Opinion ID: 2307607
Heading Depth: 1
Heading Rank: 8

Heading: Consistency with Federal and State Law

Text: RCM Customers also contend that our interpretation of Section B.2 is inconsistent with federal and/or state law and that ambiguities in the Customer Agreement should be construed to comply with applicable legal rules. [17] RCM Customers argue that RCM was subject to SEC Rules 15c3-1, 17 C.F.R. § 240.15c3-1, and 15c3-3, 17 C.F.R. § 240.15c3-3, [18] and New York state law, which would have limited RCM's rehypothecation rights with respect to excess margin securities. However, even assuming arguendo the existence of ambiguities in the Customer Agreement, we disagree. The district court rejected these arguments regarding federal law based on our decision in United States v. Finnerty, 533 F.3d 143 (2d Cir.2008). RCM II, 586 F.Supp.2d at 191-92. Finnerty held that a defendant may be liable under Section 10(b) and Rule 10(b)(5) for violation of a NYSE rule only if the defendant had made a representation regarding compliance with the rule. Finnerty, 533 F.3d at 149-50. The district court concluded that because plaintiffs made no allegations that RCM (or any Refco affiliate or employee) made any representation that RCM was subject to, or would comply with, any such regulations, much less [Rules 15c3-1 and 15c3-3], RCM could not be found liable under Section 10(b) and Rule 10b-5 for violating Rules 15c3-1 and 15c3-3. RCM II, 586 F.Supp.2d at 192. Here, more than simply remaining silent as to whether it was complying with U.S. law, RCM represented that it was not a U.S.-regulated company. Although RCM did state that it was subject to all applicable laws in the trade confirmations, that simply raises the question of what laws were applicable. In short, RCM's alleged violation of federal law does not in and of itself constitute deceptive conduct. The Security and Exchange Commission has expressed a concern, as amicus curiae, that affirming the district court in this regard will viscerate the so-called shingle theory of broker-dealer liability under Section 10(b), and will be inconsistent with our recent decision in VanCook v. SEC, 653 F.3d 130 (2d Cir.2011). We disagree. Under the shingle theory, a broker makes certain implied representations and assumes certain duties merely by hanging out its professional shingle. Grandon v. Merrill Lynch & Co., Inc., 147 F.3d 184, 192 (2d Cir.1998). In VanCook, we held that VanCook's late-trading practice violated [Rule 10b-5] because it constituted an implied representation to mutual funds that VanCook was complying with a rule restricting late-trading. VanCook, 653 F.3d at 141. We reasoned that by submitting orders after that time for execution at the current day's [Net Asset Value], VanCook made an implied representation that the orders had been received before 4:00 p.m., because such late trading incorporates an implicit misrepresentation by falsely making it appear that the orders were received by the intermediary before 4:00 p.m. when in fact they were received after that time. Id. at 140-41 (internal quotation marks and alterations omitted). We also noted that VanCook's scheme violated his employer mutual funds' own express wish's, as set out in their prospectuses, id. at 140, and involved steps to make it appear to any outside observer ... that his customers'... orders had been finalized by 4:00 p.m., id. Based in part on the explicit and implied misrepresentations, we affirmed the order of the SEC that VanCook violated Rule 10b-5 and Section 10(b). Id. at 141. However, the facts alleged in the instant matter do not, as asserted by appellant, give rise to liability based on conduct inconsistent with an implied representation; specifically a broker-dealer's implied representation under the `shingle theory' that it will deal fairly with the public in accordance with the standards of the profession. Appellants' 18(j) Letter at 2. Surely, RCM's affirmative representations that it was not a U.S.-regulated company trump any implied representation under the shingle theory. Indeed, we have previously denied shingle theory claims against a broker that made adequate explicit disclosure with regard to the subject matter of the claimed implied duties. See Starr ex rel. Estate of Sampson v. Georgeson S'holder, Inc., 412 F.3d 103, 111 (2d Cir.2005) (denying plaintiffs' Rule 10b-5 claim under the shingle theory because defendant disclosed allegedly excessive markups). In the instant case, RCM's Customer Agreement and its standard form Trade Confirmation expressly disclosed RCM's rehypothecation rights as well as RCM's status as an offshore unregulated entity. These disclosures were made in conjunction with a bargained-for agreement between sophisticated counter-parties that could be expected to understand the relevant benefits and risks. Thus, there is no liability under the shingle theory. The terms of the Customer Agreement indicated that, insofar as RCM was acting as executing broker for its customers, RCM was not purporting to comply with the Rules in question but was relying on the safe harbor from broker registration provided under SEC Rule 15a-6, 17 C.F.R. § 240.15a-6. In general, Rule 15a-6 exempts from the federal broker-dealer registration requirements of Section 15(a) of the Exchange Act, 15 U.S.C. § 78o, foreign entities engaged in certain activities involving U.S. investors and securities markets. See Registration Requirements for Foreign Broker-Dealers, Exchange Act Release No. 27,017, 54 Fed.Reg. 30013, 30013 (July 18, 1989). In particular, Rule 15a-6(a)(3) exempts from registration foreign brokers [19] that induce or attempt to induce trades in securities by major U.S. institutional investors and U.S. institutional investors so long as any trades are effected through a U.S.-registered broker-dealer and various conditions are met both by the foreign broker and the registered dealer that effects the trades. See 17 C.F.R. § 240.15a-6(a)(3)(i)(A). Section G.1 of the Customer Agreement, entitled Respective Status of [RCM] and RSL, provides in relevant part: [RCM] and RSL are all wholly owned subsidiaries of the Refco Group Ltd., LLC, a U.S. corporation. RSL is a U.S. corporation and a broker-dealer registered with the U.S. Securities and Exchange Commission. [RCM] is a Bermuda Corporation. App. 156-57. This language clearly indicates that RSL is a U.S. corporation and registered with the SEC, thereby implying that RSL would comply with SEC regulations. However, Section G.1 represents RCM only as a Bermuda Corporation and makes no suggestion that RCM was registered with the SEC or would comply with federal securities regulations. Furthermore, the Customer Agreement's frequent references to RSL as introducing transactions to RCM on the customers' behalf clearly represented that trades executed at RCM for its customers would be effected through RSL to RCM in accordance with the requirements of Rule 15a-6(a)(3)(i)(A). [20] Accordingly, whether or not RCM was technically in compliance with the Rule 15a-6(a)(3) safe harbor, [21] the Customer Agreement clearly represented that RCM undertook no obligation to comply with Rules 15c3-1 and 15c3-3. Similarly, to the extent that RCM was acting as its customers' prime broker, RCM undertook no apparent obligation to comply with federal securities laws, including Rules 15c3-1 and 15c3-3. Section G.1 of the Customer Agreement establishes the role and function of RCM when acting as prime broker and states: Trades Executed Away From [RCM], but cleared by [RCM] (Prime Brokerage) [RCM] acts as your clearing, settlement and financing agent (your prime broker) in connection with Transactions executed at your Executing Broker(s). Where [RCM] is acting as your prime broker, no [RCM] entity is involved in executing Transactions. App. 157. The SEC has defined prime broker as a registered broker-dealer that clears and finances the customer trades executed by one or more other registered broker-dealers (`executing broker') at the behest of the customer. Prime Broker Comm. Request, SEC No-Action Letter, 1994 WL 808441, at  (Jan. 25, 1994). The Commission requires prime brokers to comply with certain federal securities laws, including Rules 15c3-1 and 15c3-3. Id. at . However, insofar as RCM was not a U.S.registered broker-dealer, and thus not a prime broker for purposes of complying with U.S. federal securities laws, RCM, when acting in its role as prime broker, was not representing that it would comply with Rules 15c3-1 and 15c3-3. [22] We therefore conclude that the Customer Agreement represented that RCM intended to exercise full rehypothecation rights without being subject to the Rules in question. RCM Customers also assert that RCM was subject to New York General Business Law Section 339-e, which, in general, restricts a broker's rehypothecation rights with respect to fully-paid or excess margin securities. N.Y. Gen. Bus. Law § 339-e (McKinney 2004). RCM Customers argue that Section 339-e applies because Section H of the Customer Agreement and Paragraph 6 of the Trade Confirmation specified that the agreement would be governed by, and construed in accordance with, New York law. In particular, Section H of the Customer Agreement, entitled LAW AND JURISDICTION, reads: This Agreement shall be governed by and construed with New York law and you agree that the courts of New York, located in the Borough of Manhattan (Federal or State), are to have jurisdiction to settle any disputes which may arise out of or in connection with this Agreement. Any suit, action or proceedings arising out of or in connection with this Agreement (Proceedings) commenced by you, may only be brought in New York. [RCM] may take proceedings against you in New York (Federal or State) or any other court of competent jurisdiction, U.S. or otherwise. The taking of Proceedings by [RCM] in one or more jurisdictions does not preclude the taking of Proceedings by [RCM] in any other jurisdiction, whether concurrently or not. You irrevocably waive (and irrevocably agree not to raise) any objection which you may have now or subsequently to [RCM's] laying of the venue of any Proceedings in any court and any claim that any such Proceedings have been brought in an inconvenient forum. App. 157. The district court determined that Section H constituted a choice of law provision that governed only the Customer Agreement itself. RCM II, 586 F.Supp.2d at 192 n. 27. However, RCM Customers assert that Section H establishes that New York law governed the overall relationship between RCM and RCM Customers, including RCM's use of RCM Customers' collateral. We agree with the district court. Section H neither created, nor represented, any affirmative obligations on RCM to conform to New York margin-lending restrictions. [23] By its clear terms, the provision was included only as a choice of law and venue provision that would govern should any conflicts arise out of or in connection with the Customer Agreement.