Richard Hershey v. Pacific Investment Management ( 2009 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 08-1075
JOSEF A. K OHEN , et al., on their own behalf
and that of all others similarly situated,
Plaintiffs-Appellees,
v.
P ACIFIC INVESTMENT M ANAGEMENT C OMPANY LLC
and PIMCO F UNDS,
Defendants-Appellants.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 05 C 4681—Ronald A. Guzmán, Judge.
A RGUED A PRIL 1, 2009—D ECIDED JULY 7, 2009
Before P OSNER, E VANS, and T INDER, Circuit Judges.
P OSNER, Circuit Judge. The defendants in this class
action suit have appealed from the district court’s certi-
fication of a plaintiff class. Fed. R. Civ. P. 23(f). The
suit, based on section 22(a) of the Commodity Exchange
Act, 7 U.S.C. § 25(a), accuses the defendants, collectively
“PIMCO,” of having violated section 9(a) of the Act, 7
U.S.C. § 13(a), by cornering a futures market. A corner is
2 No. 08-1075
a form of monopolization. See United States v. Patten,
226 U.S. 525, 539-42 (1913); Great Western Food Distributors,
Inc. v. Brannan, 201 F.2d 476, 478-79 (7th Cir. 1953); Peto
v. Howell, 101 F.2d 353, 358-59 (7th Cir. 1939); Robert W.
Kolb & James A. Overdahl, Understanding Futures Markets
80 (6th ed. 2006) (“a successful effort by a trader or
group of traders to influence the price of a futures con-
tract by intentionally acquiring market power in the
deliverable supply of the underlying good while simulta-
neously acquiring a large long futures position”).
The class consists of persons who between May 9 and
June 30, 2005, bought a futures contract on the Chicago
Board of Trade in 10-year U.S. Treasury notes. Earlier
they had sold such notes short, and the purchases they
made between May 9 and June 30 were pursuant to
contracts they had with other investors, including PIMCO,
to deliver to a commodity clearinghouse, for those inves-
tors’ accounts, on June 30, a specified quantity of the
notes at the price specified in the futures contracts. With
rare exceptions, however, futures speculations are com-
pleted not by delivery of the underlying commodity (such
as milk, or pork bellies, or in this case Treasury notes) to
the clearinghouse, though that is an option, but by the
making of offsetting futures contracts, as described in Kolb
& Overdahl, supra, at 17; Mark J. Powers & Mark G.
Castelino, Inside the Financial Futures Markets 20 (3d ed.
1991); Jeffrey Williams, The Economic Function of Futures
Markets 9-10 (1989); James M. Falvey & Andrew N. Kleit,
“Commodity Exchanges and Antitrust,” 4 Berkeley Bus. L.
J. 123, 127-28 (2007); see also C.B. Reehl, The Mathematics
of Options Trading 15 (2005). The following table
illustrates the process.
No. 08-1075 3
Futures Contracting
D ay Price Trade SS’s position B’s position
1 $1,000 SS sells SS deposits B deposits $100
contract $100 (10% of in his account;
(to de- the value of the acquires the right
liver pork contract) in his to require deliv-
bellies) to account with ery of pork bel-
B. clearinghouse lies from clear-
(required mar- inghouse.
gin); acquires
the obligation
to deliver pork
bellies to clear-
inghouse.
2 $1,500 None SS’s account B’s account in-
falls to –$400, creases to $600; B
so SS must de- still has the right
posit $500 in his to require deliv-
account to ery of pork bel-
maintain his lies from the
10% margin; SS clearinghouse.
is still obligated
to deliver pork
bellies to the
clearinghouse.
3 $1,500 SS caps SS’s trade ex- B’s trade extin-
his losses tinguishes his guishes his origi-
and buys original con- nal contract: his
contract tract: his obliga- right to require
(to de- tion to deliver delivery from the
liver pork to the clearing- clearinghouse is
bellies) house is offset offset by his obli-
from B. by his right to gation to deliver
require delivery to the clearing-
from the clear- house.
inghouse.
4 No. 08-1075
In the example in the table, a short seller, SS, sells a
specified quantity of pork bellies to B (buyer) at a price of
$1,000 for delivery in June (hence a “June Contract”).
SS hopes the price will fall by then. But before the delivery
date arrives the price rises to $1,500, and SS decides to
cap his losses. The simplest way to do this, as in the
table, is for SS to buy from B the same quantity of pork
bellies as SS had sold to B, paying $1,500. SS now has
offsetting contracts to sell and to buy the same number
of pork bellies, and B now has offsetting contracts to buy
and sell the same number of pork bellies, so neither has
a delivery obligation. Neither wants to have such an
obligation, because both are speculators rather than
farmers or meat packers. (Notice in the table that losses
and gains are debited and credited to the traders’ accounts
with the clearinghouse every day, to minimize the risk
of loss to the clearinghouse, which guarantees the ful-
fillment of the futures contract. But this detail plays no
role in this case.)
Changes in the demand for or the supply of the underly-
ing commodity will make the price of a futures contract
change over the period in which the contract is in force.
If the price rises, the “long” (the buyer) benefits, as in our
example, and if it falls the “short” (the seller) benefits.
But a buyer may be able to force up the price by “corner-
ing” the market—in this case by buying so many June
contracts for 10-year Treasury notes that sellers can fulfill
their contractual obligations only by dealing with that
buyer. United States v. Patten, supra, 226 U.S. at 539-41;
Zimmerman v. Chicago Board of Trade, 360 F.3d 612, 616
(7th Cir. 2004); Board of Trade v. SEC, 187 F.3d 713, 724
(7th Cir. 1999) (“a person who owns a substantial portion
No. 08-1075 5
of the long interest near the contract’s expiration date
also obtains control over the supply that the shorts need
to meet their obligations. Then the long demands
delivery, and the price of the commodity skyrockets. It
takes time and money to bring additional supplies to
the delivery point, and the long can exploit these costs to
force the shorts to pay through the nose”); Roberta
Romano, “A Thumbnail Sketch of Derivative Securities
and Their Regulation,” 55 Md. L. Rev. 1, 29-30
(1996); “United States Commodity Futures Trading Com-
mission Glossary,” www.cftc.gov/educationcenter/
glossary/glossary_co.html (visited June 10, 2009).
Board of Trade v. SEC, supra, 187 F.3d at 725, remarks that
since the possibility of manipulation “comes from the
potential imbalance between the deliverable supply and
investors’ contract rights near the expiration date[,] . . .
[f]inancial futures contracts, which are settled in cash,
have no ‘deliverable supply’; there can never be a mis-
match between demand and supply near the expiration,
or at any other time.” But while it is correct that most
financial futures contracts are settled in cash, CFTC v.
Zelener, 373 F.3d 861, 865 (7th Cir. 2004); Kolb, supra, at
16, and that if a cash option exists there is no market to
corner (no one can corner the U.S. money supply!), futures
contracts traded on the Chicago Board of Trade for ten-
year U.S. Treasury notes are an exception; they are not
“cash settled.” Short sellers who make delivery must do
so with approved U.S. Treasury notes; otherwise they
must execute offsetting futures contracts. Chicago Board
of Trade Rulebook, “Chapter 19: Long-Term U.S. Treasury
Note Futures (6 ½ to 10-Year),” www.cmegroup.com/
rulebook/CBOT/V/19/19.pdf (visited June 22, 2009); CME
6 No. 08-1075
Group, “U.S. Treasury Futures Delivery Process,” (4th ed.
2008), www.cmegroup.com/trading/interest-rates/files/
CL-100_TFDPBrochureFINAL.pdf (visited June 22, 2009).
The note approved for delivery in this case was the
“2/12 Treasury Note” (a Treasury note that expires in
February 2012). The plaintiffs claim that PIMCO increased
the percentage of these notes that it owned from 12 to
42 percent over a two-week span, with the result that they
would have had to pay a monopoly price to get enough
notes to close out their contracts. So instead they made
offsetting futures contracts, and they claim that as a result
they lost more than $600 million, the amount they would
have saved had they been able to buy offsetting contracts
at a competitive price. (These are just allegations; we do
not vouch for their correctness.)
The class certified by the district court consists, as we
said, of all persons who between May 9 and June 30, 2005,
bought a June Contract in order to close out a short posi-
tion. PIMCO challenges the definition on the ground
that it includes persons who lack “standing” to sue
because they did not lose money in their speculation on
the June Contract. For example, some of the class
members might have taken both short and long positions
(in order to hedge—that is, to limit their potential losses)
and made more money in the long positions by virtue
of PIMCO’s alleged cornering of the market than they
lost in their short positions. The plaintiffs acknowledge
this possibility but argue that its significance is best
determined at the damages stage of the litigation. If
PIMCO is found to have cornered the market in the
June Contract, then each member of the class will have
to submit a claim for the damages it sustained as a result
No. 08-1075 7
of the corner. Carnegie v. Household Int’l, 376 F.3d 656, 661
(7th Cir. 2004); 7AA Charles Alan Wright, Arthur R. Miller
& Mary Kay Kane, Federal Practice & Procedure § 1784
(2009). Some of the class members, discovering that they
were not injured at all, will not submit a claim, and others
will submit a claim that will be rejected because the
claimant cannot prove damages, having obtained off-
setting profits from going long.
PIMCO argues that before certifying a class the district
judge was required to determine which class members
had suffered damages. But putting the cart before the
horse in that way would vitiate the economies of class
action procedure; in effect the trial would precede the
certification. It is true that injury is a prerequisite to
standing. But as long as one member of a certified class
has a plausible claim to have suffered damages, the
requirement of standing is satisfied. United States Parole
Commission v. Geraghty, 445 U.S. 388, 404 (1980); Wiesmueller
v. Kosobucki, 513 F.3d 784, 785-86 (7th Cir. 2008). This is true
even if the named plaintiff (the class representative) lacks
standing, provided that he can be replaced by a
class member who has standing. “The named plaintiff
who no longer has a stake may not be a suitable class
representative, but that is not a matter of jurisdiction and
would not disqualify him from continuing as class repre-
sentative until a more suitable member of the class was
found to replace him.” Id. at 786.
Before a class is certified, it is true, the named plaintiff
must have standing, because at that stage no one else
has a legally protected interest in maintaining the suit. Id.;
8 No. 08-1075
Sosna v. Iowa, 419 U.S. 393, 402 (1975); Walters v. Edgar, 163
F.3d 430, 432-33 (7th Cir. 1998); Murray v. Auslander, 244
F.3d 807, 810 (11th Cir. 2001). And while ordinarily an
unchallenged allegation of standing suffices, a colorable
challenge requires the plaintiff to meet it rather than
stand mute. Lujan v. Defenders of Wildlife, 504 U.S. 555, 561
(1992). PIMCO tried to show in the district court that
two of the named plaintiffs could not have been injured by
the alleged corner. We need not decide whether it suc-
ceeded in doing so, because even if it did, that left one
named plaintiff with standing, and one is all that is neces-
sary.
If the case goes to trial, this plaintiff may fail to prove
injury. But when a plaintiff loses a case because he
cannot prove injury the suit is not dismissed for lack of
jurisdiction. Jurisdiction established at the pleading stage
by a claim of injury that is not successfully challenged
at that stage is not lost when at trial the plaintiff fails to
substantiate the allegation of injury; instead the suit is
dismissed on the merits. American Civil Liberties Union v.
St. Charles, 794 F.2d 265, 269 (7th Cir. 1986). Pressed at
argument, PIMCO’s counsel retreated, conceded or at
least seemed to concede that the issue was not jurisdic-
tional, and clarified that his argument was only that the
class members lacked “statutory standing.” Then he
took back his concession, arguing that if any class member
were found not to have sustained damages, the court
would have no jurisdiction over that class member, who
would therefore not be bound by any judgment or settle-
ment and so could bring his own suit for damages.
That is to say that if a plaintiff loses his case, this shows
that he had no standing to sue and therefore can start
No. 08-1075 9
over. That would be an absurd result, and PIMCO need
not fear it. Id.; Bruggeman v. Blagojevich, 324 F.3d 906, 909
(7th Cir. 2003).
The term “statutory standing” is found in many cases,
e.g., Ortiz v. Fibreboard Corp., 527 U.S. 815, 830 (1999); Steel
Co. v. Citizens for a Better Environment, 523 U.S. 83, 96-97
and n. 2 (1998); United States v. U.S. Currency, in Amount
of $103,387.27, 863 F.2d 555, 560-61 and n. 10 (7th Cir. 1988),
but it is a confusing usage. It usually refers to a situation in
which, although the plaintiff has been injured and would
benefit from a favorable judgment and so has standing in
the Article III sense, he is suing under a statute that was
not intended to give him a right to sue; he is not within the
class intended to be protected by it. Steel Co. v. Citizens for
a Better Environment, supra, 523 U.S. at 97; Warth v. Seldin,
422 U.S. 490, 500 (1975); Harzewski v. Guidant Corp., 489 F.3d
799, 803-04 (7th Cir. 2007). This is not such a case.
What is true is that a class will often include persons who
have not been injured by the defendant’s conduct; indeed
this is almost inevitable because at the outset of the case
many of the members of the class may be unknown, or if
they are known still the facts bearing on their claims may
be unknown. Such a possibility or indeed inevitability does
not preclude class certification, Carnegie v. Household Int’l,
supra, 376 F.3d at 661; 1 Alba Conte & Herbert Newberg,
Newberg on Class Actions § 2:4, pp. 73-75 (4th ed. 2002),
despite statements in some cases that it must be reasonably
clear at the outset that all class members were injured by
the defendant’s conduct. Adashunas v. Negley, 626 F.2d 600,
604 (7th Cir. 1980); Denney v. Deutsche Bank AG, 443 F.3d
253, 264 (2d Cir. 2006). Those cases focus on the class
10 No. 08-1075
definition; if the definition is so broad that it sweeps within
it persons who could not have been injured by the defen-
dant’s conduct, it is too broad.
A related point is that a class should not be certified if
it is apparent that it contains a great many persons who
have suffered no injury at the hands of the defendant,
see Oshana v. Coca-Cola Co., 472 F.3d 506, 514-15 (7th Cir.
2006); Romberio v. Unumprovident Corp., 2009 WL 87510, at
*8 (6th Cir. Jan. 12, 2009); cf. Brown v. American Honda, 522
F.3d 6, 28-29 (1st Cir. 2008), if only because of the in
terrorem character of a class action. In re Bridgestone/
Firestone Tires Products Liability Litigation, 288 F.3d 1012,
1015-16 (7th Cir. 2002); Parker v. Time Warner Entertainment
Co., L.P., 331 F.3d 13, 22 (2d Cir. 2003); EP Medsystems, Inc.
v. EchoCath, Inc., 235 F.3d 865, 881 (3d Cir. 2000). When
the potential liability created by a lawsuit is very great,
even though the probability that the plaintiff will succeed
in establishing liability is slight, the defendant will be
under pressure to settle rather than to bet the company,
even if the betting odds are good. Blair v. Equifax Check
Services, 181 F.3d 832, 834 (7th Cir. 1999); In re Rhone-
Poulenc Rorer Inc., 51 F.3d 1293, 1297-1300 (7th Cir. 1995).
For by aggregating a large number of claims, a class action
can impose a huge contingent liability on a defendant.
PIMCO is a very large firm, however, with assets under
management of more than $750 billion, www.pimco.com/
LeftNav/PressCenter/PIMCOFacts.htm (visited June 10,
2009). This suit does not jeopardize its existence. But it
has good reason not to want to be hit with a multi-
hundred-million-dollar claim that will embroil it in
protracted and costly litigation—the class has more than
a thousand members, and determining the value of
No. 08-1075 11
their claims, were liability established, might thus
require more than a thousand separate hearings.
So if the class definition clearly were overbroad, this
would be a compelling reason to require that it be nar-
rowed. Adashunas v. Negley, supra, 626 F.2d at 603-04;
Robidoux v. Celani, 987 F.2d 931, 937 (2d Cir. 1993); Eastland
v. Tennessee Valley Authority, 704 F.2d 613, 617-18 (11th
Cir. 1983); 7AA Charles Alan Wright et al., supra, § 1760,
pp. 139-49; cf. Crawford v. Equifax Payment Services, 201
F.3d 877, 882 (7th Cir. 2000). But this has not yet been
shown. Although some of the class members probably
were net gainers from the alleged manipulation, there is
no reason at this stage to believe that many were. A
short seller hopes the price of the security that he’s
selling will fall. He knows it may rise and his speculative
gamble therefore fail, but if the rise is caused or increased
by a violation of law the incremental loss caused by
the violation entitles him to an award of damages. And
while it is true that short sellers may want to hedge part
of the risk of a rise in the price of the security that they
are selling short, they will not hedge the entire risk, as
that would eliminate the prospect of speculative gains
that motivates short selling. Suppose a short seller sells
a security at $80, hoping the price will fall below that by
the delivery date; but fearing that it might rise far enough
to bankrupt him, he hedges by contracting to buy the
security at $100 should it rise that high. That will cap
his potential loss at $20, but he will sustain a loss if the
defendant drives the price of the security to any level
above $80.
12 No. 08-1075
A further possibility, however, is that some of the
members of the class were actually speculating on a rise
in the price of the June Contract, and made some short
sales merely as a hedge, and because of PIMCO’s alleged
conduct obtained a net profit. We do not know how
many of these “long” speculators the class may contain,
but probably not many. Otherwise PIMCO would not
have made huge purchases of the June Contract in order
to drive up the price at which short sellers would have
to close out their sales. Put differently, were there not a
great many net short sellers of the June Contract, PIMCO
could not have driven its price to an artificially high
level because only short sellers would buy at such a
price, for they alone would have to close out their short
positions by buying the June Contract. (Not that the
plaintiffs have proved that PIMCO tried to corner the
market, or succeeded; but at this stage in the pro-
ceeding we must assume that they can prove it.)
So while PIMCO states correctly in its reply brief that “a
proper class definition cannot be so untethered from
the elements of the underlying cause of action that it
wildly overstates the number of parties that could
possibly demonstrate injury,” it has failed to justify the
use of the word “wildly” to describe the extent to which
the class definition may be too broad.
PIMCO’s repeated, indeed obsessive, citations to the
Supreme Court’s decision in Dura Pharmaceuticals, Inc. v.
Broudo, 544 U.S. 336 (2005), a case that does not involve
class certification, suggests desperation. The Court held
in that case that an allegation that the plaintiffs had
No. 08-1075 13
bought securities at “artificially inflated prices” did not
state a claim that the plaintiffs had been injured by the
inflation because, for all that appeared, the prices had
remained at that level, or even a higher one, or the plain-
tiffs had sold before the price bubble burst. The Court
refused to “allow recovery where a misrepresentation
leads to an inflated purchase price but nonetheless does
not proximately cause any economic loss.” Id. at 346.
In this case, too, the plaintiffs claim that the defendants
forced up the price, but there the resemblance between
the two cases ends. The plaintiffs sold short, so, prima
facie at least—being forced as they were to cover by
June 30—they were injured if the price of cover was
artificially inflated during the period between their
sale and the delivery date.
At argument PIMCO’s lawyer told us that he could
obtain names of class members. If so, he can, as in Bell v.
Farmers Ins. Exchange, 9 Cal. Rptr. 3d 544, 550-51, 568, 571
(Cal. App. 2004), and Long v. Trans World Airlines, Inc., 1988
WL 87051, at *1 (N.D. Ill. Aug. 18, 1988), depose a
random sample of class members to determine how
many were net gainers from the alleged manipulation
and therefore were not injured, and if it turns out to be
a high percentage he could urge the district court to
revisit its decision to certify the class. Cf. Hilao v. Estate of
Marcos, 103 F.3d 767, 782-84 (9th Cir. 1996); Long v. Trans
World Airlines, Inc., 761 F. Supp. 1320, 1325-30 (N.D. Ill.
1991); Marisol A. v. Giuliani, 1997 WL 630183, at *1
(S.D.N.Y. Oct. 10, 1997). PIMCO has not done this;
should it take the hint and try to do so now, this will be
an issue for consideration by the district judge.
14 No. 08-1075
PIMCO also argues that class certification should have
been denied because of potential conflicts of interest
among class members that will make it impossible for
class counsel to represent all of them all impartially. Fed.
R. Civ. P. 23(a)(4); Amchem Products, Inc. v. Windsor, 521
U.S. 591, 625-26 (1997); Secretary of Labor v. Fitzsimmons, 805
F.2d 682, 697 (7th Cir. 1986); Valley Drug Co. v. Geneva
Pharmaceuticals, Inc., 350 F.3d 1181, 1189 (11th Cir. 2003);
Pickett v. Iowa Beef Processors, 209 F.3d 1276, 1280-81 (11th
Cir. 2000). Class members covered by buying the June
Contract, thus capping their losses, at different times
during the seven-week period embraced by the complaint.
One who covered very early would want to show that the
effect of PIMCO’s alleged misconduct peaked then.
Moreover, the curve of rising prices for the June Contract
dipped at one point during the complaint period and
class members who covered during the dip might want
to show that PIMCO’s effect on the price level was com-
pleted by then and the post-dip rise in prices was due
to market forces for which PIMCO was not responsible.
Suppose the price had risen from $100 at the beginning
of the complaint period to $130 at the bottom of the
dip, and from $130 to $150 between then and the
delivery date. Short sellers who covered during the dip
would want to show that it was PIMCO who pushed the
price up from $100 to $130, and that insofar as market
forces were shown to be responsible for part of the
price rise they operated after the dip rather than before.
Short sellers who covered at the end of the period would
want to show that the entire price increase, from $100
to $150, was due to PIMCO’s illegal activity.
No. 08-1075 15
At this stage in the litigation, the existence of such
conflicts is hypothetical. If and when they become real,
the district court can certify subclasses with separate
representation of each, Fed. R. Civ. P. 23(c)(5); Reynolds
v. Benefit Nat’l Bank, 288 F.3d 277, 282 (7th Cir. 2002);
Blackie v. Barrack, 524 F.2d 891, 909 (9th Cir. 1975); 7AA
Charles Alan Wright et al., supra, § 1769.1, pp. 455-58, if
that would be consistent with manageability. In re Cendant
Corp. Securities Litigation, 404 F.3d 173, 201 (3d Cir. 2005);
John C. Coffee Jr., “Class Action Accountability: Reconcil-
ing Exit, Voice, and Loyalty in Representative Litigation,”
100 Colum. L. Rev. 370, 398 (2000). To deny class certifica-
tion now, because of a potential conflict of interest that
may not become actual, would be premature. Int’l Wood-
workers of America, etc. v. Chesapeake Bay Plywood Corp., 659
F.2d 1259, 1269 (4th Cir. 1981); 1 Conte & Newberg,
supra, § 3.25, p. 422; cf. Smilow v. Southwestern Bell Mobile
Systems, Inc., 323 F.3d 32, 40 (1st Cir. 2003).
PIMCO’s attempt to derail this suit at the outset is ill
timed, ill conceived, and must fail. The district court’s
class certification is
A FFIRMED.
7-7-09