Tuesday, January 12, 2016

Flash Crash Suit Against Congress and the SEC Goes Up in Smoke


Author: David Schwartz J.D. CPA

Angry investor Clyde Calvin Grady II has had his day in court. In a November 2015 ruling, the U.S. Court of Claims dismissed Grady’s suit against Congress and the Securities and Exchange Commission alleging that, by failing to prevent the 2010 “Flash Crash,” the SEC had breached an implied contract with investors. 

 

Mr. Grady, representing himself, alleged a breach of contract between the United State and investors in the U.S. stock market, claiming that a contract was created when Congress enacted the Securities Exchange Act of 1934.  According to Mr. Grady, this contract “obligated the Congress to take action necessary to ensure the ‘maintenance of a fair and orderly’ U.S. stock market for the ‘protection of investors.’”  He further claimed that Congress breached this obligation by failing to conduct proper oversight of the Securities and Exchange Commission necessary to ensure a fair and orderly stock market, resulting in the SEC’s failure to prevent Mr. Grady’s losses sustained as a result of the May 6, 2010 Flash Crash.

 

Specifically, Grady accused Congress of failing to ensure that the SEC dealt with issues relating to the removal of the “uptick” rule, naked short selling, high frequency traders, and elimination of “specialists.” As a result of the Flash Crash, investors like Mr. Grady are estimated collectively to have lost more than $200 million as a result of the unintended consequences from using “stop-loss orders.” During the Flash Crash, these stop-loss orders intended to limit losses by selling stocks when they drop below certain prices instigated unwanted sales of stocks at prices far below their true market value, resulting in losses.

 

In a four-page opinion by Judge Elaine P. Kaplan, the Court granted the government’s motion for summary judgement dismissing the suit mainly on jurisdictional grounds.  The Court explained that, even if what Mr. Grady alleges were true, his theory “collides with the well-established principle that the government’s ‘performance of its regulatory or sovereign fictions does not create contractual obligations.”  

In addition, the Court explains, Mr. Grady is not even able to establish the basic elements of a contract that is “implied in fact” (i.e., one that founded upon a meeting of the minds regarding specific terms of agreement).  

 

Judge Kaplan then goes on to fault Mr. Grady for taking his theory one step too far: “He then makes a rather substantial leap of logic, arguing that, by enacting legislation with this general goal [the regulation of fair and orderly securities markets], Congress evinced an intent that it would be contractually obligated to ensure that the legislation’s general goal was met through oversight.”

 

Because Mr. Grady was unable to make any credible claim that a contract, either actual or implied in fact, existed between the U.S. and investors like him, the Court of Claims simply does not have jurisdiction to hear the matter.  Judge Kaplan dismissed the claim without prejudice, however, leaving the possibility that Mr. Grady may try again perhaps on another theory.  With this latest dismissal, Grady’s has struck out three times. He previously sued the SEC alone in the U.S. Court of Claims and in Federal district court, and upon dismissal of those suits, appealed to the U.S. Supreme Court, which declined to hear the case.

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