defendants (see e.g. NYSE Specialists, 405 F. Supp. 2d 281, 292-
96, 313-14 (S.D.N.Y. 2005)), and they do not provide any data
demonstrating unusual patterns of activity (i.e. data
demonstrating that their trades were failing at a higher rate
than non-direct access customers) .°

Having failed to raise a strong inference of scienter on
the part of any individual specialist defendant, plaintiffs’
claims for violation of 10b-5 against the specialist defendants

are dismissed.

iv.

Plaintiffs also bring claims against the exchange defendants
under both 10b-(5)(b) for false and misleading statements and
10b(5) (a) and 10b(5)(c) for participation in a fraudulent and
manipulative scheme. Although the complaint is filled with
allegations that the exchange defendants failed to enforce their
own rules, in their opposition brief, plaintiffs have made clear

that they are not seeking to impose liability on the exchange

° Plaintiffs do allege that they submitted hundreds of
thousands of trades and tens of thousands of those trades failed.
Assuming arguendo, that this aggregated allegation is suggestive
of the fact that plaintiffs’ orders were failing at an unusual
rate, the allegation still fails to demonstrate that any
particular plaintiff’s orders submitted to any specific
specialist defendant failed at an unusual rate.

20



specialists discriminated against direct access customers’
orders.‘

Because the staff report dealt solely with the AMEX, my
analysis of its effect on plaintiffs’ claims naturally divides
into two groups: 1) those transactions that occurred on the AMEX;
and 2) those transactions that occurred on another exchange.
Turning to the non-AMEX transactions first, the staff report does
not help plaintiffs meet their burden of pleading scienter with
regard to any transaction on the CBOE, the PCX, or the PHLX
because it does not contain any findings that relate to
specialists on these exchanges.

With respect to plaintiffs’ transactions that occurred on
the AMEX, the findings of the staff report undeniably call into
question specialist behavior on the AMEX. It must be pointed

out, however, that the staff report only analyzed a sample of

4 The report found that:

{When AMEX specialists were busy,] 37.6% of the orders
from customers of direct access firms and 5.2% of the
orders from other firms were handled in likely
violation of the firm quote rule. The staff also
analyzed the fill rate for market orders and found that
when specialists were not busy . . . 24.5% of market
orders from direct access firms and 2.5% of market
orders from other customers went unfilled in likely
violation of the firm quote rule.

14



aware of, and responsible for, express representations made by
the Exchanges, in documents filed with the SEC and statements
posted on the internet, to the effect that all public customer
marketable limited orders and market orders will receive
‘instantaneous automatic execution’ for up to a predetermined
number of contract... .” These generalized allegations do not
contain the requisite specificity. Cathedral Trading, LLC v.
Chicago Bd. Options Exch., 199 F. Supp. 2d 851, 857 (N.D. Ill.
2002).

The exchange defendants have pointed the court to three
allegedly misleading statements contained in plaintiffs’
complaint that are pled with some specificity.” Plaintiffs
allege that the exchange defendants made misleading statements in
a promotional pamphlet entitled “Understanding Options” (the

“options pamphlet”) sponsored by the exchange defendants, that

"® any claim based upon any other misleading statement or
omission that has not been brought to the court’s attention by
either party is deemed waived.

° In the options pamphlet, plaintiffs allege that the
exchange defendants made misleading statements such as:

Listed options are executed on the trading floors of
national SEC-regulated exchanges where all trading is
conducted in an open, competitive auction market

and

Orderly, efficient and liquid markets. Flexibility,
Leverage. Limited Risk. Guaranteed Contract

24



[I]dentified the origin, and then knowingly mishandled
the execution of thousands of orders to buy and sell
options that were sent to defendants by engaging in
various illegal trading practices such as refusing to
automatically, or promptly, execute the orders or send
confirmations upon the execution of orders, changing
(or “fading”) the quoted prices after receiving the
orders, delaying the execution of orders, refusing to
honor requests to cancel orders, and unilaterally
terminating or adjusting the prices on orders that were
previously executed and confirmed, and conducting
thousands of proprietary trades for the Specialists’
own accounts that were executed in advance of, or
instead of, executing Plaintiffs’ marketable limit
orders (i.e. orders to purchase or sell a set amount of
options at a specific price equal to the bid or offer
price actually disseminated by a Specialist on a
particular exchange).

In addition to this scheme of intentional mishandling, plaintiffs
allege that the specialist defendants made implied and express
misleading statements regarding their order handling. Plaintiffs
allege that the exchange defendants intentionally developed the
technology to facilitate the abovementioned scheme and also made
misleading statements regarding order handling on _ their
respective exchanges.
I.

The specialist defendants and the exchange defendants have
each filed a motion to dismiss. On a motion to dismiss, I
accept all well pled allegations in the complaint as true,
Turner/Ozanne v. Hyman/Power, 111 F.3d 1312, 1319 (7th Cir.

1997), and grant the motion only if the plaintiff can prove no



defendants for failure to enforce exchange rules.’° Plaintiffs
argue two different theories of liability: 1) that the exchange
defendants participated in a manipulative scheme with the
specialist defendants by developing the technology that allowed
the specialists to discriminate against them in violation of 10b-
S{a) and (c); and 2) that the exchange defendants made false and
misleading statements regarding the operations of their markets
in violation of 10b-5(b).

Turning to plaintiffs’ first theory, plaintiffs allege that
the exchange defendants directly participated in a scheme to
defraud by developing their proprietary auto execution systems to
include features that: 1) allowed the specialist defendants to
identify the source of orders placed; and 2) allowed the
specialist defendants to disable the auto-execution feature and
manually fill orders.

Plaintiffs’ have failed to plead facts that lead to a strong
inference of scienter with respect to this claim. The only facts
contained in the complaint supporting an inference of scienter go

toward showing that the exchange defendants had motive and

In any event, plaintiffs would be unable to bring these
claims because there is no private right of action against an
exchange for violation of its own rules. See Spicer v. Chicago
Bd. of Options Exch., Inc., 977 F.2d 255, 259-61 (7th Cir. 1992).

21



o

price of an underlying security due to the dissemination of
misleading information into the marketplace.!® As a result,
absent any actual reliance, there is no causal link between these
statements and the losses for which plaintiffs seek recovery.
See Spicer, 1990 U.S. Dist. LEXIS 14469 at *35-36 (“The purpose
of a reliance requirement is to ensure that causation exists

between a defendants’ acts and a plaintiff's harm.”).

'6 Plaintiffs allege that they submitted orders to buy or
sell options at a specific price, and that the specialist
defendants, after having identified the origin of the order,
either raised the price, refused to execute, or induced
plaintiffs to cancel their order. If one were to accept the
fraud-on-the-market theory was applicable to the facts of this
case, one would presume that misleading information about the
operation of the exchanges was disseminated into the marketplace
and thereafter inflated the price of options across the
marketplace. See e.g., Spicer, 1990 U.S. Dist. LEXIS 14469, at
*34-37. Plaintiffs’ claims, however, do not seek recovery for
any inflation in price (as reflected in an option quote) that may
have existed in the options that they sought to buy or sell.
Rather, plaintiffs seek recovery for a different loss. For
example, in the case of a trade that was filled at a less
favorable rate than originally quoted, plaintiffs claim their
loss would be the differential between the quoted price and the
price at which their order was filled. According to their
complaint, this price differential was caused by a specialist
defendant’s specific discriminatory reaction to the fact that the
order was placed by a direct access customer. That specific loss
(i.e., the less favorable price) was experienced only by that
single direct access customer in that single trade. This loss is
completely independent from, and unrelated to, the underlying
value of the option, which may or may not have been inflated due
to misleading information.

27



earlier, this type of result-based reasoning and unsupported
speculation is insufficient to meet the requirements of the
PSLRA, which requires plaintiffs to allege facts from which I
could strongly infer scienter at the time the technology was
developed.

Plaintiffs’ second theory of liability against the exchange
defendants is that the exchanges made false and misleading
statements and omissions regarding order handling by specialists
on their exchanges. Under § 10b-5(b) plaintiffs must allege that
“1) the defendant made a misstatement or omission 2) of material
fact 3) with scienter 4) in connection with the purchase or sale
of securities 5) upon which the plaintiff justifiably relied 6)
and that the false statement or omission proximately caused the
plaintiff’s damages.” Otto, 134 F.3d at 851.

In their response, plaintiffs repeatedly argue in general
terms that their complaint alleges in detail numerous misleading
statements and omissions, but do not point the court to any
specific misrepresentations in their complaint.'4 For the most
part, the complaint is filled with generalized allegations such

as “[t]he Defendants each directly represented, and / or are

| plaintiffs directed the court to paragraphs 7, 8, 69, 71
and 101-02. I found no specific misstatements or omissions in
those paragraphs, however.

23



[of scienter}] . . . [mJore is required in a securities fraud
case”); see generally, DiLeo, 901 F.2d at 627-28.°

The problem with plaintiffs’ complaint originates in the
fact that it generally makes allegations on behalf of all
plaintiffs against all the specialist defendants and lacks any
information detailing the relationship between any of the
individual plaintiffs and any of the individual specialist
defendants. See Makor, 437 F.3d at 603 (group pleading
impermissible under the PSLRA). Thus, the complaint does nothing

more than allege a general scheme under which every specialist

§ Moreover, the allegations describing these transactions
appear to be missing key facts that would make it fair to
conclude that many of these transactions actually are
representative of the manipulative scheme alleged by plaintiffs.
For example, Exhibit A lists 195 transactions between Last
Atlantis and specialist defendants that were ultimately cancelled
or never executed. Plaintiffs’ complaint describing three of the
transactions found in Exhibit A states that “MDNH unilaterally
canceled three (3) executed trades after confirming to Plaintiffs
that its Orders had been executed in violation of PSE’s Honor
Executed Trade Exchange Rules.” The manipulative scheme alleged
in plaintiffs’ complaint, however, describes a scenario in which
the specialist defendants would intentionally mishandle
plaintiffs’ orders under circumstances in which it would be
advantageous for the specialist defendant to trade from (or
refrain from trading from) its own proprietary account (or else
there would be no motive to mishandle). Yet completely absent
from plaintiffs’ description of these transactions are any
allegations that demonstrate or explain why it was advantageous
for MDNH to cancel these specific orders. Thus, it would seem
that these are not truly examples of the manipulative scheme
alleged by plaintiffs, but rather just examples of transactions
that failed.

18



general allegations against all specialist defendants describing
the trading process between direct access customers and
specialists. Plaintiffs’ allegations describe a situation in
which a specialist would have a financial motive and the
opportunity to mishandle plaintiffs’ orders in order to trade
from their own proprietary accounts. Plaintiffs’ claims, whether
cast as a manipulative scheme under 10b-5(a) and (c), or as false
and misleading statements under 10b-5(b), fail to state a claim
because plaintiffs have failed to allege facts that give rise to
a strong inference of scienter.

Plaintiffs attempt to meet their burden of pleading facts
that lead to a strong inference of scienter in three ways: 1)
through allegations of motive and opportunity; 2) by citation to
three documents: a) a letter to the SEC from Interactive Brokers

Group (“IAG”) commenting on a proposed rule of the Boston Stock

allegations are true, defendants’ statements are false.” Id. at
* 13, Regrettably, this sentence was poorly worded and was
interpreted by plaintiffs as stating that it would be sufficient
for a single plaintiff to plead its claims with specificity (i.e.
plead specific example transactions) against the specialist
defendants. This is not the case. In multiple defendant cases,
a single plaintiff must plead with specificity and raise an
inference of scienter against all defendants. Makor, 437 F.3d at
602-03. It naturally follows that each plaintiff has the burden
to plead with specificity and raise an inference of scienter
against all defendants in a multiple plaintiff-multiple defendant
case. Although this has created a deficiency with plaintiffs’
complaint, this deficiency was not outcome determinative.

10



who invokes the fraud-on-the-market theory must acknowledge that
all public information is reflected in the price . .. .”).
Plaintiffs’ own allegations demonstrate that their claim must
fail.

Additionally, this claim also fails because plaintiffs have
failed to allege facts from which I could strongly infer that
these three statements (if deemed material and misleading) were
made with scienter. As discussed above, plaintiffs’ complaint
alleges that the exchange defendants had each adopted publically
available rules to deal with orders that were not executed on
their original terms. Furthermore, the options pamphlet
incorporated into plaintiffs’ complaint incorporates the ODD
which states that order execution is not guaranteed at all times
and that exchanges will not operate as efficient markets at all
times. Therefore, given that each exchange defendant has
disseminated information to the public that clearly indicates
that trade execution is not “guaranteed,” I cannot reasonably
infer that the three statements “guaranteeing” execution were
made with scienter.

Accordingly, plaintiffs’ 10b-5 (b) claims against the
exchange defendants also fail. The exchange defendants’ motion

to dismiss is granted.

30



(b) To make any untrue statement of a material
fact or to omit to state a material fact
necessary in order to make the statements
made, in the light of the circumstances under
which they were made, not misleading, or

(c) To engage in any act, practice, or course of
business which operates or would operate as a
fraud or deceit upon any person, in
connection with the purchase or sale of any
security.

17 C.F.R. § 240.10b-5.

“To state a claim under Rule 10b-5(a) and (c), a plaintiff
must allege that the defendant (1) committed a deceptive or
manipulative act (2) with scienter, (3) that the act affected the
market for securities or was otherwise in connection with their
purchase or sale, and (4) that defendants' actions caused the
plaintiffs’ injuries.” In re Parmalat Sec. Lit., 414 F.Supp. 2d
428, 432 (S.D.N.Y. 2006). To state a claim under Rule 10b-5(b),
the plaintiffs must allege that “1) the defendant made a
misstatement or omission 2) of material fact 3) with scienter 4)
in connection with the purchase or sale of securities 5) upon
which the plaintiff justifiably relied 6) and that the false
statement or omission proximately caused the plaintiff's
damages." Otto v. Variable Annuity Life Ins. Co., 134 F.3d 841,
851 (7th Cir. 1998). Additionally, both SEC Rule 10b-5 and Feb.

R. Civ. P. 9(b) require that plaintiffs plead these claims of



set of facts to support the allegations in her claim. Strasburger
v. Bd. of Educ., 143 F.3d 351, 359 (7th Cir. 1998). A “plaintiff
can plead himself out of court by alleging facts which show that
he has no claim, even though he was not required to allege those
facts.” Soo Line R.R. Co. v. St. Louis S.W. Ry., 125 F.3d 481,
483 (7th Cir. 1997).
II.
Section 10(b) of the Exchange Act provides in pertinent

part:

It shall be unlawful for any person, directly or
indirectly, by the use of any means or instrumentality
of interstate commerce or of the mails, or of any
facility of any national securities exchange-

(b) To use or employ, in connection with the purchase
er sale of any security registered on a national
securities exchange or any security not so registered,
or any securities-based swap agreement (as defined in
section 206B of the Gramm-Leach-Bliley Act), any
manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate in
the public interest or for the protection of investors.

15 U.S.C. § 783.

SEC Rule 10b-5 provides in pertinent part:
It shall be unlawful for any person, directly or
indirectly, by the use of any means or instrumentality
of interstate commerce, or of the mails or of any

facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to
defraud,



would have the motive and opportunity to mishandle every direct
access customer order where the specialist could gain financially
by trading from its proprietary account and provides nothing more
than examples of failed transactions to infer intent. To hold
that plaintiffs had stated a claim would, in essence, allow any
direct access customer to bring a claim against any specialist
based upon any failed transaction. This holding would clearly
run afoul of the PSLRA which requires that “with respect to each
act or omission alleged, [plaintiffs] state with particularity
facts giving rise to a strong inference that the defendant acted
with [scienter].” 15 U.S.C. § 78u-4(b) (2).

Plaintiffs concede that there are a number of reasons why a
transaction may fail that are unrelated to a _ specialist’s
intentional or reckless mishandling. For example, plaintiffs
acknowledge that the exchange rules allow trades to go unexecuted
or quotes to be adjusted under certain circumstances. Moreover,
trades may go unexecuted or be adjusted due to unintentional
error. The complaint lacks any information from which I could
strongly infer that the failures set forth in plaintiffs’
complaint were mishandled with scienter. Plaintiffs do not
allege any facts obtained from confidential sources suggesting
scienter (see e.g. Makor, 437 F.3d at 596), they do not rely on

SEC findings implicating any of the specific specialist

19



statement was false or misleading.” Makor Issues & Rights, Ltd.
v. Tellabs, Inc., 437 F.3d 588, 602 (7th Cir. 2006) (quoting
Adams v. Kinder-Morgan, Inc., 340 F.3d 1083, 1105 (10th Cir.
2003)). “Motive and opportunity may be useful indicators, but
nowhere in the statute does it say that they are either necessary
or sufficient.” Id. at 601; See also Stephenson v. Hartford Life
& Annuity Ins. Co., 2003 U.S. Dist. LEXIS 17036, at *24-25 (N.D.
Ill. 2003) (“The complaint may plead facts showing motive and
opportunity, but there still must be specific facts supporting a
strong inference that the defendant acted with [scienter].”)In
multiple defendant cases, the allegations must create an
inference of scienter against each specific defendant. Makor,
437 F.3d at 602-03.
II.
I turn first to the specialist defendants’ motion to

dismiss.+ As already discussed, plaintiffs’ complaint makes

' an earlier draft of plaintiffs’ complaint was dismissed
because plaintiffs had failed to plead their claims with the
particularity required by Fep. R. Civ. P. 9(b) and the PSLRA, In
that opinion, I held that the complaint failed to properly allege
the who, what, when, where, and how of the misleading statements
and failed to “allege facts to support a ‘strong inference of
scienter.’ See Last Atlantis Capital LLC v. Chicago Bd. Options
Exch., Inc., 2005 U.S. Dist. LEXIS 23930, at *15 (N.D. Ill.
2005). In that opinion, I also stated that “[w]hile plaintiffs
need not detail each allegedly fraudulent transaction (of which
they claim there are hundreds, if not thousands), they must plead
at least one such transaction where, if the plaintiffs’

9



exchange defendant PCX made misleading statements in an SEC
comment letter,'4 and that PHLX made misleading statements
regarding order execution on its website.!®

With regard to these statements, plaintiffs have failed to
state a § 10b-5(b) claim because they have failed adequately to
allege justifiable reliance. Plaintiffs do not allege that any
plaintiff, let alone all of the plaintiffs, read these statements
and were misled by them. Rather, in arguing reliance, plaintiffs
cite to a case, Spicer v. Chicago Bd. Options Exchange, Inc.,

1990 U.S. Dist. LEXIS 14469 (N.D. Ill. 1990), which applies the

Performance. These are the major benefits of options
traded on securities exchanges today.

“4 The complaint alleges that PCX made the following
statements in a document entitled “Notice of Filing of Proposed
Rule Change by the Pacific Exchange, Inc. Implementing a One Year
Pilot Program Relating to its Automatic Execution System”
submitted to the SEC which reads in part:

The Auto-Ex feature of POETS permits eligible market or
marketable limit orders sent from member firms to be
executed automatically at the displayed bid or offering
price. Participating market makers are designated as
the contra side to each Auto-Ex order. . .

'S The complaint alleges that PHLX made the following
statements on its website that read in part:

AUTOM was created in 1988. It is the Philadelphia Stock
Exchange’s retail electronic options order execution
system and is available for all PHLX-traded equity and
index options. The Auto-X function provides automatic
execution for all market and marketable limit orders,
guaranteeing the price is consistent with the National
Best Bid or Offer (NBBO)... .

25



IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS

EASTERN DIVISION

LAST ATLANTIS CAPITAL LLC, LOLA
LLC, LULU LLC, GOODBUDDY SOCIETY
LLC, FRIENDLY TRADING LLC, and
SPEED TRADING LLC, BRYAN RULE,
BRAD MARTIN, and RIVER NORTH
INVESTORS, LLC,

Plaintiffs,
v.

CHICAGO BOARD OPTIONS EXCHANGE,
INC., AMERICAN STOCK EXCHANGE LLC,
PACIFIC EXCHANGE, INC.,
PHILADELPHIA EXCHANGE, INC., AGS
SPECIALIST PARTNERS, BEAR HUNTER
STRUCTURED PRODUCTS LLC, BEAR
WAGNER SPECIALISTS LLC, BOTTA
CAPITAL MANAGEMENT LLC, COHEN,
DUFFY, MCGOWAN & CO., INC., D.A.
DAVIDSON & CO., INC., EQUITEC
PROPRIETARY MARKETS, LLC, EQUITEC
STRUCTURED PRODUCTS, LLC, EQUITEC
TRADING LLC, EQUITEC-PREMIER LLC,
EQUITEC-BROWN LLC, EQUI'TEC-FELDMAN
LLC, EQUITEC-FURMAN LLC, EQUITEC-
SCHWARTZ LLC, GENEVA DPM LIC,
GROUP ONE TRADING LP, KNIGHT
FINANCIAL PRODUCTS LLC, KNIGHT
TRADING GROUP, INC., LABRANCHE &
co., INC., LABRANCHE STRUCTURED
PRODUCTS LLC, MDNH TRADERS LLC,
MDNH PARTNERS LP, MORGAN STANLEY,
MORGAN STANLEY DW, INC., MORGAN
STANLEY & CO., INC., SLK-HULL
DERIVATIVES LLC, SPEAR, LEEDS &
KELLOGG LP, SPECIALISTS DPM LLC,
SUSQUEHANNA INTERNATIONAL GROUP
LLP, SUSQUEHANNA INVESTMENT GROUP,
SUSQUEHANNA SECURITIES, TD OPTIONS
LLC, VAN DER MOOLEN OPTIONS USA
LLC, VAN DER MOOLEN HOLDINGS NV,
and WOLVERINE TRADING LP,

Defendants.

No.

04 C 397



Second, plaintiffs point to the three aforementioned
documents discussing specialist behavior. These documents
generally state that specialists mishandle trades on various
exchanges, but do not contain facts implicating any specific
specialist defendant in this case. Therefore, these documents do
not help raise an inference of scienter against any of the
specific specialist defendants. See Gurfein v. Ameritrade, 411
F. Supp. 2d 416, 426 (S.D.N.Y. 2006).

Plaintiffs quote language from the IAG letter dated February
12, 2003 stating that specialists, in general, have the motive
and opportunity to mishandle orders and that specialists do in
fact mishandle orders.? The letter, however, only makes general

allegations that such practices occur on “some exchanges” and

2 The quoted text reads in relevant part:

[O]n the floor based exchanges, market makers and
specialists have an inherent time and place advantage
because they can see orders before others can see them
and can often take their time to decide whether to
interact with these orders or not. . . specialists can
and do fade their quotes after receiving an order, and
the likelihood of an execution goes up as the market
maker moves against the customer . . . on some
exchanges specialists simply disable auto-ex systems
seemingly at will, regardless of whether there is a
valid reason. Once orders are kicked out of auto-ex
systems and on to the floor, they are subject to faded
quotes, delays in execution, or disparate treatment,
based on the originating order entry firm (if that
firm’s order flow is perceived to be ‘smart’). ...

12



Exchange; b) a letter to the SEC from the head of the Options
Market Makers Association of AMEX; and c) an SEC Staff report on
AMEX Options Order Handling; and 3) by detailing a number of
allegedly mishandled transactions (contained in Exhibits A and B
attached to their complaint) between a single plaintiff, Last
Atlantis, and the specialist defendants. In concluding that
plaintiffs have failed to raise a strong inference of scienter, I
have considered all of plaintiffs’ allegations in the aggregate.
Makor, 437 F.3d at 603 (“(WJe will aggregate the allegations in
the complaint to determine whether it creates a strong inference
of scienter ... .”).

Turning to these specific allegations, first, plaintiffs
have alleged facts demonstrating that each specialist defendant
had a financial motive and the opportunity to mishandle
plaintiffs’ trades. Plaintiffs’ general allegations, however,
have described a situation in which every specialist has the
motive and opportunity to mishandle every single trade in which a
direct access customer has presented a more competitive bid than
their own. Under these circumstances, plaintiffs’ allegations of
motive and opportunity may be relevant, but are not strong
indicators of scienter. See e.g. Stephenson, 2003 U.S. Dist.
LEXIS 17036 at *25 (“[A]llegations of financial motive cannot

alone satisfy plaintiff's burden of pleading scienter.”).

11



III. Conclusion

Having dismissed all of plaintiffs’ federal claims, I
decline to exercise jurisdiction over plaintiffs’ remaining state

law claims.

ta.

Elaine E. Bucklo
United States District Judge

DATED: September /2 , 2006

31



fraud with particularity. See In re Health Care Compare Corp.
Sec. Litig., 75 F.3d 276, 280-81 (7th Cir. 1996) (“Pleading fraud
with specificity is both an element of the SEC Rule 10b-5 cause
of action and a pleading requirement of the Federal Rules.”). To
satisfy the particularity requirement, plaintiffs must allege
“the who, what, when, where, and how: the first paragraph of any
newspaper story." Dileo v. Ernst & Young, 901 F.2d 624, 627 (7th
Cir. 1990).

Furthermore, plaintiffs must comply with the pleading
requirements of the Private Securities Litigation Reform Act
(“PSLRA”), which requires that the complaint specify each
allegedly misleading statement and the reasons why it is
misleading. 15 U.S.C. § 78u-4(b)(1). The PSLRA also requires
that plaintiffs, “with respect to each act or omission alleged,
state with particularity facts giving rise to a strong inference
that the defendant acted with [scienter]” for claims brought
under any section of 10b-5. 15 U.S.C. § 78u-4(b)(2). Scienter
is an “intent to defraud or recklessness.” Caremark, Inc. v.
Coram Healthcare Corp., 113 F.3d 645, 650 (7th Cir. 1997) (citing
Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1043-45 (7th
Cir. 1977)). “We [] understand a ‘strong inference’ of scienter
to be a conclusion logically based upon particular facts that

would convince a reasonable person that the defendant knew a



opportunity. According to plaintiffs, the exchange defendants’
motives were: 1) to provide this technology to specialists (who
desired this technology in order to increase their own
profitability) in order to encourage the specialists to remain
members of their respective exchanges; and 2) to increase
exchange revenues, which are in part based upon profits earned by
specialists and cancellation fees. Given that there are
countless legitimate reasons to develop these features aside from
discrimination, these allegations of motive do not create a
strong inference of scienter. See Stephenson, 2003 U.S. Dist.
LEXIS 17036 at *25 (financial motive alone is insufficient to
create strong inference of scienter). Because the complaint
group-pleads these allegations against all of the exchange
defendants, it is devoid of specific factual information from
which I could conclude that the development of any specific
exchange technology was in any part driven by a desire to foster
discrimination against direct access customers. Beyond this
general financial motive, plaintiffs’ argument amounts to a
suggestion that because these technological features exist at
all, and because these features were subsequently abused by the
specialist defendants, the exchange defendants must have
developed these features in concert with the specialists as part

of a scheme to defraud direct access customers. As discussed

22



Additionally, any reliance (direct or indirect) on these
statements would not be justifiable. It is plaintiffs’
contention that these statements were misleading (to them and
other investors since they argue fraud-on-the-market) because the
statements “guarantee” execution. First, reliance would not be
justifiable because a number of the factual assertions in these
statements are too vague to constitute material representations
of fact (e.g., that the exchanges are “orderly” and “efficient”
and “liquid”). See Searls v. Glasser, 64 F.3d 1061, 1066 (7th
Cir. 1995). Furthermore, even if these statements were arguably
material, plaintiffs allege in their complaint that each of the
exchange defendants has adopted publically available detailed
rules that explain the circumstances under which a customer's
orders may be cancelled, adjusted, or otherwise not executed in
accordance with the original terms of the order (referred to by
plaintiffs as the “Firm Quote Rules” and “Obvious Error Rules”).
[See complaint Paragraphs 94-102] Also, the options pamphlet
cited by plaintiffs in their complaint states that “[p]rior to
buying or selling options, a person must receive a copy of
Characteristics and Risks of Standardized Options (the “ODD”)
{and thus the pamphlet incorporates the ODD by reference). The
ODD states that “the systems of an options market . . . may fail

or may not work effectively or efficiently at times” and “no

28



orders, by buying or selling the designated options from its own
proprietary account.

Plaintiffs characterize themselves as direct access
customers implementing arbitrage trading strategies which attempt
to take advantage of price discrepancies of options. For
example, if a specialist’s buy bid on one exchange is $5.00 and a
specialist’s sell bid on a different exchange for that same
option is $4.90, plaintiffs would attempt to execute simultaneous
orders to sell on the first exchange and buy on the second
exchange in order to achieve a .10 cent profit per option while
incurring minimal risk.

According to plaintiffs, in general, specialists make
significant profit from the “spread” when they are able to fill
orders from their proprietary accounts. Plaintiffs allege that
(as direct access customers who have better access to information
and technology than typical customers) their placement of limit
orders at a better price than a specialist is offering (which are
required to be filled before a specialist can trade out of its
own proprietary account) have greatly cut into specialists’
profits. As a result, plaintiffs allege that since April 1,
2001, the specialist defendants have engaged in a practice of
discrimination against their orders. Specifically, plaintiffs

allege that the specialist defendants have:



orders placed by three major direct access firms’ that were
handled by an unspecified number of unidentified specialists over
a one week period in October 2001. Under circumstances nearly
identical to those in this case, the court in Gurfein addressed
whether this very same report met the PSLRA pleading requirements
against an AMEX specialist defendant. Gurfein, 411 F. Supp. 2d
at 426. The court held that the report did not help raise a
strong inference of scienter and stated:

Since the [staff report’s] conclusions rest on

different transactions by different specialists in

different options classes, placed through different

direct access firms, at times over a year earlier and

not involving any defendant in this case, they cannot

be taken as evidence of a defendant's participation in

the scheme to defraud, or give rise to the ‘strong

inference’ of scienter necessary to state a

securities-violation claim against the defendants.
Id.

In this case, plaintiffs’ Exhibits A and B do include a
number of transactions conducted by Last Atlantis on the AMEX.
Similar to the transactions analyzed in Gurfein, however, Last

Atlantis’ transactions occurred more than a year and a half after

the staff report was published in 2001.° Also similar to

5 The three firms whose data was analyzed are: Spear, Leeds
and Kellogg; Interactive Brokers; and Preferred Capital Markets.

© Beyond these specific examples of Last Atlantis’ trading,
the complaint only generally alleges that all plaintiffs traded
on all four exchanges during the relevant period. This
allegation is far too vague for the court to conclude that any

15



plaintiff Last Atlantis attempted with the specialist defendants
between January and September 2003 that were ultimately cancelled
or never executed.’ According to the complaint, Exhibit A shows
that each specialist defendant found in the exhibit cancelled or
failed to execute between one and forty trades with Last Atlantis
during the sample period. Exhibit B lists approximately 30
trades that Last Atlantis attempted during the same time period
with the specialist defendants that were all allegedly mishandled
in some manner. Plaintiffs argue in conclusory fashion that
these transactions raise an inference of scienter, but do not
explain their reasoning. It would appear, however, that
plaintiffs are attempting to imply that the fact that these
transactions failed in and of itself demonstrates scienter. This
type of result-based reasoning, which attempts to infer scienter
from the fact that a transaction has failed, is impermissible.
See Gurfein, 411 at 426 (“nor do the failures of execution of

{plaintiff’s] orders on December 6, 2002 support that inference

7 The actual Exhibit A chart contains a spreadsheet with
transaction data. While some of the columns of data are self-
explanatory, others have only cryptic headings such as “Exit Px”
or “Exit Trade Price,” the meaning of which the court is unaware.
Accordingly, since plaintiffs never attempt to explain the
significance of the vast majority of the data in this chart, the
court will rely solely on the textual description of these
transactions found in plaintiffs’ complaint in evaluating the
significance of these exhibits.

17



have engaged in tortuous interference with the plaintiffs’
businesses (Claim VII).

The plaintiffs' allegations concern activities related to
the trading of options. An option is a contract that provides
its owner the right to purchase or sell a fixed quantity of the
underlying interest (here, securities traded on a national
securities exchange) at a fixed price when certain conditions are
met. Dealers, who effect transactions for themselves, and
brokers, who effect transactions for others, supply the market
for publicly-traded options. A bid price is the highest price at
which a dealer or broker is willing to buy an option; an ask or
offer price is the lowest price at which a dealer or broker is
willing to sell an option. The exercise price is the price at
which the option owner has the right to exercise the option to
buy or sell.

The following facts come from plaintiffs’ complaint: A
specialist is a dealer/broker tasked with the responsibility of
establishing the quote (the bid and offer prices) for every
option in the option class it has been designated. The
specialist must execute (“fill”) orders submitted to it by buyers
and sellers by either: 1) matching orders to buy options with
contra-side customer orders to sell options at the same prices or

2) in the event there are no existing contra-side customer



fraud-on-the market doctrine of reliance and imply that reliance
may be presumed in this case. I disagree. The difference
between the reliance element in a traditional securities fraud
case and one that utilizes the fraud-on-the-market theory has
been described as such:

If this were a traditional securities suit--if, in
other words, an investor claimed to have read or heard
the statement and, not having access to the truth,
relied to his detriment on the falsehood--then
plaintiffs’ argument would be correct. But this is not
a traditional securities claim. It is a
fraud-on-the-market claim. None of the plaintiffs
asserts that he read any of Baxter’s press releases or
listened to an executive’s oral statement. Instead the
theory is that other people (professional traders,
mutual fund managers, securities analysts) did the
reading, and that they made trades or recommendations
that influenced the price. In an efficient capital
market, all information known to the public affects the
price and thus affects every investor. Basic Inc. v.
Levinson holds that reliance on the accuracy of the
price can substitute for reliance on the accuracy of
particular written or oral statements, when the
statements affect the price--as they do for large and
well-followed firms such as Baxter, for which there is
a liquid public market.

Asher v. Baxter Int'l Inc., 377 F.3d 727, 731 (7th Cir. 2004)
(citations omitted). The facts of this case are such that fraud-
on-the-market theory cannot be used to presume reliance.
Assuming, arguendo, that the three statements pointed to by
plaintiffs were material and misleading, the fraud-on-the-market
doctrine does not apply to plaintiffs’ claims because plaintiffs

do not seek recovery for a loss caused by the inflation of the

26



MEMORANDUM OPINION AND ORDER

Plaintiffs Last Atlantis Capital LLC, Lola LLC, Lulu LLC,
Goodbuddy Society LLC, Friendly Trading LLC, Speed Trading LLC,
Bryan Rule, Brad Martin, and River North Investors, LLC allege
numerous violations of federal and state law by defendants.
Defendants include the Chicago Board Options Exchange, Inc.
(“CBOE”), the American Stock Exchange LLC (“AMEX”), the Pacific
Exchange, Inc. (“PCX”), and the Philadelphia Exchange, Inc.
(“PHLX”) , collectively, the “exchange defendants”, as well as 35
securities brokers and/or dealers, collectively, the “specialist
defendants.” Specifically, plaintiffs allege that the specialist
defendants violated § 10b of the Exchange Act and SEC Rule 10b-5
(a), (b) and (c) (Claim I); that the exchange Defendants violated
§ 10b of the Exchange Act and SEC Rule 10b-5 (a), (b) and (c)
(Claim II); that all defendants are in breach of contract (Claim
III); that all defendants have engaged in common law fraud (Claim
IV); that the specialist defendants breached their fiduciary duty
to. plaintiffs and that the exchange defendants aided and abetted
that breach of fiduciary duty (Claim V); that all defendants
violated the Illinois Consumer Fraud and Deceptive Practices Act,

815 Ill. Comp. Stat. 505/2 (Claim VI); and that all defendants



“”

system can be expected to work perfectly at all times ... .
Given these public statements that are alleged in plaintiffs’
complaint to have been made by each exchange defendant, which
explain the specific circumstances under which order execution is
not “guaranteed,” any knowledgeable investor would be aware of
the fact that orders can, and do, go unexecuted. Thus, a
reasonable investor would be aware that these three statements
“guaranteeing” order execution were not accurate. Plaintiffs
themselves allege that they have placed hundreds of thousands of
orders and engage in sophisticated arbitrage trading strategies.
Thus, given the public information available and their own
experiences, even if plaintiffs had in fact read these
statements, any reliance upon them would not be justifiable.
Teamsters Local 282 Pension Trust Fund v. Angelos, 762 F.2d 522,
530 (7th Cir. 1985) (“The investor cannot ask a court to focus on
the lie and ignore the remaining pieces of information already
available to him (or, in the case of a publicly traded security,
already available to others and reflected in the price of the
security.)”). Similarly, even if I were to accept plaintiffs’
argument that reliance could be presumed in this case, these
three statements could not have been justifiably relied upon by a
reasonable investor and could not have adversely affected the

price paid for options. Id; Asher, 377 F.3d at 732 (“An investor

29



does not in any way identify or implicate any specialist
defendant in this case or any transaction conducted by a
plaintiff in this case.

Similarly, the letter to the SEC from the head of the
Options Market Makers Association of AMEX dated April 12, 2004
fails to raise a strong inference of scienter. The author of the
letter states that “it is the position of the AMEX as well as the
SEC to honor all customer orders with fair and equitable

Ww

execution, unlike many of our competitors. Again, nothing in
this document in any way identifies or implicates any specialist
defendant in this case.

Plaintiffs also rely on an SEC Staff Report (the “staff
report”) from June 16, 2003. The report analyzed “audit trail
data from the week of October 22, 2001 to evaluate order handling

by AMEX specialists.” The report concluded that “AMEX

specialists routinely violated the firm quote rule” and that

3 The letter goes on to state:

Currently the AMEX specialists doesn’t even know whom
he is trading with until after the trade is
consummated, so on the AMEX we treat everyone equally.
Conversely on other exchanges they see the ‘give up’ of
the order and fade non advantageous option originated
orders . .. . This happens on a regular basis, but
since it happens on the CBOE we on the AMEX seem not to
have any way of policing this flagrant violation.

13



Gurfein, plaintiffs have not alleged that any plaintiff used any
of the three direct access firms analyzed in the staff report,
that any plaintiff traded any of the option classes specifically
mentioned in the staff report, that any specialist defendant in
this case was analyzed by the study, or otherwise forged a link
between the report and the transactions for which plaintiffs seek
recovery (beyond the fact that plaintiffs generally alleged that
they traded on the AMEX). I am persuaded by the court in Gurfein
that the staff report does not help plaintiffs meet their burden
of alleging scienter under the PSLRA. To hold otherwise and find
that each plaintiff had raised an inference of scienter against
each specialist defendant would, in essence, hold that any direct
access customer could meet the scienter requirement for a § 10b-5
claim by alleging a failed transaction with any AMEX specialist
for a transaction executed at any point in time regardless of
whether the specialist defendant was ever implicated in improper
activity.

Third, plaintiffs point to Exhibits A and B, which provide
the details of a series allegedly mishandled orders placed by

Last Atlantis. Exhibit A lists approximately 195 orders that

specific plaintiff conducted any trade with any specific
specialist on the AMEX during the time period in which the SEC
took its sample.

16