Opinion
Case No. 01 C 6840
January 22, 2003
MEMORANDUM OPINION AND ORDER
On September 1, 2000, Masters Capital Management, an investment management firm founded and managed by Michael Masters, placed an order with Salomon Smith Barney, one of MCM's brokers, to buy call options in Associates First Capital Corp. (abbreviated "AFS" on securities exchanges), a financial services company. MCM directed SSB to bid for up to 5000 AFS call option contracts with a strike price of $27.50 and an expiration date of September 16, 2000. SSB filled MCM's order on two consecutive trading days: Friday, September 1 and Tuesday, September 5 (Monday, September 4 was a holiday). Also on September 1, SSB placed AFS on its "Watch List," a bulletin shared with only "a limited group of `need to know' [SSB] employees. . . ." that suggests that something big is coming down the pike. SSB's Sales Trading Manual, September 1999, attached as Exhibit 2 to Plaintiffs' 56.1 Statement of Additional Facts. On September 6, 2000, Citigroup, which owned SSB, publicly announced that it was acquiring AFS. Following the merger announcement, AFS stock, which had been trading at less than $28 on September 1 and September 5, climbed over $10 a share to close at $38.63. MCM exercised the options, sold the AFS shares at the higher price, and made a killing — roughly $5 million.
The trader does not simply pull a date out of the air here; at least at the CBOE, the expiration date for stock options is the Saturday immediately following the third Friday of the expiration month. See Affidavit of Steven Ross, Exhibit A (Ross' Affidavit is attached as Exhibit 1 to plaintiffs' 56.1 statement of additional facts).
The plaintiffs, all "market makers" for AFS derivative securities at the Chicago Board Options Exchange, sold the AFS options to MCM; they have sued MCM alleging insider trading in connection with the AFS order. MCM has moved for summary judgment, which is appropriate "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(c).
"[M]arket makers provide liquidity in option trading by risking their own capital for personal trading"; "[t]hey take the opposite side of public orders by competing in an open outcry auction market." Ross Affidavit, Exhibit A.
Trading on the basis of material nonpublic information violates Section 10(b) and Rule 10b-5 "where the trading arises `in connection with' a breach of a fiduciary duty." SEC v. Maio, 51 F.3d 623, 631 (7th Cir. 1995) (citing Dirks v. SEC, 463 U.S. 646, 663 (1983); Chiarella v. United States, 445 U.S. 222, 232-36 (1980); SEC v. Cherif, 933 F.2d 403, 410 (7th Cir. 1991)). To prove their claim, the plaintiffs have to show first that MCM received a tip and traded on the basis of that tip, and also that the tipper's disclosure of such information was improper, and that MCM knew or should have known that the disclosure was improper. Maio, 51 F.3d at 631-32; Abrams v. Prudential Securities, Inc., No. 99 C 3884, 2000 WL 390494, at *2-*3 (N.D.Ill. March 21, 2000).
In its summary judgment motion and memorandum, MCM does not address any of these requirements directly, instead arguing that the evidence "nullif[ies] any inference of fraudulent intent" because it shows MCM's purchase of the options was consistent with its normal trading patterns. Defendant's Memorandum in Support of Motion for Summary Judgment, p. 7. This, MCM argues, defeats any contention by plaintiffs that circumstantial evidence can sustain their claim of insider trading. Id. With the issue for summary judgment thus defined, we turn to an assessment of the parties' contentions.
MCM says that it bought the AFS options based on publicly-disseminated research reports and consistent with its "catalyst" investment approach. Masters testified that during the last week of August 2000, after reviewing the reports coming out of First Call, a subscription service with research reports from more than fifty different brokers, he decided to pursue a trade in AFS securities. Deposition of Michael Masters, pp. 7-8. Specifically, Masters testified that he relied on the following: (1) an August 31, 2000 report from USBancorp Piper, which raised the price target on AFS from $28 to $33, predicting that "multiple expansion will occur over future quarters . . . leading to improved outlook for margins and financial stocks" and noting that "[m]anagement visibility is increasing in the near-term with the upcoming September 14, 2000 . . . presentation. . . ." Masters Deposition, pp. 61-63; Affidavit of Michael Masters, Exhibit 4; (2) an August 21, 2000 report from Morgan Stanley/Dean Witter, which predicted that "AFS shares could trade to low-$30s by year end," predicted a "near term upside" and advised looking "to analyst meetings in NYC (Sept. 14) and Japan (Nov. 8) for bullish guidance." Masters Deposition, pp. 63-65; Masters Affidavit, Exhibit 3; and (3) an August 18, 2000 report from Prudential Securities raising the price target from $28 to $33 based on improving fundamentals and market sentiment. Masters Deposition, pp. 68-71; Masters Affidavit, Exhibit 2 (MCM submitted copies of these reports in support of Masters' testimony; they are attached as Exhibits 2, 3 and 4 to Masters' Affidavit). Masters also stated that after reading the reports, he — and he alone — decided to buy AFS, that he decided to buy options instead of shares because they were less risky, and that he then called the trading desk at SSB, one of MCM's brokers, to place the order. Masters Deposition, pp. 7-10, 35-36, 100. Masters told the SSB broker that he wanted the order "worked" and that he wanted him to stay "on the bid side," to suggest a less aggressive approach to obtaining the contracts. Id. at pp. 11-13.
To counter the plaintiffs' allegations that the circumstances of the AFS trade suggested something fishy, Masters testified that the AFS trade was a typical one for MCM in terms of the type of order (for call options), number of options and the expiration date, id. at pp. 12-13, 28-29, 42-49, and MCM submitted market reports detailing MCM's holdings on September 1 and 2, 2000 to bolster that testimony. Masters Affidavit, Exhibits 11 12. Similarly, Masters testified, MCM had made other trades that were as profitable or more profitable than the AFS transaction. Masters Deposition, pp. 48-49.
In response to MCM's motion, the plaintiffs submitted an affidavit from one of their own, Steven Ross. Ross essentially states that MCM's documentary evidence — the research reports and the market reports — actually supports the plaintiffs' allegations, not MCM's explanation of events. Ross states that MCM's interest in AFS was not supported by any publicly-available information and that the reports Masters claims he relied on would not have justified MCM's AFS options order. See Affidavit of Steven Ross, ¶¶ 14-15. He also states that the AFS trade was atypical for MCM, and he explains how each of the seemingly similarly transactions detailed on the market report is actually distinguishable from the AFS trade whether in terms of the expiration date, the number of contracts, the market value at time of purchase and the total position held. Id. at ¶¶ 16-20.
Generally speaking, the evidence is consistent with Masters' arguments. But it is not so one-sided that no reasonable jury could find for the plaintiffs. For example, although a jury could certainly believe that the research reports dated August 18, 21 and 31 could have spurred Masters to buy AFS on September 1, a jury could also believe, as Ross explains, that under Masters' "catalyst" theory, MCM would have purchased the options before September 1 if he intended to capture any market gain associated with the positive reports. Additionally, although the market reports seem to show that MCM held numerous other call options positions that were identical or similar to its AFS positions, the evidence does not allow the Court to determine whether any of those positions were opened or purchased in the same month as they expired. Thus, at least based on the evidence presented, a jury reasonably could agree with Ross that the AFS transaction was atypical in terms of the near term expiration. Accordingly, we will not enter summary judgment on the basis urged by MCM.
In its reply brief, MCM argued, for the first time, that the plaintiffs will be unable to prove the other elements of their tippee liability claim, i.e., that the disclosure of information from the tipper to Masters was improper and that Masters knew or should have known that the disclosure was improper. See Maio, 51 F.3d at 632. And, to be sure, the plaintiffs cannot win this lawsuit without such evidence. See id. (a tippee's liability is derivative; thus, absent improper disclosure by the tipper, the tippee is not liable); Abrams, 2000 WL 390494, at *3 ("Illegal trading occurs when the tippee knew the tipper was breaching a fiduciary duty by disclosing the insider information."). To date, the plaintiffs have offered no evidence about who the tipper was or how the alleged tip was disclosed. But, given the limited basis on which MCM argued the case in its opening memorandum, plaintiffs would have had no reason to address these issues. Accordingly, the Court has refrained from considering these points until plaintiffs have had a fair opportunity to address them.
Conclusion
For the reasons explained above, the Court denies without prejudice the defendant's motion for summary judgment [docket #26-1]. The plaintiffs are directed to respond to pages 8-10 of MCM's reply brief by February 5, 2003; MCM is directed to reply on the issues contained in that brief — and only those issues — by February 12, 2003. The Court will rule promptly after receiving MCM's brief. Both sides are directed to deliver courtesy copies to chambers, room 1778.