The Second Circuit Prevents UBS from Arbitrating $350 Million Claim Against Nasdaq in Facebook IPO

In Nasdaq OMX Group, Inc. v. UBS Securities, LLC, 770 F.3d 1010 (2d. Cir. 2014), the Second Circuit Court of Appeals held defendants could not require Nasdaq OMX Group Inc. and the Nasdaq Stock Market LLC (collectively “Nasdaq”) to arbitrate claims concerning Nasdaq’s alleged mismanagement of the highly anticipated initial public offering (“IPO”) of Facebook, Inc. (“Facebook”).

According to the allegations, Nasdaq, on May 18, 2012, scheduled secondary trading for the Facebook IPO to begin at 11:00 a.m. Eastern Standard time. Technical difficulties with “Cross,” the computerized system that typically launches IPO trading by matching buy and sell orders to determine the opening price, caused a delay in the commencement of trading. As a result, over 30,000 orders entered between 11:11:00 a.m. and 11:30:09 a.m. were not included in the completed IPO Cross. Nasdaq canceled some of these orders and released the others into the market at 1:50 p.m. In addition, Cross failed to transmit certain trade confirmations for orders placed before 11:30:09 a.m. Consequently, Nasdaq members could not determine if their orders processed and what position they held in Facebook securities.

The Securities and Exchange Commission (“SEC”) initiated an investigation and ultimately brought disciplinary charges against Nasdaq. Nasdaq settled the case with the SEC and paid a civil penalty of $10 million. The SEC press release for this case can be found here.

In the aftermath of the Facebook IPO, Nasdaq amended its rules to permit the establishment of a voluntary procedure to compensate Nasdaq members injured in connection with the Facebook IPO. Defendant, UBS Securities, LLC (“UBS”), did not pursue that opportunity for relief and instead initiated an arbitration proceeding against Nasdaq under a separate services agreement for breach of contract, indemnification, breach of implied duties of good faith and fair dealing, and gross negligence and sought over $350 million in damages.

Nasdaq commenced a declaratory judgment action to prevent UBS from pursuing arbitration. On June 28, 2013, the United States District Court for the Southern District of New York ruled in Nasdaq’s favor, and UBS appealed to the Second Circuit. 

UBS contended the district court erred in exercising federal question jurisdiction in a case presenting only state law claims. UBS also contended the district court improperly concluded the court, rather than an arbitrator, should decide whether UBS’s claims were subject to arbitration. Lastly, UBS challenged the district court’s decision that its claims against Nasdaq were not arbitrable.

With respect to federal question jurisdiction, the Second Circuit observed that a court may properly exercise jurisdiction over a “special and small” category of actual state claims that present significant, disputed issues of federal law. Although UBS’s arbitration demand asserted only New York state law claims, the claims necessarily raised actually disputed issues of federal securities law. In addition, the issues presented were of substantial importance to the federal system, as a whole, and, as a result, the exercise of federal jurisdiction in these circumstances would not disrupt any federal-state balance approved by Congress.

In considering the role of the courts in resolving the issue of arbitrability, the Second Circuit relied on the premise that the law generally treated the issue as one for judicial determination “unless the parties clearly and unmistakably provide[d] otherwise.” Nasdaq and UBS were parties to a bilateral service agreement that was silent as to who should decide arbitrability. Accordingly, the Second Circuit held the district court correctly determined that it should resolve the arbitrability of UBS’s claims, rather than commit that question to an arbitrator.

The Second Circuit also affirmed the trial court’s decision that the relevant issues were not subject to arbitration. Both UBS and Nasdaq agreed their agreement to arbitrate was valid; therefore, the only issue on appeal was whether the agreement covered UBS’s claims. The Second Circuit looked to the language of the contract to define the disputes subject to arbitration. The service agreement stated the parties intended to submit all disputes to arbitration “except as provided in the Nasdaq OMX Requirements.” The “Nasdaq OMX Requirements” incorporated Nasdaq rules and rule interpretations. Because Nasdaq Rule 4626(a) forbid claims on losses experienced during trading on the exchange, the Second Circuit held that the parties could not have intended to arbitrate claims precluded by the provision.   

In conclusion, the Second Circuit Court of Appeals upheld the district court’s decision to enjoin UBS from pursuing arbitration against Nasdaq and remanded the case to the district court for further proceedings.

The primary materials for this case may be found on the DU Corporate Governance website. 

Robin Alexander