The Second Circuit concluded that a putative class action brought by Electronic Trading Group, LLC on behalf of short sellers against Bank of America Securities, LLC and other prime brokers was preempted. Specifically, the court held that the securities laws preempted Sherman Act Section 1 liability for claimed price fixing regarding the fees charged for certain securities located to cover short sales. In re Short Sales Antitrust Litig., Docket No. 08-0420-cv (2nd Cir. Decided Dec. 3, 2008).

Plaintiff claimed that defendants arbitrarily designated certain securities as “hard-to-borrow” and then fixed the price for them in violation of the Sherman Act. SEC regulation SHO requires that, before selling short, the party must borrow the securities. The prime broker charges a fee for this service. The district court dismissed the complaint based on Credit Suisse Securities (USA), LLC v. Billing, 551 U.S. 264 (2007) in which the Supreme Court found that antitrust liability was precluded by the securities laws in the IPO litigation. .

Under Billings, the preclusion analysis turns on four key points: (1) if the area of conflict is squarely within the “heartland” of securities regulation; (2) whether the SEC has clear and adequate authority to regulate; (3) if there is active and ongoing regulation; and (4) whether there would be a serious conflict between antitrust and securities regulation. Here, an analysis of each prong dictated preclusion.

First, the “heartland” prong of the test requires the court to determine if the practices challenged are squarely within the area that is regulated. In this case, the question is thus whether short selling is within the heartland of the securities business. Here, the district court concluded that it is, a point the plaintiff admitted.

The second prong of the test focuses on the existence of regulatory authority. Under Section 10(a) of the Exchange Act, the SEC is given broad regulatory authority. That authority, the court concluded, extends not just to the prevention of fraud, but also permits the SEC to regulate the role of the prime brokers in short selling and the borrowing fees charged. In addition, Section 6 of the Exchange Act permits a national securities exchange to impose a schedule or fix rates of commissions, allowances, discounts or other fees to be charged by its members. This Section, at a minimum, gives the SEC the indirect authority to regulate rates. It is thus clear that the SEC has adequate regulatory authority in this area.

Equally clear is the fact that there is on-going regulation in this area – the third factor. In 2004, the SEC adopted Regulation SHO which imposes a “locate” requirement on brokers involved in short selling before the trade can be accepted. This regulation constitutes an exercise by the SEC of its authority over prime brokers in the area of short selling. Indeed, the complaint here implicitly confirms active regulation, the court found.

Finally, it is also apparent that there is a conflict between the two regulator regimes. The question here is whether allowing antitrust liability in this case would inhibit otherwise permissible market behavior. In this regard, plaintiffs claimed that there should be little difficulty in distinguishing between collusive fee-fixing agreements and routine communications regarding stock availability under Regulation SHO.

The Second Circuit rejected plaintiff’s claim, concluding that there are both actual and potential conflicts with the securities regime. Antitrust liability would inhibit the conduct that the SEC permits and which assists the efficient functioning of the market. “It is a lot to expect” of a broker, the court stated, “’to distinguish what is forbidden from what is allowed,’ so that the broker collects just so much information as required to satisfy the locate requirement and for the efficient functioning of the short selling market – but not an iota more – or suffer treble damages,” quoting Billings.

Likewise, a potential conflict exists since the SEC may act on its authority to regulate the borrowing fees set by prime brokers. This potential conflict, coupled with the actual one, considered in conjunction with the other three Billings factors makes is clear that antitrust liability is precluded and that the district court correctly dismissed the action.