days” as would be the case with a “flex or short term option hedge?”

Could the options market maker exemption exempt trades from Regulation SHO’s closeout requirements if stock did not appear on “the Reg sho list” of threshold securities until 

after a short sale as a hedge? If Merrill Clearing were long in the stock, could Hazan use 

that position to offset short sales? 

On the afternoon of February 23, Cooper told colleagues, in an email, Hazan was 

threatening to leave Merrill Clearing for another firm if Merrill could not (without 

providing further specifics) “accommodate his trading style.” One colleague responded 

“I would say we can’t.” At his deposition, Cooper could not recall what he had meant by 

“trading style,” but admittedly knew at the time it involved trading in threshold (hard-to-
40

borrow) stocks, doing “riskless” trades, “delta-neutral” trades, conversions, and reversals. 

He also admitted having at least a general understanding Hazan could profit from the 

spread between the pricing of the options components of reverse conversions. And he 

admitted the reverse conversions the SEC later investigated and for which it imposed 

sanctions, were the sort of trade Merrill was clearing. 

At around the same time—that is, February 2005—Cooper also began working 

with Arenstein. Cooper spoke to Arenstein about possibly opening an account, and 

Merrill Clearing’s Managing Director, Curt Richmond, told Arenstein he and Cooper 

were “speaking to compliance about Reg-SHO.” 

In a March 4, 2005 e-mail, Richmond and Merrill Clearing’s President, Thomas 

Tranfaglia, Jr., discussed how Arenstein wanted to talk to Tranfaglia about Regulation 

SHO and Merrill Clearing’s related policies. Richmond stated: “After the Hazan incident 

I informed [Arenstein] that we had no interest in clearing his ‘Reg-SHO fail with FLEX 

Options Strategy.’ ” Richmond noted Arenstein had taken “some of the other side of 

Hazan’s closing trades,” but told Tranfaglia “it is your call.” Arenstein particularly 

wanted to know if Merrill Clearing would charge market makers lending fees on a fail to 

deliver if there was no violation of Regulation SHO, and whether Merrill Clearing would 

give its clients a chance to “get out on their own” before Regulation SHO deadlines. 

At the end of the month, Cooper relayed to superiors a trading strategy suggested 

by Hazan—to use a “one day flex” in which Hazan would buy and sell calls in the same 

number of shares. Cooper asked “[c]ould we fail” on those shares “from the assignment 

the next day.” The admitted goal was “to reestablish a new short and not borrow it.” 

Cooper was asked to discuss the matter in person, and the conversation went offline. At 

his deposition, Cooper claimed he did not believe the goal of such a trade was to evade 

Regulation SHO, but to address Hazan’s desire to avoid fees related to the supposedly 

unnecessary, automated borrowing of shares imposed by the computer system Merrill 

Clearing had inherited from Sage. 

The following month, in April 2005, Cooper filled in parts of a spreadsheet listing 

certain securities Hazan was holding (none of which were Overstock). In the far right 
41

column, Cooper marked down checks indicating Hazan “will not pay negative rebate” 

and had a “desire to fail.” 

In mid-May, Cooper oversaw a “Reg SHO test trade” by Hazan. The trade would 

establish a new 350,000 share short position in a security (one other than Overstock) for 

which options had been placed before implementation of Regulation SHO, and Merrill 

Clearing would not process the trade for delivery.21 At his deposition, Cooper again 

claimed the purpose of this exotic trade was not to evade Regulation SHO’s delivery 

requirement, but to move a position from a “faulty” account that required borrowing of 

shares, to a different account which would allow a bona fide market maker to sell short 

without borrowing. In an internal e-mail that same day, Cooper said he told Hazan he 

would be subject to Regulation SHO’s buy in requirement, even though Hazan had earlier 

hoped for assurances “that the position would not be subject to Reg Sho buy-in in 13 

days.” 

The compliance department wanted to have further discussions to get more 

comfortable with the test trade, and wanted to have a procedure set up to deal with 

“hold[ing] these trades back”—a procedure that it would “need . . . to provide to the 

SEC.” But the trade was already in motion.

On May 25, 2005, after trade execution, a Managing Director at both Merrill 

entities and President and Chief Operating Officer of Merrill Clearing, Peter Melz, 

responded to the compliance department’s concern about the trade saying: “fuck the 

compliance area—procedures, scmecedures.” At her deposition, Merrill’s compliance 

officer stated she watched Melz draft the e-mail and it was made as part of an in-office

jest. 

 

21 Under the version of Regulation SHO in effect between 2005 and 2007, naked 

positions put on before a security became a threshold security were “grandfathered” and 

not subject to the regulation’s ordinary delivery requirement. (See former 17 C.F.R. 

§ 242.203(b)(3)(i)–(ii) [effective to August 28, 2005].) None of the parties have 

discussed whether any component of this “test” trade was or was not grandfathered under 

the then-effective regulation.
42

By mid 2005, Merrill Clearing remedied the computer trading system it had 

acquired from Sage, and completed implementation of an automated “do not flip” 

process. This new process ensured trades in negative rebate securities (those, like 

Overstock, with high borrow fees) would not automatically “flip” to settlement when a 

market maker was selling short. Thus, Merrill Clearing would no longer inform Merrill 

Brokerage of the need to acquire shares to settle such short sales. Both firms were aware 

if the brokerage firm kept on its books the shares of negative rebate securities it otherwise 

would have provided to comply with Regulation SHO, those shares could be lent out for 

profit. 

Merrill Clearing claims the “do not flip” process was the means by which, as 

allowed by Regulation SHO, it allocated responsibility for delivery to bona fide market 

maker clients. Yet, Merrill still had a policy of (1) giving such clients notice of 

impending 13-day deadlines to close out fail to deliver positions, and (2) actually “buying 

in” clients who did not comply—a “buy in” being a trade ostensibly conducted to close 

out a fail to deliver and enable delivery to a waiting buyer. 

By summer 2005, discussions within Merrill turned to handling “buy ins.” In late 

July, Cooper noted Hazan “trades many hard to borrows and will need as much color 

[that is, information] on potential buy-ins as possible.” On August 29, one of Cooper’s 

employees, Hugh Skinner, wrote to Cooper that Hazan wanted early notification of buyins because late notice “could prevent him from selling into the buy-in.” At his 

deposition, Cooper stated traders like Hazan wanted estimates of impending buy-ins so 

they could “sell into it” and, in the case of naked shorts, re-obtain the naked short 

position and remain risk neutral. This would, Cooper understood, effectively “reset” the 

Regulation SHO clock and give traders, at least from Merrill’s perspective, a new period 

of time to complete delivery of shares. As we have discussed, the SEC found this scheme
43

to reset the Regulation SHO clock and avoid delivery to be an egregious violation of the 

regulation.

22

 

It was the San Francisco office that provided the notification function for Hazan 

and other clients in and around August 2005, but not necessarily for the entire period 

relevant here. At his deposition, Cooper denied taking an active role in Hazan’s trades or 

the trades of other Merrill Clearing clients, and viewed his role as largely clerical. He 

also denied reviewing trades to see if anyone repeatedly used reset transactions to 

perpetuate the naked short positions. 

Despite Cooper’s assertions of passive ignorance, on August 4, 2005, a Merrill 

Clearing director-level employee, Bill Stein, noticed Cooper’s traders “were knowingly 

putting on shorts and then basically rolling them every 13 days.” At his deposition, 

Cooper said he did not recall exactly what this statement referred to, but conceded Stein 

was referring to “beating the Reg SHO obligation.” Certainly by July of 2006, Cooper 

understood this regulation-evasion aspect of the trading strategy Hazan and others were 

pursuing, noting “FLEXs were being questioned” and wrote in an email “[a] few traders 

have figured out how to use the FLEXs to deal with Reg SHO.” 

In December 2005, Merrill Clearing’s chief compliance officer sent a bulletin 

noting the firm had received regulatory inquiries and scrutiny over “flex trades by two 

. . . clients in OSTK.” 

 

22 While Merrill claims the sanction orders found Hazan and Arenstein deceived 

their clearing firms and thus exonerated the firms, that is not a fair reading of the orders. 

The SEC order against Hazan, for example, describes how, under Regulation SHO, “a 

clearing firm is permitted reasonably to allocate a fail-to-deliver position to a broker or 

dealer whose short sale resulted in the position” and states Hazan’s clearing firm 

“notified” him on numerous occasions it had “allocated” to him the close-out obligation. 

The order goes on to point out the prime brokerage firms “created the demand for the 

reverse conversion” trades Hazan was making because by purchasing those conversions 

they could “create inventory.” It further discusses how Hazan’s “clearing firm,” based on 

Hazan’s “purported ‘purchase’ of shares,” would “reset” his “Reg SHO close out 

obligation to day one” thus giving him “another thirteen settlement days in which to close 

out the short position.” The SEC concluded this strategy was a patent violation of the 

regulation—and there is no exoneration of the clearing firms.
44

In an internal January 2006 telephone call, the compliance officer talked about 

Arenstein’s trading, how he was not acting as a bona fide market maker, and how it was 

“not okay” to be “recycling” his “short position.” She said: “You know, I—we really—I 

got to set up a meeting where we have to talk to the business, because these guys, they 

must be spoken to. Like-and not by you. You know what I’m saying? Like this is not 

okay. Like you cannot be recycling this short position. I mean, I don’t understand. If 

he’s got—If he’s got, you know, a buy-in due today, tomorrow, and the next day, right? 

Then he can’t short anymore in these next few days.” 

That same month, the compliance officer followed up with an email to Merrill 

Clearing executives, telling them “as you know” Arenstein had been involved in trading 

activity the NASD was questioning as inconsistent with Regulation SHO, and informing 

them of the flex option recycling scheme and how Merrill’s net fails to deliver in 

Overstock were not diminishing. She noted if the firm were to drop Hazan and 

Arenstein, the database of fails “shrinks unbelievably.” There is also evidence, during 

this time frame, of compliance communications with Hazan and Arenstein during which 

they insisted they were acting as bona fide market makers, and a telephone call to 

Arenstein confronting him about recycling of trades and requesting he to do real buy-ins. 

Nevertheless, Merrill Clearing continued to clear Hazan’s and Arenstein’s trades 

for another seven months and did not even begin to wind down its “clearing relationship” 

with them until August 2006—just before the SEC and New York exchange issued 

stipulated sanctions orders against the two traders. Even after Hazan was told to leave 

Merrill Clearing, he continued to increase his short positions there for several months 

before he was finally terminated. 

All told, Merrill cleared Hazan’s and Arenstein’s exotic trades designed to support 

perpetually naked short positions for more than a year, and as a result failed to deliver 

Overstock shares for settlement every single day between August 1, 2005 and the end of 

2006. The number of failed deliveries quickly rose above a million shares, and at one 

point reached three million shares. 
45

i.) Triable Issue Merrill Clearing Was a Primary Violator

As we have discussed, even if there is a triable issue Merrill Clearing knew Hazan 

and Arenstein’s trades were designed to evade Regulation SHO and knew it was clearing 

sham trades, that is not enough to raise a triable issue of primary liability under 

sections 25400 and 25500. Rather, the evidence must be such that Merrill Clearing’s 

conduct was arguably akin to “directing” Hazan’s and Arenstein’s trading schemes

(Levitt, supra, 710 F.3d at pp. 466–467), or to deciding with them how to effect a 

manipulative trade (see Blech III, supra, 2002 WL 31356498, at p. *11), or to providing 

calculated “access” to the means to engage in unlawful trading (In re Mutual Funds Inv. 

Litigation, supra, 384 F.Supp.2d at pp. 861–862), or to “initiating, instigating, and 

orchestrating the scheme” (id. at p. 862), or to having “intimate,” “hands-on 

involvement” and participating in “key decisions” about the “details” of the exotic trades

(Scone Investments, L.P. v. American Third Market Corp., supra, 1998 WL 205338, at 

pp. *8–*9).

While a close question, we conclude the evidence is sufficient to raise a triable 

issue Merrill Clearing did more than provide normal clearing services, bearing in mind 

the observation of the district court in Blech III, that “[i]n this difficult distinction . . . 

between aiding and abetting and direct action, the line will be drawn with respect to 

summary judgment in favor of protecting the investing public rather than the clearing 

broker.” (Blech III, supra, 2002 WL 31356498, at p. *15.)

There is clearly a triable issue Merrill Clearing had knowledge, indeed abundant

knowledge, its clients were rolling shorts and engaging in sham reset transactions to 

mimic the appearance of genuine trading. There is a triable issue Merrill did not believe, 

or, at the very least, could not have reasonably believed, Hazan and Arenstein were bona 

fide market makers engaging in legitimate trading. And there is a triable issue Merrill 

took an active, direct role in their trading schemes to cause, and to profit from, ongoing 

failures to deliver shares in short sales of Overstock, as well as other hard-to-borrow 

securities. 
46

For example, there is a triable issue Cooper and others within Merrill Clearing 

purposefully developed or “contrived” procedures, at the request of Hazan and Arenstein, 

by which Merrill Clearing could, and repeatedly did, effect their one-day FLEX options

“to reestablish a new short and not borrow it.” Arguably, Hazan effectively asked Merrill 

Clearing to review and approve the exotic “test trade” he concocted to flagrantly violate 

the securities laws. Not only did Merrill give its stamp of approval, it continued to clear 

Hazan’s unlawful trades even after compliance personnel made it clear this was “not ok.” 

Indeed, Merrill did so for another seven months and only stopped clearing those trades on 

the eve of the SEC sanction ruling. Such contriving behavior is akin to that found 

actionable in In re Mutual Funds Inv. Litigation, supra, 384 F.Supp.2d at page 862, in 

which the clearing firm provided clients with access to trading platforms that enabled 

manipulative late trades, and in Blech III, in which the clearing firm and clients discussed 

and agreed upon a strategy that would manipulate the market. 

Even if Merrill’s do-not-flip procedures were initially designed as a legitimate 

means to correct the Sage computer problem, they arguably became deliberately 

employed as tools to implement Hazan’s and Arenstein’s well-understood strategy of 

perpetuating naked short positions. Similarly, even if buy-in notifications are usually 

normal clearing activities, it is arguable Cooper went beyond giving routine notice and 

knowingly coached Hazan and Arenstein on handling buy-in obligations for the very 

purpose of selling into them and re-obtaining naked short positions. Moreover, the 

arguable buy-in coaching of these traders cannot be viewed in isolation from the evidence 

showing Merrill Clearing’s involvement with the development, for these same abusive 

traders, of the process to “roll shorts.”

Cooper’s techniques were, indeed, known, and ratified, within Merrill Clearing. 

Cooper’s clients, said one colleague, “were knowingly putting on shorts and then 

basically rolling them every 13 days.” In 2005, Tanfaglia was given the “call” on 

whether to add Arenstein as a client given his “FLEX Options Strategy” and the “Hazan 

incident”—and Arenstein became a client. In early 2006, a Merrill Clearing compliance 
47

officer was aware of Arenstein “recycling” his “short position” and called for action, but 

the abusive trading practices continued. 

In sum, while close, when the evidence is viewed in the light most favorable to 

plaintiffs, as it must be on review from summary judgment, it suffices to raise a triable 

issue Merrill Clearing, through its San Francisco office, did more than provide normal 

clearing services, and did more than knowingly clear its clients’ manipulative trades and 

sham reset transactions. There is enough to commit to a jury the difficult “distinction 

between aiding and abetting and direct action.” (Blech III, supra, supra, 2002 WL 

31356498, at p. *15.)

ii.) There Is a Triable Issue Merrill Clearing Acted to Induce Trading in 

a Manipulated Stock

It is not enough for there to be a triable issue Merrill Clearing crossed the line 

from aider and abettor to primary violator in a scheme to evade Regulation SHO for the 

benefit of its clients. Rather, to impose liability under section 24500, subdivision (b), 

there must be evidence raising a triable issue Merrill participated in Hazan and 

Arenstein’s manipulative trading scheme for the purpose of inducing the purchase or sale 

of shares of Overstock by someone else. 

Plaintiffs’ principal evidence that Merrill Clearing had the requisite purpose of 

inducing market activity in Overstock was not the direct statements by defendants 

recounted above. Rather, they relied on expert opinions. That is, their experts drew 

inferences about the clearing firm’s purpose from its knowing participation in Hazan’s 

and Arenstein’s trading schemes and their opinion Merrill benefited financially when the 

stock price declined. Since the firm benefitted from price declines, and since market 

activity is necessary to generate a decline, the experts opined Merrill must have intended 

to induce further market activity.

Plaintiffs’ experts declared the recycling of naked short positions created 

downward pressure on Overstock’s price, and plaintiffs’ expert Conner, in particular, 

testified the clearing firm benefited from price declines, which would spur further short 

selling and increase transaction fees. Also, when the clearing firm had a fail to deliver 
48

position, it might have to pay a “mark” to the party not receiving its shares if the share 

price rose. If the share price declined, the clearing firm got a “mark.” The clearing firm 

thus did not profit directly from price declines, but rather held the mark money in a 

reserve account in case the share price rose. Meanwhile, however, the firm and its client 

earned interest on the money. Conner, thus, opined Merrill Clearing had a strong 

financial incentive to see this play out.23 

While the evidence Merrill Clearing had the requisite purpose to induce market 

activity in Overstock stock is attenuated, even “weak” evidence can permit an inference 

of unlawful intent or purpose, as intent and purpose are rarely established with direct 

evidence and are typically questions for the trier of fact. (See Page v. MiraCosta 

Community College Dist. (2009) 180 Cal.App.4th 471, 497 [“A subjective state of mind 

is rarely susceptible of direct proof, and a trial court will usually have to infer it from 

circumstantial evidence.”]; Nazir v. United Airlines, Inc. (2009) 178 Cal.App.4th 243, 

283 [Proof of discriminatory intent often depends on inferences rather than direct 

evidence such that “ ‘very little evidence of such intent is necessary to defeat summary 

judgment’ ” thus “summary judgment should not be granted unless the evidence cannot 

support any reasonable inference for plaintiff.”]; id. at p. 286 [intent cases “are rarely 

appropriate for disposition on summary judgment, however liberalized” summary 

judgment has become]; see also Press v. Chem. Inv. Servs. Corp. (2d Cir. 1999) 166 F.3d 

529, 538 [the question of whether a plaintiff has established the requisite intent for a 

section 10(b) violation is a factual question “ ‘appropriate for resolution by the trier of 

fact’ ”]; S.E.C. v. Masri (S.D.N.Y. 2007) 523 F.Supp.2d 361, 367, 375 [“defendant’s 

manipulative intent can be inferred from the conduct itself” and a defendant broker need 

not share the same nefarious intent as a client, so long as the intent is actionable].) 

Here, plaintiffs presented evidence of opportunity and motive, which, when taken 

with all the other evidence of Merrill’s knowing conduct, was at least for now sufficient 

 

23 The trial court overruled defendants’ objections to the pertinent portions of 

Conner’s declaration, and defendants have not challenged these evidentiary rulings on 

appeal.
49

to survive summary judgment. (See Bains v. Moores (2009) 172 Cal.App.4th 445, 463–

464 [timing and amount of stock transactions may bear on scienter of person accused of 

insider trading]; Blech II, supra, 961 F.Supp. at pp. 582–583 [as to pleading scienter, 

allegations Bear Stearns was motivated to see prices rise because this would decrease its 

financial risks associated with Blech’s transactions and remove debit balances on Blech’s 

accounts was sufficient to state 10(b)(5) claim]; CompuDyne Corp. v. Shane (S.D.N.Y. 

2006) 453F.Supp.2d 807, 824 [“The FAC has alleged a strong inference of FNY 

Millennium’s scienter based upon: (1) its own shorting of CompuDyne stock after being 

informed of the confidential non-public PIPE; (2) its continued shorting of CompuDyne 

stock after receipt of the Purchase Agreement that unequivocally prohibited any trading 

in CompuDyne stock; and (3) its ‘naked’ unlawful shorting of CompuDyne stock in 

direct contravention of the Purchase Agreement.”]; cf. McDaniel v. Bear Stearns & Co., 

Inc. (S.D.N.Y. 2002) 196 F.Supp.2d 343, 357–358 [affirming arbitration award as 

supported by sufficient evidence of intent to aid and abet a violation of section 10(b):

“Bear had both the motive and the opportunity to engage in Baron’s fraud. One factor 

motivating Bear was the simple desire to continue to collect clearing fees and other 

income it received from Baron as part of the Clearing Agreement. [Citation.] . . . 

[While] the mere desire ‘to prolong the benefits’ of an ordinary clearing relationship is 

not enough to support the scienter element of an aiding and abetting claim . . . the Panel 

also found that Bear was motivated by its desire to recover from Baron’s on ‘loans above 

and beyond the normal clearing debt’—loans the Panel described as ‘extraordinary’. ”].)

Merrill Clearing claims, of course, it was the one being deceived by the likes of 

Hazan and Arenstein, and believed these clients were engaged in legitimate options 

market making activity and therefore the firm could, under Regulation SHO, delegate its 

delivery obligations to them. (17 C.F.R. 242.203(b)(3)(vi) (2014).) However, a clearing 

firm can only “reasonably” delegate its delivery obligations. (Ibid.) Plaintiffs’ experts

opined Hazan, Arenstein, and like traders were not plausibly acting as bona fide market 

makers and the voluminous, ongoing fails to deliver in Overstock were not due to 

inadvertence, but were intentional. Similarly, the SEC and other sanctioning bodies 
50

easily concluded Hazan and Arenstein were not engaged in bona fide market making. 

Moreover, the evidence supports an inference Merrill Clearing was sufficiently aware of 

the supposed market makers’ strategies to avoid Regulation SHO (rolling short, etc.) such 

that any delegation of delivery obligations under that regulation would be unreasonable.

Merrill Clearing also views the evidence as showing no more than a desire to 

make additional fees and commissions, citing cases holding that is not enough to incur 

liability under the securities laws. (E.g., Louisiana Pacific Corp. v. Money Market 1 

Institutional Inv. Dealer (N.D. Cal., Mar. 28, 2011, No. C 09-03529 JSW) 2011 WL 

1152568 *1, *8 [“The desire to earn commissions or fees is a common motive to all for 

profit enterprises, and that motive—without more—is insufficient to give rise to a strong 

inference of scienter.”], italics added; Pope Investments II LLC v. Deheng Law Firm

(S.D.N.Y., Nov. 21, 2011, No. 10 Civ. 6608 (LLS)) 2011 WL 5837818 *1, *7 [“Because 

plaintiffs do not allege that defendants possessed any motive other than receipt of 

professional fees, they do not plead that defendants had a motive to commit securities 

fraud.”].) No doubt Merrill was motivated to maximize fees and commissions. But that 

does not mean it necessarily had no intent to induce trading in Overstock by others. (Cf. 

Rothman v. Gregor (2d Cir. 2000) 220 F.3d 81, 93 [“Although virtually every company 

may have the desire to maintain a high bond or credit rating . . . not every company has 

the desire to use its stock to acquire another company” in a potentially manipulative 

way.].)

iii.) There Is a Triable Issue Actionable Conduct Occurred “In This 

State”

There must also be a triable issue the manipulative conduct engaged in for the 

purpose of inducing trading activity occurred “in this state.” (§ 25400; Diamond, supra, 

19 Cal.4th at p. 1040.)

As we have recited in detail, Cooper, who was in Merrill Clearing’s San Francisco 

office, figures prominently in the manipulative trading schemes at issue. That other 

Merrill Clearing officers and employees, who interacted with Cooper and the malfeasant 

traders, were located in Merrill offices outside California, or that portions of the clearing 
51

and settlement processes may have occurred on computers elsewhere, does not mean the 

clear connection with California can be ignored. (See Diamond, supra, 19 Cal.4th at 

pp. 1051–1052 & fn. 14 [“ ‘in this state’ ” does not “operate to confine liability for 

violation of section 25400 to intrastate transactions”].) 

Further, plaintiffs’ expert, Conner, based on Merrill Clearing records, declared 

part of the clearing process for numerous of the manipulative trades involved providing

trade data to Pacific Clearing Corporation, a regional clearing center located in California 

and affiliated with the Pacific Stock Exchange.24 The trial court ruled this expert 

testimony lacked foundation, and sustained an objection to it. This was error. Conner’s 

testimony was based on his own established expertise and on confirmatory conversations 

with another expert with experience (and also personal knowledge, having worked at 

Goldman Clearing, in particular). Thus, there was adequate foundation for Conner’s 

declaration testimony, and it is for the trier of fact to weigh the credibility of his opinion 

and any countervailing opinion or evidence (of which there is currently none).25 (See 

Howard Entertainment, Inc. v. Kudrow (2012) 208 Cal.App.4th 1102, 1121 [trial court 

erred in excluding expert testimony establishing an industry custom, and thus an 

understanding of a contract: “Bauer’s experience in and knowledge of the entertainment 

industry is adequate for him to render an opinion on specific practices, even if he was not 

a personal manager at the time of the agreement in issue.”].) Crediting Connor’s 

 

24 Pacific Clearing Corp. generates data for the Pacific Exchange and the National 

Settlement and Clearing Corp. on stocks sold or bought on the exchanges. The clearing 

activity by Pacific Clearing Corp. does not take the place of the clearing functions 

performed by clearing firms like Merrill Clearing. Rather, clearing firms, like Merrill,

must send trade data to Pacific Clearing Corp. for trades executed on the Pacific 

Exchange as part of the process of clearing trades.

25 That a jury might be precluded from learning of any hearsay statement by 

Conner’s confirming source (see Korsak v. Atlas Hotels, Inc. (1992) 2 Cal.App.4th 1516, 

1524–1525), does not mean Connor’s opinion lacked foundation. In Korsak, the 

testifying expert was not qualified to opine on the topic of the hearsay statements he 

related. (Id. at p. 1527 [“Indeed” the expert “admitted he had never dealt with such a 

problem before, and had no other reliable data upon which to base an opinion.”].) Here, 

in contrast, Conner was accepted as an expert on numerous topics, including “clearing.” 
52

testimony for purposes of summary judgment, as we must, it shows Merrill Clearing’s 

clearing activity related to the sham reset transactions necessarily occurred, at least in 

part, in California.

26

We reject Merrill’s assertion section 25008 controls when actionable conduct 

occurs “in” California. Section 25008 defines when “[a]n offer or sale of a security is 

made in this state” and when “[a]n offer to buy or a purchase of a security is made in this 

state.” (§ 25008, subd. (a).) It doe not address where a series of transactions are 

“effected.” (See § 25400, subd. (b).) Moreover, the phrases “offer or sale” and “offer to 

buy or purchase” pertain most clearly to the language of section 25400, subdivisions (c) 

and (e), which prohibit the inducement of certain sale and purchase activity. (See 

 

26 Accordingly, the “location” of the Pacific Stock Exchange, itself, while a topic 

of great debate amongst the parties is not material. And even if it was, we would readily 

conclude it was located in California during all relevant periods. Despite its name change 

in 2006, the exchange was undisputedly registered with the SEC as a national exchange 

in San Francisco, California. (See Self-Regulatory Organizations et al., Notice of filing 

and Immediate Effectiveness of Proposed Rule Change and Amends. No. 1 & 2, etc., 

Release No. 53615 (April 7, 2006), available at 2006 WL 2794649, *1, *2; see also 

Bauman v. DaimlerChrysler Corp. (9th Cir. 2011) 644 F.3d 909, 925 [mentioning in 

passing the “Pacific Stock Exchange located in San Francisco”], reversed on other 

grounds by Daimler AG v. Bauman (2014) 134 S.Ct. 746, 748.) Merrill, itself, wrote to 

the Pacific Exchange in San Francisco at 115 Sansome Street. And plaintiff’s expert,

Conner, declared the exchange still houses options trading, and its regulatory and 

business functions in San Francisco, even if its computers for securities trading are 

located out of state. Merrill’s claim the exchange was “in” the locale where its computers 

happened to be, is untenable and lacking in any legal support. Computers can be located 

anywhere, including overseas or in multiple places, and they can be moved. Moreover, in 

the context of venue, a quintessential question of locale, it is well established an 

exchange is located where it is registered, with no mention made of where its computer 

hardware happens to be. (See United States v. Geibel (2d Cir. 2004) 369 F.3d 682, 697–

698 [“There was evidence in the record establishing that AMEX is located and 

headquartered in New York. Accordingly, since there was evidence in the trial record 

establishing that venue in the SDNY was appropriate, we must affirm . . . .”]; United 

States v. Svoboda (2d Cir. 2003) 347 F.3d 471, 483–484 [execution of trades on the New 

York Stock Exchange and American Stock Exchange is sufficient to establish venue in 

the Southern District of New York]; SEC v. Suman (S.D.N.Y. 2010) 684 F.Supp.2d 378, 

385 [action against defendants residing in Utah and Canada brought in New York where 

they purchased stock on New York-based NASDAQ exchange].)
53

Diamond, supra, 19 Cal.4th at p. 1050.) “[T]o the extent” section 25400, subdivisions (a) 

and (b), prohibit selling or offering to sell or purchasing or offering to purchase, section 

25008 may provide guidance on when that conduct occurs in this state. (Id. at p. 1051.) 

But to the extent these two subdivisions embrace other conduct necessary to “effect, alone 

or with one or more other persons, a series of transactions,” section 25008 does not 

address the term. (See id. at pp. 1051–1052.) 

iv.) There Is a Triable Issue As to Causation and Damages

Section 25500, establishing a private right of action for violations of 

section 25400, permits liability only when the plaintiff buys or sells a security “at a price 

which was affected by such act or transaction” and sustains “damages.” (§ 25500.) 

“Such damages shall be the difference between the price at which [the plaintiff] 

purchased or sold securities and the market value which such securities would 

[otherwise] have had . . . .” (Ibid.)

27

 

Plaintiffs’ damages expert, Shapiro, discussed two theories of causation and 

damages: a quantity theory and a signaling theory. Put simply, the quantity theory states 

Overstock’s price declined because naked short sales affected the supply of Overstock 

shares; the signaling theory states Overstock’s price declined because naked short sales 

falsely signaled to the market Overstock was in a worse position than it really was.

Under the quantity—or supply and demand—theory, Shapiro concluded “all fails 

to deliver cause harm” and “even if it is determined that some but not all of the fails . . . 

are to be included in this case, I could readily calculate the damages to plaintiffs.” 

Merrill Clearing presented no expert testimony rebutting Shapiro’s. Instead, 

Merrill contends his quantity theory is unsubstantiated conjecture, based solely on 

parroted allegations from plaintiffs’ complaint and without citation to authority. 

However, Shapiro never quoted plaintiffs’ complaint and cited two academic 

 

27 While plaintiffs assert defendants never raised causation and damages in their 

notice of motion for summary judgment, defendants raised these issues on page 42 of 

their combined opening memorandum in the trial court. “An omission in the notice may 

be overlooked if the supporting papers make clear the grounds for the relief sought.” 

(Luri v. Greenwald (2003) 107 Cal.App.4th 1119, 1125.)
54

publications, statements of witnesses in this case, and statements of government officials 

in support of his expert opinion that naked short sales create a false impression of 

increased supply without concomitantly changing demand, therefore lowering price. 

Shapiro also described the process he would use to calculate damages flowing from the 

appearance of increased supply from particular fails to deliver.28 

This is not a case, then, where an expert failed to wrestle with other experts’ 

opinions or ignored inconvenient facts. (See Nardizzi v. Harbor Chrysler Plymouth 

Sales, Inc. (2006) 136 Cal.App.4th 1409, 1415.) Nor did Merrill challenge Shapiro’s 

expertise and ability to opine on what appears to be a basic matter of economics.

29

 

Indeed, cases suggest a supply and demand model can address both causation and 

damages. (E.g., L.C. Eldridge Sales Co., Ltd. v. Azen Manufacturing Pte., Ltd. (E.D. 

Tex., Nov. 14, 2013, No. 6:11CV599) 2013 WL 7964028; Burton v. City of Alexander 

City, Ala. (M.D. Ala., Mar. 20, 2001, No. Civ. A. 99-D-1233-E) 2001 WL 527415, *1, 

*10, fn. 31.) 

Especially given the lack of admissible expert testimony rebutting Shapiro’s 

methods and conclusions, the trial court’s decision to admit his declaration as to the 

quantity theory, over defendants’ foundational objections, was proper. (See Imonex 

Services, Inc. v. W.H. Munzprufer Dietmar Trenner GMBH (Fed. Cir. 2005) 408 F.3d 

1374, 1381 [“Imonex did not present any competent testimony of its own specifically” 

 

28 Thus, Shapiro provided evidence the naked short positions perpetuated and reestablished by the various reset transactions were manipulative, causing external, 

“artificial” pressure on the price of Overstock. (See GFL, supra, 272 F.3d at pp. 207–

208.) Indeed, it was essential to the reset trades that “a manipulator act[] as both the 

buyer and seller in order to give the false appearance of actual trades without assuming 

any actual risk.” (Cohen, supra, 722 F.Supp.2d at p. 424.)

29 Whether a fail to deliver actually “creates” a phantom share or merely gives the 

appearance of extra supply—an issue Merrill raises—is not relevant to Shapiro’s

analysis, as the supply and demand model is based on appearances. Shapiro, in turn,

cited witness testimony and government sources, such as the SEC, as supporting his 

conclusion naked short sales create the appearance of additional supply. 
55

addressing the reliability of expert testimony; “[t]herefore, this court detects no abuse of 

discretion in the district court’s admission of” it].)

Since we conclude Shapiro’s declaration as to the quantity effects theory is 

sufficient to defeat summary judgment on the matter of causation and damages, we need 

not determine whether his signaling effects theory, alone, would be adequate to do so. At 

a minimum, the trial court did not err in allowing his testimony on signaling effects as 

corroboration of his quantity effects theory.

Merrill contends Shapiro, in his analysis of signaling effects, improperly relied on 

a so-called “Granger Analysis,” which some academics, asserts Merrill, believe shows 

correlation but not directional causation. Also, Merrill complains that in his signaling 

effects analysis, Shapiro—though he allocated 75.3 percent of defendants’ fails to Merrill 

Clearing and 24.6 percent to Goldman Clearing—assumed both firm’s fails to deliver 

were all abnormal and manipulative and grouped them, to measure signal strength, in one 

large clump, as combining the fails would amplify these effects.

There is nothing untoward, given the facts before us, about Shapiro employing a 

Granger Analysis to corroborate his independent conclusion that fails to deliver were 

“inject[ing] false information into the market” and causing the observed price decline in 

Overstock, based upon his review of market conditions, comparable companies, and 

events. (See Pickett v. IBP, Inc. (M.D. Ala., Apr. 10, 2003, No. Civ. 96-A-1103-N) 2003 

WL 24275809, *1, *4, fn. 3 [“The Granger causality test should not be used in isolation 

to determine causation. When used with other tests and models, however, the Granger 

test is an appropriate vehicle from which to base an opinion.”].) 

Even if Shapiro’s signaling effects analysis was weakened because it depended on 

measuring the aggregated “signal” from all fails to deliver, without accounting for 

whether they were manipulative, tied to California, or associated with any particular 

clearing firm, portions of the signaling effects model still offered corroboration for the 

conclusions of the quantity effects analysis. For example, Shapiro’s event study 

demonstrated irregular forces (unrelated to Overstock’s performance and the performance 

of the larger market) were aggravating the decline on Overstock’s price. 
56

Accounting for causation and damages in a case so complex and fluid is no easy 

task, and Shapiro’s declaration suitably acknowledged and accommodated for this, at 

least for purposes of defeating summary judgment. (See CILP Associates, L.P. v. 

PriceWaterhouse Coopers LLP (2d Cir. 2013) 735 F.3d 114, 126 (CILP Associates) [as 

to a section 10(b) claim, a high “level of precision was not required to defeat summary 

judgment for the simple reason that the amount of overstatement relates to damages, not 

liability. To defeat summary judgment, the plaintiffs merely had to establish a genuine 

dispute as to whether they purchased their shares at inflated prices, regardless of the 

amount of the inflation.”].) Further, fact witnesses from defendants and third parties 

testified to a link between naked short sales and declining prices. 

Thus, while not a particularized showing by any means, plaintiffs provided enough 

evidence of causation and damages to raise a triable issue. (See CILP Associates, supra,

735 F.3d at p. 126; see also Kurinij v. Hanna & Morton (1997) 55 Cal.App.4th 853, 864

[“causation . . . is ordinarily a question of fact which cannot be resolved by summary 

judgment” and “[t]he issue of causation may be decided as a question of law only if, 

under undisputed facts, there is no room for a reasonable difference of opinion”]; GHK 

Associates v. Mayer Group, Inc. (1990) 224 Cal.App.3d 856, 873 [“Where the fact of 

damages is certain, the amount of damages need not be calculated with absolute certainty. 

[Citations.] The law requires only that some reasonable basis of computation of damages 

be used, and the damages may be computed even if the result reached is an 

approximation.”].)

e. Preemption

Merrill Clearing also raises the specter of preemption and exclusive federal 

jurisdiction. It maintains California cannot impose liability for conduct that otherwise 

complies with Regulation SHO and asserts federal courts have exclusive jurisdiction over

Regulation SHO claims.

Merrill would be correct if plaintiffs simply alleged violations of Regulation SHO. 

Section 27 of the SEA provides: “The district courts of the United States and the United 

States courts of any Territory or other place subject to the jurisdiction of the United 
57

States shall have exclusive jurisdiction of violations of this title [citation] or the rules and 

regulations thereunder, and of all suits in equity and actions at law brought to enforce any 

liability or duty created by this title [citation] or the rules and regulations thereunder. . . .” 

(15 U.S.C. § 78aa, subd. (a); see Matsushita Elec. Indus. Co., Ltd. v. Epstein (1996) 

516 U.S. 367, 381; Lippitt v. Raymond James Financial Services, Inc. (9th Cir. 2003) 

340 F.3d 1033, 1037 (Lippitt) [“any claim that properly falls within the scope of § 27 is 

necessarily federal in character”].)

But section 28 of the SEA provides: “ ‘The rights and remedies provided by this 

chapter shall be in addition to any and all other rights and remedies that may exist at law 

or in equity . . . Except as otherwise specifically provided in this chapter, nothing in this 

chapter shall affect the jurisdiction of the securities commission (or any agency or officer 

performing like functions) of any State over any security or any person insofar as it does 

not conflict with the provisions of this chapter or the rules and regulations 

thereunder. . . .’ ” (Lippitt, supra, 340 F.3d at p. 1037, quoting 15 U.S.C. § 78bb(a)(1)–

(2).)

“On its face, § 28 preserves both common law and statutory authority over 

securities matters and thus reflects Congressional recognition of state competence in the 

securities field.” (Lippitt, supra, 340 F.3d at p. 1037; Gold v. Blinder, Robinson & Co., 

Inc. (S.D.N.Y. 1984) 580 F.Supp. 50, 53–54 [“The exclusive jurisdiction of federal courts 

over claims under the 1934 Act does not bar a plaintiff from pursuing at its option 

cognate remedies based entirely upon state law.”].) This has been recognized by 

California courts for as long as the modern Corporate Securities Law has been in force. 

(Roskind v. Morgan Stanley Dean Witter & Co. (2000) 80 Cal.App.4th 345, 352 

(Roskind) [“ ‘Congress plainly contemplated the possibility of dual litigation in state and 

federal courts relating to securities transactions.’ ”]; Twomey v. Mitchum, Jones & 

Templeton, Inc. (1968) 262 Cal.App.2d 690, 704–706 [“As has already been pointed out, 

the rights and remedies provided by the Securities Exchange Act of 1934 “ ‘shall be in 

addition to any and all other rights and remedies that may exist at law or in equity.’ ”].)
58

In Lippitt, defendants sought removal of plaintiff’s California Unfair Competition 

Law claim, asserting it was a thinly-veiled attempt to enforce New York Stock Exchange 

(NYSE) rules issued under the SEA. (Lippitt, supra, 340 F.3d at p. 1036.) Although the

plaintiffs’ complaint tracked the language of the NYSE rules, defendants could not 

“federalize” the case on that basis. (Id. at p. 1037.) Plaintiff had challenged defendants’ 

“conduct solely under state law—irrespective of whether it is legal under” NYSE rules. 

(Id. at p. 1042.) “That the specific goal of protecting California customers from 

dishonest business practices, whether by brokers or otherwise, may comport with the 

broader regulatory goals of the Exchange Act and certain NYSE rules and regulations is 

not enough to sweep Lippitt’s complaint within the exclusive jurisdictional ambit of § 27 

of the SEA.” (Id. at pp. 1043–1044;30 see also Dennis v. Hart (9th Cir. 2013) 724 F.3d 

1249, 1252 [complaint’s “repeated references” to federal law “insufficient to confer 

jurisdiction” when state, not Federal claims alleged]; Roskind v. Morgan Stanley Dean 

Witter & Co. (N.D. Cal. 2001) 165 F.Supp.2d 1059, 1066–1067 [granting motion to 

remand, as state common law and the UCL, not NASD rules, defined the scope of 

defendant’s liability; violations of NASD rules “are a method to assess defendant's 

misconduct, but establishing a violation is not a necessary element of plaintiff’s 

claims”].) 

 

30 Key to Lippitt was the lack of any dispositive federal question. (Lippitt, supra

340 F.3d at p. 1042.) This distinguishes Lippitt from Pet Quarters, Inc., supra, 559 F.3d 

772, Whistler Investments, Inc. v. Depository Trust and Clearing Corp. (9th Cir. 2008) 

539 F.3d 1159 (Whistler), and Nanopierce Technologies, Inc. v. Depository Trust and 

Clearing Corp. (2007) 123 Nev. 362 (Nanopierce), cited by Merrill. In all three cases, 

plaintiffs challenged the federally-approved operations of a federally-authorized “Stock 

Borrow Program.” (Pet Quarters, supra, 559 F.3d at p. 776; Whistler, supra, 539 F.3d at 

p. 1167; Nanopierce, supra, 123 Nev. at p. 379) Each court perceived plaintiffs to be 

seeking “a determination from a state factfinder that a program declared efficient in rules 

approved under federal law was in fact not . . . because imposing state standards of 

efficiency would interfere directly with Commission approved operation of” the Stock 

Borrow Program. (Pet Quarters, supra, 559 F.3d at p. 781; Whistler, supra, 539 F.3d at 

pp. 1166–1167; Nanopierce, supra, 123 Nev. at p. 379.)
59

Although plaintiffs broadly discuss Regulation SHO, their claim under 

sections 25400 and 25500 remains a state-law claim.31 To prove market manipulation 

under section 25400, there are a plethora of requirements, none of which is a predicate 

violation of Regulation SHO or any other federal securities statute or rule. State laws 

against purposeful market manipulation in no way conflict with the SEA regime, 

including implementation of Regulation SHO.32

IV. DISPOSITION

The judgment is affirmed as to Goldman, Sachs & Co., Goldman Sachs Execution 

& Clearing, L.P., and Merrill Lynch, Pierce Fenner & Smith Inc.. As to Merrill Lynch 

Professional Clearing Corp., the judgment is reversed as to plaintiffs’ California 

securities law claim under sections 25400 and 25500, subdivision (b), and is affirmed in 

all other respects.

The parties are to bear their own costs on appeal.

 

31 We note that the instant case was for some time consolidated with Avenius v. 

Banc of America Securities (S.F. Super. Ct. case No. 06-453422), which also concerns 

manipulative naked short selling. The defendants in Avenius, represented by some of the 

same lawyers as defendants here, sought removal to the federal district court. The 

plaintiff, represented by some of the same lawyers as plaintiffs here, opposed and sought 

remand. Citing Lippitt, the district court remanded the case, concluding the bank’s 

“intent with respect to delivery [of stock] is central to the proof of Plaintiffs’ claims” and 

as such, “the duty or liability is not created by federal law [namely, Regulation SHO]; 

rather it is created by state statute.” A “substantial disputed question of federal law [is 

not a] necessary element of the Section 25400 claim.” (Avenius v. Banc of America 

Securities LLC (N.D. Cal., Dec. 30, 2006, No. C06-04458 MJJ) 2006 WL 4008711.) In 

this case, defendants did not attempt removal. 

32 Plaintiffs’ request for judicial notice filed June 17, 2013, is hereby denied.
60

_________________________

Banke, J.

We concur:

_________________________

Margulies, Acting P. J.

_________________________

Dondero, J.

A135682, Overstock.com, Inc. v. Goldman Sachs & Co.
61

Trial Judge: The Honorable John E. Munter

Trial Court: San Francisco County and City Superior Court

Theodore A. Griffinger, Jr., Ellen A. Cirangle and Jonathan E. Sommer and Lubin Olson 

Niewiadomski LLP and Myron Moskovitz for Plaintiffs Overstock.com, Inc. et al.

Joseph Edward Floren and Morgan, Lewis & Bockius LLP for Defendants Goldman 

Sachs & Co. et al.

Matthew David Powers, Andrew J. Frackman and Abby F. Rudzin and O’Melveny & 

Myers LLP for Defendants Merrill Lynch, Pierce Fenner & Smith, Inc. et al.