Kohen et al v. Pacific Investment Mgmt Company LLC et al

RESPONSE to 11 Motions to Quash

D.D.C.December 13, 2006

IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA IN RE SUBPOENA ISSUED TO THE COMMODITY FUTURES TRAING COMMISSION Misc. No. 06-00489 Judge Colleen Kollar- Kotelly Kohen, et al., Plaintiffs, v. Pacific Investment Management Company, LLC, PIMCO Funds, and John Does 1-100, No. 05 C 4681 (N.D. ILL.) Judge Ronald A. Guzman Magistrate Michael T. Mason Defendants. COMMODITY FUTURES TRADING COMMISSION'S POSITION STATEMENT In September 2006, plaintiffs in Kohen, et al. v. Pacific Investment Management Company, LLC, etal., No. 05-C-4681 (N.D. IlL.) served a document subpoena on the Commission. The Kohen class action complaint alleges that Pacific Investment Management Company ("PIMCO") and a related entity manipulated the price of the June 2005 lO-year Treasury Note futures contract traded on the Chicago Board of Trade ("CBOT"), as well as the price of the cheapest-to-deliver Treasury Note (i.e., the February 2012 Note) underlying the June 2005 contract. . The Commission has considered plaintiffs' subpoena as subsequently modified (described in Section II) under its Touhy regulations, 17 C.F.R. Part 144, and details its objections and proposed additional modifications below. See generally United States ex reI. Touhy v. Ragen, 340 U.S. 462 (1951). Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 1 of 15 I. BACKGROUND A. The Commission The CFTC is an independent agency created by Congress in 1974. The Commission's mandate is to regulate commodity futures and option markets in the United States. See generally 7 U.S.C. § 2(a)(2). The mission of the CFTC is to protect market users and the public from fraud, manipulation, and abusive practices related to the sale of commodity and financial futures and options, and to foster open, competitive, and financially sound futures and option markets. See 7 U.S.C. § 5(b). The records subject to the Kohen subpoena are collected by the Commission's Division of Market Oversight ("DMO").l In general, DMO has regulatory responsibility for oversight of registered futures exchanges and derivatives transaction execution facilities. DMO also is responsible for market surveilance. This function is accomplished by, inter alia, collecting and reviewing market position and transaction data, and surveying market participants.2 B. The Ten Year Treasury Note Futures Contracts 1. General description of the contract The CBOT lists a future contract on the Ten Year United States Treasury Note for the months of March, June, September, and December. The contract 1 For a detailed discussion on the Commission's operations, see http://www.cftc.gov/cftclcftcabout.htm ?from =home&page=aboutcftcleft . 2 For a detailed discussion on the Commission's surveillance program, see http://www.cftc.gov/opa/backgrounder/opasurveil.htm . 2 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 2 of 15 expires on the seventh business day preceding the last business day of the delivery month. This is also the last trading day. The last delivery day is the last business day of the delivery month. The delivery month for the June 2005 contract was June 1,2005 to June 30,2005. A Treasury Note has a face amount of $100,000 or multiple thereof. 2. The June 2005 contract In early August 2005, major newspapers reported that the U.S. Treasury Department was looking into a short squeeze in the now-expired Ten Year June 2005 Treasury Note futures contract. See Deborah Lagomarsino, Treasurv Department Examines Short SQueeze in Futures Contract, Wall Street Journal, August 9,2005, C3.4 The newspapers reported that problems in the market began in late May 2005 when "traders who had sold the 10-year note short suddenly found that they could no longer go into the open market and borrow the securities for delivery to their purchasers. If sellers of a security cannot deliver it to the buyers, the traders cannot settle. ...this is called a 'faiL'" See Gretchen Morgenson, Was Someone SQueezing Treasuries?, New York Times, August 7, 2005, Section 3,2005 WLNR 12419969. According to the New York Times, PIMCO was the largest holder 3 For additional details about the terms and conditions of this contract, see http://www.cbot.com/cbot/pub/cont_detail/l. 3206,1520+ 14433, OO.html . 4 A squeeze causes short-sellers to pay inflated prices to cover open positions because a significant portion of the deliverable supply is under the control of another trader. See CFTC Glossary: A Layman's Guide (1991). 3 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 3 of 15 of the Ten-Year Treasury security, and would benefit the most from a short squeeze. Id. c. The Kohen complaint On August 16, 2005, a single trader filed a class action alleging that PIMCO manipulated the price of the June 2005 Ten Year Treasury Note futures contract, and the underlying cheapest-to-deliver Treasury Note in violation of Sections 9(a) and 22(a) of the Commodity Exchange Act ("CEA"), 7 U.S.C. §§ 13(a), 25(a). The First Amended Complaint filed in May 2006 further asserted that PIMCO had created a "short squeeze," and caused an inordinate number of "fails" in the repurchase agreement market. See Kohen, et al. v. Pacific Investment Management Company, LLC, et al., Civ. No. 05-4681 (N.D. ILL.) (Docket No. 80) at ~~ 5-13, 102, attached hereto as Exhibit A. Plaintiffs are seeking actual damages. Id. at p. 21- 22. II. PLAINTIFFS' MODIFIED SUBPOENA REQUESTS The Kohen plaintiffs have agreed to several modifications to the subpoena, which as of the date of this filing would limit production by the Commission to the following: 1. large trader reports, without any form of masking of traders' identities, for the June 2005 Ten Year Treasury Note futures contract that were filed with the Commission between the period March 1, 2005 and June 30, 2005, produced pursuant to a protective order that limits disclosure to attorneys and experts only; 2. daily transactional logs for trading for the June 2005 Ten Year Treasury Note futures contract between the period March 1, 2005 to June 30, 2005, coded and masked, so that the identities of market participants, other than PIMCO, are coded, and produced 4 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 4 of 15 pursuant to a protective order that limits disclosure to attorneys and experts only; and 3. surveilance communications regarding the June 2005 Ten Year Treasury Note futures contract between Commission employees and PIMCO representatives during the period March 1, 2005 to June 30, 2005. III. THE COMMISSION'S POSITION A. Trading Data Generally As reflected in Section 8(a)(I) of the CEA, 7 U.S.C. § 12(a)(I), the trading data the Commission collects as part of its regulatory and enforcement functions is highly sensitive. The relevant portion of 7 U.S.C. § 12(a)(I) reads: The Commission may publish from time to time the results of any such investigation and such general statistical information gathered therefrom as it deems of interest to the public: Provided, That except as otherwise specifically authorized in this Act (7 USC §§ 1 et seq.), the Commission may not publish data and information that would separately disclose the business transactions or market positions of any person and trade secrets or names of customers: Provided further, That the Commission may withhold from public disclosure any data or information concerning or obtained in connection with any pending investigation of any person. The Court of Appeals for this Circuit explained in 1968 that the provisions of Section 8(a) are designed to provide a needed element of secrecy to traders, both hedgers and speculators. See Freeman v. Seligson, 405 F.2d 1326, 1350 (D.C. Cir. 1968). In Friedman v. Bache Halsey Shields, Inc., 738 F.2d 1336, 1343 (D.C. Cir. 1984), the court of appeals reiterated that CEA Section 8(a) permits the Commission to withhold data and information from public disclosure. The Commission recognizes, however, that the publication bar in Section 8(a) does not apply to "discovery requested pursuant to rules 26 and 45" of the Federal Rules of 5 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 5 of 15 Civil Procedure. Id. Rather, as the Friedman court explained, the disclosure of information in a court proceeding is based on "the relative weight of the claimant's need and the government's interest in confidentiality." See Friedman, 738 F.2d at 1344. 1. Large trader reports a. Generally At the heart of the Commission's surveilance system is a large-trader reporting system. See 17 C.F.R. Parts 15-19, 21. Under this system, clearing members, futures commission merchants, and foreign brokers (collectively called "reporting firms") electronically fie daily reports with the Commission. See 17 C.F.R. Part 17.5 These reports contain the futures and option positions of traders that hold positions above specific reporting levels set by CFTC regulations. See 17 ' C.F.R. Part 15. The reportable limit for the Ten Year Treasury Note is 2000 contracts. The aggregate of all large-traders' positions reported to the Commission usually represents 70 to 90 percent of the total open interest in any given market.6 b. The Commssion's position on the production of large trader reports for the June 2005 Ten Year Treasury Note futures contract As described above, plaintiffs in the Kohen case have agreed to modify the request for large trader reports to limit it to the June 2005 futures contract for the 5 While the large trader information is now collected by the Commission via an electronic data feed, the type of information collected is specified in CFTC Form '01. A copy is attached hereto as Exhibit B. 6 See http://www.cftc.gov/opa/backgrounder/opa-ltrs.htm . 6 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 6 of 15 period March 1, 2005 to June 30, 2005, and to limit access, pursuant to protective order, to attorneys and experts eyes only.7 To the extent that the Kohen plaintiffs seek trader identities as part of a production of large trader reports, the Commission objects. Accordingly, the Commission is amenable to the production of large trader reports with two further modifications: . First, the Commission is prepared to produce the requested reports with the traders' identities concealed by coding; and . Second, the Commission is prepared to allow plaintiffs to return to the Commission to request the identity of a trader or traders, if an identity is needed. Following a specific identity request, the Commission would notify the trader of the request before deciding whether to produce the trader's identity or object to the disclosure of the identity. These additional proposed limitations on the production of the large trader reports are based, in part, on the generality of the reasons plaintiffs have advanced for their claim of need for trader identities. See Plaintiffs' Opposition to Citadel Investment Group, L.L.C.'s Motion to Quash (Docket No.3) at p. 7. Plaintiffs' principal justification for that claim appears to be that the information is needed to assist in "identification of class members and the required sending of class notice to class members." Id. This explanation is unpersuasive, in part, because the period that defines the class composition is inconsistent with the 7 Subpoena Request No.1, as originally served, sought large trader reports for all market participants in the March, June, September, and December 2005 Ten Year Treasury Notes futures contracts for the period January 2005 to September 2005. Subpoena Requests Nos. 2, 6, 10, 12, 13, and 22 sought information captured in the large trader reports. A copy of the Kohen subpoena is attached to Citadel Investment Group, L.L.C.'s Motion to Quash (Docket No.1). 7 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 7 of 15 period for which plaintiffs seek large trader reports. Plaintiffs define the class as comprised of traders who were in the June 2005 futures contract market between May 9,2005 and June 30, 2005. See Exhibit A at ~ 94. In contrast, the large trader reports sought by plaintiffs from the Commission cover a greater period of almost 120 days (i.e., March 1 to June 30, 2005), and would mean that plaintiffs would receive the trader identities of every large trader for that four-month period. Given that these periods do not match, it is difficult to accept plaintiffs' explanation that large trader reports should be unmasked and uncoded. Moreover, the actual identities, as opposed to coded identities as the Commission here urges, are not plainly necessary for either the damages modeling or the determination of the extent of market concentration, which are also grounds advanced by the plaintiffs.8 The Commission believes that the further modifications it recommends here address plaintiffs' actual need for large trader reports and reduce the likelihood of harm that might occur with the disclosure of trader identities and position information. The two-step process the Commission recommends would give traders the opportunity to object to identification if plaintiffs seek any trader's identity in a more focused context. Finally, market participants, specifically Citadel, argue that trading strategies and identities could be deduced and thus harm them even from coded 8 To the extent plaintiffs determine that identities of particular traders are later needed, the Commission's proposal provides a mechanism for plaintiffs to obtain them. 8 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 8 of 15 data. See Citadel Investment Group, L.L.C. Reply to Plaintiffs' Opposition to Citadel Investment Group, L.L.C.'s Motion to Quash (Docket No.6) at 4-5. Market participants also argue that the proposed more restrictive protective order provisions are not foolproof. See Citadel Investment Group, L.L.C.'s Reply to Plaintiffs' Opposition to Citadel Investment Group, L.L.C.'s Motion to Quash (Docket No.6) at 7-8; Reply in Support of Ronin Capital, L.L.C.'s Motion to Quash (Docket No.9) at ~ 2. While the Commission agrees with these arguments in the abstract, the specifc showing needed to sustain them is better obtained from the interveners. See Freeman, 405 F.2d at 1351-52 (explaining that traders should intervene to assert their positions "(i)nsofar as the interest protected by (CEA Section 8) is business privacy (rather than the need to assure effective function and regulation of markets)").9 2. Daily transaction logs a. Generally The Commission receives on a regular basis the daily transaction Ìnformation from the futures exchanges. In general, it consists of a record of every trade made in a particular futures contract. The data includes the account numbers of all 9 The Commission notes that the concern about trader identities as well as the production of large trade reports may be mooted by the recent magistrate decision in the Kohen case in Chicago. On December 8, the magistrate judge granted plaintiffs' motion to compel and ordered the CBOT to produce, before December 29, 2006, large trader reports related to the June 2005 U.S. Ten Year Treasury Note futures contract for the period between April 30 through July 10, 2005. See Order, Kohen, et al. v. Pacificlnvestment Management Company, LLC, et al., No. 05-C- 4681 (ND IlL.) (Docket No. 203). A copy is attached as Exhibit C. The CBOT collects comparable large trader data pursuant to CBOT Rule 425.01(b). 9 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 9 of 15 market participants, the prices at which the transaction is made, and the number of contracts involved. Accordingly, there are millions of transactions reflected in the daily transaction logs for the June 2005 Ten Year Treasury Note futures contract during the period set by the Kohen subpoena. 10 b. Positions of interveners In its motion to quash, the CBOT objects to the production of daily transaction logs. The CBOT has explained that plaintiffs' request seeks a substantial amount of transactional information involving open auction trades and electronic trades. See Chicago Board of Trade's Motion to Quash (Docket No. 11) at p. 4. The CBOT argues that the Kohen subpoena should be quashed because: (a) the request is overbroad and burdensome; (b) the daily transaction logs contain confidential commercial information pertaining to customers and the CBOT; (c) the plaintiffs have failed to make a showing of substantial need pursuant to Rule 45(c)(3)(B) of the Federal Rules of Civil Procedure; (d) the logs contain information irrelevant to plaintiffs' manipulation case; and (e) the plaintiffs could go directly to the traders or their clearing firms for the data. See Chicago Board of Trade's Motion to Quash at 4-5 (Docket No. 11).11 10 Subpoena Request No.9 seeks the daily transaction logs for the Ten Year Treasury Notes futures contracts for the relevant period. Subpoena Requests Nos. 5, 6-8, 12, and 13 seek information captured in the daily transaction logs. 11 The daily transaction logs were not subject to the order or plaintiffs' motion to compel against CBOT in the Kohen case mentioned in footnote 9, above. 10 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 10 of 15 Citadel, Ronin and Lehman Brothers have argued that the production of the daily transaction data would disclose proprietary trading practices and trading strategies of market participants. See Citadel Reply at p. 5; Ronin Motion at ~ 8; Lehman Brothers Objection at ~~ 2, 4. They also contend that the disclosure of daily transaction logs would create economic harm. Id. c. The Commssion's position on the production of daily transaction logs The Commission agrees with the CBOT that even plaintiffs' modified request seeks an enormous amount of daily transaction data for the June 2005 Ten Year Treasury Note futures contract. And the Commission agrees that the relevance of this enormous collection of data is not obvious, while the congressional determination that the data is presumptively sensitive is manifest. See 7 U.S.C. § 12(a)(I). Accordingly, subject to the interveners' arguments for greater protection, the Commission believes that production of the daily transaction logs should only be done with the identities of traders concealed and coded, and under the more restrictive protective order proposed by plaintiffs. Moreover, plaintiffs should b~ required to specify and justify a narrower time period within the March 1 to June 30, 2005, time period.12 B. Surveillance Communications between the Commssion and PIMCO 12 The Court should be aware that the Commission and plaintiffs are discussing narrowing the scope of the requested daily transaction logs to specific trading days. 11 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 11 of 15 As originally served, the Kohen subpoena sought documents constituting (a) communications between Commission employees; (b) communications between Commission employees and other federal regulators; (c) communications between Commission employees and the CBOT employees; and (d) communications between Commission employees and market participants.13 As described in Section II, the Kohen plaintiffs have agreed to limit their request for communications to communications between Commission employees and PIMCO. The Commission does not object to the production of documents constituting surveillance communications between Commission employees and PIMCO employees. Accordingly, the Commission is prepared to produce e-mail conversations, with and without attachments, that are responsive to plaintiffs' request. 13 See Kohen subpoena Request Nos. 4-7, 10-13, 16-22, and 26. 12 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 12 of 15 CONCLUSION The Commission respectfully requests that this Court issue an order that considers the Commissions' objections and establishes the recommended limitations on the production of the subpoenaed documents. Respectfully submitted, Glynn L. Mays, D.C. Bar # 184531 Senior Assistant General Counsel Isl Gloria P. Clement Gloria P. Clement, D.C. Bar # 446163 Assistant General Counsel COMMODITY FUTURES TRADING COMMISSION Office of the General Counsel 1155 21st Street, N.W. Three Lafayette Centre Washington, D.C. 20581 Telephone: (202) 418-5122 Facsimile: (202) 418-5424 E-mail: gmays((cftc.gov; gclement((cftc.gov Dated: December 13, 2006 13 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 13 of 15 CERTIFICATE OF SERVICE I, Gloria P. Clement, hereby certify that on December 13, 2006, I served a copy of the Commodity Futures Trading Commission's Position Statement and accompanying exhibits by ECF, e-mail, or facsimile on the following persons: Wiliam J. Nissen Eric J. Grush Jennifer Tan SIDLEY AUSTIN One Dearborn Street Chicago, Illinois 60603 Telephone: (312) 853-7000 Facsimile: (312) 853-7036 E-mail: wnissen((sidley.com; egrush((sidley.com; jtan((sidley.com Counsel for PIMCO David Kotler DECHERT LLP Princeton Pike Corporate Center P.O. Box 5218 Princeton, New Jersey 08543 Telephone: (609) 620-3226 Facsimile: (609) 620-3259 E-mail: david.kotler(dechert.com Counsel for PIMCO Funds Marvin A. Miller Anthony F. Fata MILLER FAUCHER AND CAFFERTY LLP 30 North La Salle Street, Suite 3200 Chicago, Illinois 60602 Telephone: (312) 782-4880 Facsimile: (312) 782-4485 E-mail: mmiler(milerfaucher.com; afa ta((millerfa ucher .com Designated Local Counsel for Plaintiffs Michael T. Hannafan MICHAEL T. HANNAFAN & ASSOCIATEDS, LTD. One East Wacker Drive, Suite 1208 Chicago, Illinois 60601 Telephone: (312) 527-0055 Facsimile: (312) 527-0220 E-mail: mtf((hannafanlaw.com Counsel for PIMCO Funds Kevin King WINSTON & STRAWN LLP 1700 K Street, N.W. Washington, D.C. 20006 Telephone: (202) 282-5749 Facsimile: (202) 282-5100 E-mail: kking((winston.com Counsel for Citadel Investment Group, L.L.C. Christopher Lovell Gary S. Jacobson Merrick S. Rayle Craig Essenmacher LOVELL, STEWARD, HALEBIAN LLP 500 Fifth Avenue New York, New York 10110 Telephone: (212) 608-1900 Facsimile: (212) 718-4677 E-mail: msrayle((sbcglobal.net Counsel for Plaintiffs Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 14 of 15 Louis F. Burke LOUIS F. BURKE, P.C. 460 Park Avenue New York, New York 10022 Telephone: (212) 682-1700 Facsimile: (212) 808-4280 E-mail: lburke((lfblaw.com Counsel for other Plaintiffs Lee Ann Russo Karey V. Skiermont JONES DAY 77 West Wacker Chicago, Illinois 60601-1692 Telephone: (312) 782-3939 Facsimile: (312) 782-8585 E-mail: larusso((jonesday.com; kskiermont((jonesday.com Counsel for Lehman Brothers, Inc. Geoffrey Horn Vince Briganti LOWEY DANNENBERG BEMPORAD & SELINGER, P.C. One North Lexington Avenue, 11th Floor White Plains, New York 10601 Telephone: (914) 997-0500 Facsimile: (914) 997-0035 E-mail: ghorn((ldbs.com; vbriganti((ldbs.com Counsel for other Plaintiffs Marshall E. Hanbury Lisa A. Dunsky MAYER, BROWN, ROWE & MAW, LLP 71 South Wacker Drive Chicago, Illinois 60606 Telephone: (312) 782-0600 Facsimile: (312) 706-8626 E-mail: mhanbury((mayerbrownrowe.com; ldunsky((mayerbrownrowe.com Counsel for Ronin Capital, LLC Isl Gloria P. Clement Gloria P. Clement 2 Case 1:06-mc-00489-CKK Document 13 Filed 12/13/2006 Page 15 of 15 Exhibit A Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 1 of 32 IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION --------------------------------------------------------------------------------X JOSEF A. KOHEN, BREAKWATER TRADING LLC, and : RICHARD HERSHEY, : Plaintiffs, : CLASS ACTION : -against- : : Civil Action#: : 05C 4681 (RG) PACIFIC INVESTMENT MANAGEMENT Company LLC, : PIMCO FUNDS, and John Does 1-100, : : JURY TRIAL : DEMANDED Defendants. : : ---------------------------------------------------------------------------------X FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT Plaintiffs bring the Commodity Exchange Act (“CEA”) action on behalf of themselves and the Class defined in ¶ 94. Plaintiffs’ claims as to themselves and their own actions are based upon knowledge. All other allegations are based upon information and belief pursuant to the investigation of counsel which included (a) review of defendants’ filings with governmental agencies, news articles, CBOT data, proprietary data, and other statistics, (b) interviews of market participants, and (c) and other steps. As and for their Complaint, plaintiffs allege as follows: I. SUMMARY OF ALLEGATIONS 1. (a) Between 2000 and 2004, the volume and open interest of Chicago Board of Trade Ten Year Treasury Note futures contract trading steadily increased while the “float” (or readily available trading supply) of deliverable notes remained constant or somewhat declined. (b) By late 2004 and 2005, this growing imbalance made such Ten Year Treasury Note futures contracts much more susceptible to manipulation by a person who controlled large long Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 1 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page of 32 2 positions, refused to liquidate such long positions, and otherwise exacerbated an imbalance between the volume of futures contracts and the readily available supply of notes to deliver thereunder. 2. With knowledge of the foregoing, Pacific Investment Management Company LLC (hereinafter “PIMCO”) dramatically changed its prior behavior in late 2004 and 2005. 3. First, PIMCO engaged in the highly unusual conduct of purchasing, by March 31, 2005, an extraordinarily large long position of in excess of $16,000,000,000 worth of the June 2005 Ten Year Treasury Note futures contract (sometimes referred to as “June contract”). 4. Second, as the open interest in the June contract plunged by 70% during a short time in May and June 2005, PIMCO engaged in the highly unusual conduct of not commensurately (or at all) liquidating its extraordinary June contract long positions. 5. Third, during the time from April 1 until end of June 2005, PIMCO engaged in the highly unusual conduct of purchasing an extraordinarily large holding, $13.3 billion worth, of the U.S. Treasury note that was the cheapest to deliver on the June contract. 6. As a result of all this highly unusual conduct, (a) PIMCO held a substantial portion of the open interest in the June contract from late May 2005 forward; (b) during June 2005, this portion grew to in excess of 60% of the open June contracts; and (c) by the end of the June contract, PIMCO’s holding of the cheapest to deliver note constituted between in excess of 75% and 90% of the float (i.e., the readily available trading supply) in such note. 7. PIMCO’s foregoing highly unusual conduct manipulated the prices of the June contract to artificially high levels and increased the volatility of prices of the June contract during May and June 2005. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 2 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 3 of 32 3 8. Such conduct was also a cause of a number of additional highly unusual occurrences indicative of June futures contract price artificiality. These included: (a) an extremely high number of “fails” occurred in the repo market for the cheapest to deliver note on the June contract; (b) such note traded “special” at substantial premiums; (c) normal price relationships between the note and other notes were thrown out of line; and (d) various regulatory changes were enacted to prevent PIMCO from repeating its highly unusual conduct, e.g., the Chicago Board of Trade placed a maximum limit on positions of 50,000 contracts and the U.S. Treasury required position reports from persons holding in excess of $2,000,000,000 in any note issue. 9. Although the new 50,000 contracts limit is an enormous position, it is less than 33 1/3% of the known long position in the June contract that PIMCO held. Although $2,000,000,000 is a large note position, PIMCO held almost six times that amount after its corner of the cheapest to deliver note on the June contract. 10. From June 2005 forward, market participants have claimed that a short squeeze had occurred, and the United States Treasury and possibly others have begun to investigate whether a squeeze in the cheapest to deliver notes did occur. 11. As the holder of an extraordinarily large long position in the June contract as well as significant portions of a deliverable supply, PIMCO had important responsibilities and duties to the market including duties to make its holdings of cheapest to deliver notes available and to liquidate its futures contracts. PIMCO intentionally failed to observe these duties and responsibilities. On the contrary, PIMCO intentionally exacerbated the conditions to inflate prices. 12. After the June contract finished trading, PIMCO, per its CEO, sought to explain Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 3 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 4 of 32 4 PIMCO’s highly unusual conduct by stating that PIMCO would continue to hold for investment its extraordinary concentrated position in the illiquid note which was then no longer deliverable. But PIMCO turned around and sold (or was already selling) all of its holdings of such note in order to “bury the corpse” of its manipulation of the June contract by September 30, 2005. 13. PIMCO intended to and did manipulate prices of the June contract to artificially high levels during the Class Period. Plaintiffs held short positions in the June contract during the Class Period and purchased back such June contracts at the artificially high prices caused by PIMCO’s highly unusual behavior during the Class Period. PIMCO’s unlawful conduct caused damages to plaintiffs. II. JURISDICTION AND VENUE 14. A United States Treasury note with a maturity between 6.5 and 10 years (“Treasury note”) is a “commodity” and is the “commodity underlying” 10-year Treasury note futures contracts traded on the Board of Trade of the City of Chicago (“CBOT”). See Sections 1a(4) and 22 of the CEA, 7 U.S.C. §§ 1a(4) and 25(a)(1)(D), respectively. 15. This Court has jurisdiction over this action pursuant to Section 22 of the CEA, 7 U.S.C. § 25, and 28 U.S.C. §§ 1331 and 1337. 16. The CBOT is located at 141 West Jackson Boulevard, Chicago, Illinois 60604. Venue is proper in this District pursuant to Section 22 of the CEA, 7 U.S.C. § 25(c), because the claims arose in this District. Defendants’ unlawful acts manipulated the prices of the June 2005 and 10- year Treasury notes futures contract traded on the CBOT. 17. The defendants, directly and indirectly, made use of the means and instrumentalities of transportation or communication in, or the instrumentalities of, interstate commerce, or of the Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 4 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 5 of 32 5 mails in the connection with the unlawful acts and practices and course of business alleged herein. III. PARTIES Plaintiffs 18. During and before the Class Period, plaintiff Josef Kohen sold short June contracts. During the Class Period, Kohen liquidated or purchased back these contracts at a loss. 19. During the Class Period, plaintiff Richard Hershey purchased a June 10-year Treasury notes futures contract to liquidate a short position, and incurred a loss on the transaction. 20. During and before the Class Period, plaintiff Breakwater Trading LLC, sold a very large short position of in excess of 10,000 June 10-year Treasury note futures contracts. During the Class Period, it purchased June contracts in order to liquidate its short positions, and incurred a loss on such transactions. 21. The prices that plaintiffs paid to purchase back June contracts during the Class Period were artificially high and caused losses and damages to each plaintiff. Defendant 22. Pacific Investment Management Company LLC (hereinafter “PIMCO”) is an institutional money manager specializing in fixed income management. PIMCO is incorporated in the state of Delaware and is headquartered in Newport Beach, California. PIMCO manages the largest investment company bond funds in the U.S 23. PIMCO Funds is a Massachusetts trust and registered open end management investment company consisting of separate portfolios. Such portfolios include the Total Return Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 5 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 6 of 32 6 Fund and other funds alleged herein. PIMCO, through William Gross and various other persons, caused PIMCO Funds to purchase the aggregate Ten Year Treasury Note futures contract positions and aggregate February 2012 U.S. Treasury Note holdings alleged herein. Because PIMCO managed and controlled PIMCO Funds and caused PIMCO Funds’ conduct at issue herein, PIMCO and PIMCO Funds are referred to collectively in this complaint as “PIMCO”. 24. PIMCO spoke to other market participants and acted through or with its associate John Doe defendants whose identities are unknown to plaintiffs. IV. SUBSTANTIVE ALLEGATIONS A. Background 25. The CBOT has been designated by the CFTC as a contract market pursuant to Section 5 of the CEA, 7 U.S.C. § 7. The CBOT submits to the CFTC for approval various rules and regulations through which the CBOT designs and creates the terms of various commodity futures contracts, and conducts trading in such contracts. A key purpose of the CBOT rules and amendments is to prevent price manipulation. 26. Included in the CBOT contracts are futures contracts for Ten Year Treasury Note futures contracts. The CBOT defines 10-year Treasury note futures contracts as “10 Year Treasury Note Futures.” The CBOT rules refer to them as “Long Term T-Notes.” 27. The futures contract is a firm commitment to make or accept delivery of a specified quantity and quality of a commodity during a specific month in the future at a price agreed upon at the time the commitment is made. There are two sides to a futures contract. The “long” side Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 6 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 7 of 32 7 is the buyer of the contract and is obligated to take delivery and pay for the commodity. The “short” side is the seller of the contract and is obligated to make delivery of the commodity. 28. Futures contracts are standardized according to the terms specified by the CBOT or the other commodity exchange which creates the contract. This standardization makes such contracts fungible. 29. Upon acceptance of any trade in the fungible contracts on the CBOT, the CBOT clearinghouse effectively becomes the seller to every buyer of a CBOT futures contract and the buyer to every seller. Futures markets, the standardized and fungible futures contracts, and the mechanism of the clearing house to hold the other side of every futures contract, are specifically designed to facilitate and ease trading in one central market place by traders who are located throughout the world. 30. Thus, deliveries on futures contracts are very rare and less than 1% of all futures contracts traded each year result in delivery of the underling commodities. Instead, traders generally offset their futures positions before their contracts mature. For example, a purchaser of one June Ten Year Treasury Note futures contract can balance (usually called “liquidate” or “cancel” or “offset”) his future obligation to the exchange clearing house to take delivery of the note by selling a June Treasury futures contract. The difference between the initial purchase price and the price of the “liquidating” sale represents the realized profit or loss for the holding of 99%-plus of the long side of the futures contracts traded. 31. The amount of contracts open to the clearinghouse is referred to as the “open interest”. Absent more liquidations through trading, the open interest in a given contract, represents the number of deliveries that will have to be made and taken. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 7 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 8 of 32 8 B. The Ten Year Treasury Note Futures Contract Was Susceptible to Manipulation 32. The CBOT Ten Year Treasury Note futures contract trades for delivery during the end month of each quarter (March, June, September and December) for the next twelve quarters. 33. When delivery is called for, the rules of the CBOT specify a number of different note issues from 6 ½ years to 10 years in time until maturity that are acceptable for delivery against the 10-year Treasury note futures contract. 34. Although multiple Treasury notes are typically deliverable against a given futures contract (e.g., the June 2005 contract), usually a single Treasury note is most economical for shorts to deliver. This is referred to as the “cheapest to deliver” (“CTD”) note. Which note is cheapest to deliver depends on a variety of factors. The pricing of the contract is based on a benchmark coupon rate of 6 percent. When interest rates are below 6 percent, it is typically cheapest to deliver the note with the shortest “duration,” where a note’s duration depends on its coupon rate and maturity. In the June contract, the February 2012 Treasury note was far cheaper or far less expensive than any other note. 35. Various notes in any given issuance are not merely purchased but socked away by foreign governments, pensions and others until maturity. Therefore, a substantial portion of the notes of any one issuance is not tradable nor readily available for trading or delivery on CBOT futures. 36. Those contracts that are readily available for trading comprise “float” for such issue. In Ten Year Treasury Note and other financial futures, the readily deliverable supply consists of the “float” of the CTD (cheapest to deliver) note. 37. In the June contracts, the CTD note was the February 2012 note. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 8 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 9 of 32 9 38. The CBOT rules also specify the value to be received in exchange for delivery of each deliverable treasury note. 39. For the June 2005 Treasury Note futures contract, the cheapest to deliver note was the U.S. Treasury Note expiring in February 2012. 40. The last trading day in the June contract was June 21, 2005 and the last delivery day was June 30, 2005. The first delivery notice day was May 31, 2005. 41. In financial futures contracts (such as Treasury Note futures contracts) one of many forms of manipulation is to acquire a large long position and fail to liquidate or trade out of the position as the open interest declines. 42. Between 2000 and the second half of 2004, the volume and open interest of Treasury Note futures contract trading expanded significantly. 43. This great expansion in open interest and trading made it easier for someone to do the following: (1) purchase a large long futures contract position, (2) fail to liquidate such position when the tipping point in the contract was reached and the open interest began to decline, and (3) otherwise act to inflate manipulate prices. 44. CBOT Ten Year Treasury Note Futures contracts have become more susceptible to manipulation when, for example, a trader can acquire an enormous long position and demand more deliveries than can reasonably be commercially made in the cheapest to deliver note on such futures contract. 45. During 2004-2005, PIMCO, per William Gross and others, was well aware of the foregoing. C. Chronology Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 9 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 10 of 32 10 i. PIMCO’s Holding During 2000-September 2004 46. From March 2000 until the present, there have been liquidity, dislocation and other risks that have made it undesirable to purchase a concentrated position in any single issue of ten year notes, i.e., notes with a maturity 6 ½ to 10 years forward. Thus, during the 2000-September 2004 time frame, PIMCO’s largest end-of quarter holding of any one series of deliverable Treasury notes (i.e., notes of 6 ½ to 10 years), varied between from $1,350,000 and $464,000,000. ii. September 2004-June 2005 48. On September 13, 2004, various PIMCO entities agreed to pay $50,000,000 and consented to cease and desist orders and to undertake reforms of their compliance and corporate governance in order to settle charges that they willfully violated or aided and abetted violation of (a) the antifraud provisions of the Investment Advisers Act of 1940 (“IAA”); (b) Section 17(d) of the Investment Company Act of 1940 (“ICA”); (c) Section 34 (b) of the ICA; and (d) Section 204A of the IAA. The SEC Order found that the PIMCO entities willfully violated each of the foregoing laws. 49. On September 15, 2004, various PIMCO entities agreed to pay over $11.6 million and to undertake disclosure and compliance reforms in order to settle SEC charges that they violated (a) Section 206(2) of the IAA and Sections 12(b), 15(c), 17(d), and 34(b) of the ICA. The SEC Order found that PIMCO entities violated the foregoing sections of the law. 50. The SEC proceedings that were settled in September 2004 ended PIMCO’s enhancement of its income through market timing and expense reduction. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 10 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 11 of 32 11 51. Shortly after September 2004, PIMCO began to change dramatically its previous behavior in the U.S. Treasury Note futures markets. 52. By March 30, 2005, PIMCO had caused to be purchased by its managed investment funds that PIMCO controlled, a total of in excess of 163,169 June 2005 United States Treasury note futures contracts. For example, PIMCO’s Total Return Fund and Total Return Fund II, both of which are managed by William Gross, then held 113,760 and 5,369 10-year Treasury note June futures contracts, respectively. As of March 31, 2005 PIMCO’s Commodity RealReturn Strategy Fund, which is managed by John Brynjolfsson, held 6,595 10-year Treasury note June futures contracts. 53. This June contract holding was far larger than any 10-year Treasury note futures contract holding by PIMCO between 2000 and September 2004. 54. Also, on March 30, 2005, PIMCO held a total of 35,700,000 Treasury notes with a maturity in February 2012, with a market value $36,876,000. This note was the cheapest to deliver note on the June 2005 contract. 55. As at June 30, 2005, PIMCO controlled a total of 11,394,100,000 Treasury bonds with a maturity date of February 2012 in its funds and portfolios, totaling a market value of $12,098,453,822. For example, as of June 30, 2005, the Total Return Fund and Total Return Fund II, managed by Mr. Gross, held a principal value of 9,811,800,000 and 290,500,000 Treasury notes with a maturity of February 15, 2012, respectively. As of June 30, 2005, the Real Return Fund, which is also managed by Mr. Brunjolfsson, held a principal value of 286,100,000 Treasury notes with a maturity of February 15, 2012. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 11 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 1 of 32 12 56. This unprecedented, fantastical position represented approximately 45 percent of the total issue of February 2012 notes and constituted in excess of 75% of the “float” of such note. See par. 4-6 above. 57. PIMCO’s humongous, concentrated holding on June 30, 2005 of the illiquid February 2012 notes, which were then no longer deliverable on Ten Year note futures contracts, was twenty five times as large as PIMCO’s next largest holding of any single issue of deliverable notes between 2000 and 2005. 58. In sum, between April 1 and June 2005, PIMCO engaged in the highly unusual conduct of purchasing and largely failing to resell (despite attractive prices) at least 11.3 billion of the CTD notes. 59. Some substantial portion of these purchases was made while PIMCO took deliveries on the June 2005 Ten Year Treasury Notes Futures contract. However, the information and knowledge of the more exact details of the precise timing and the precise rates and amounts of such purchases are exclusively within the possession of PIMCO. They are not publicly available nor otherwise available to plaintiffs absent discovery. 60. During May and early June 2005, the open interest in the June contract plummeted rapidly but PIMCO held and did not liquidate its June contract position at the same rate (or at all). Again, the information and knowledge about the details of the precise timing and the precise rates and amounts of PIMCO’s purchases, liquidations, and acceptance of deliveries on the June contract are exclusively within the possession of PIMCO. They are not publicly available nor otherwise available to plaintiffs absent discovery. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 12 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 13 of 32 13 61. From at least May 9, 2005 forward, PIMCO, through its enormous June contract position and other steps, had the ability to increase and manipulate prices of June contracts. Indeed, by May 9, 2005 at the latest, PIMCO internally committed to writing its intention to use its enormous long position and significant cash market position in a way to force the cheapest to deliver note on the June contract to go “special” by not rolling the June positions into September and by standing for delivery on June contracts. Among other statements, on May 9, PIMCO, per Chang Hong Zhu, stated: “Even if we just pulled off rolling we may be able to cause calendar to trade closer to ‘historical norm’ cheap level.” Also on May 9, PIMCO, per Chris Dialynas, stated: “Prefer to stand for delivery and exploit potential for front month to go on special.” As is alleged hereinafter, PIMCO’s unprecedented futures and cash market holdings caused the repo market for the February 2012 notes to go “special” shortly after May 9 which further caused artificially high prices in the June contract. 62. Between May 17 and 24, 2005, there was a pronounced rise in the prices of the June contract and of the February 2012 Note relative to comparable futures and notes. This spike began to dissipate through the beginning of June until another, smaller spike at the very end of June. 63. On or well before May 19, 2005, the U.S. Treasury note maturing in February 2012 became “special.” “Special” is a technical term and it refers to a sub-species of what is known as a “repurchase agreement” or “repo”. 64. A “repurchase agreement” or “repo” occurs when a Treasury note holder borrows money by selling a note to a counterparty and agreeing to buy a note back later at a slightly Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 13 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 14 of 32 14 higher price. Alternatively, such an agreement also occurs when an investor borrows a note, repays the loan with other notes purchased at a lower price, and then pockets the difference. 65. In a “special” repo, when one borrows a particular note from a lender, one must provide that specific type of note to the lender upon repayment. Typically, the reason is that such instrument is unusually scarce or valuable. 66. Between May 19 and the end of June 2005, the February 2005 note traded at least 100 basis points “special” in the repo market commencing on May 19, 2005 and continuing through the end of June. 67. The “specialness” reached 288 basis points on May 25 and 262 basis points on June 7. 68. During May and June 2005, traders who had sold the 10-year Treasury note due to mature in February 2012 found that they could not go into the open market and borrow such Note for delivery to their purchasers. 69. Billions of dollars of the 10-year Treasury repos were “failing” each day because one or more holders of the securities had stopped lending the note and there was extremely heavy demand for physical settlement. 70. A “fail” typically occurs when an investor borrows a note with the intent of selling it in the future but is unable to return the borrowed note due to scarcity of the note or other problems in the marketplace. The “fails” here are indicative of an artificial shortage of the February 2012 note, i.e., the cheapest to deliver note on the June contract. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 14 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 15 of 32 15 71. Usually only exogenous events cause these types of “fails” in the marketplace. For example, one of the largest spikes in “fails” occurred in response to the September 11, 2001 terrorist attacks. 72. No such exogenous event occurred in May and June 2005. However, PIMCO’s highly unusual conduct was then occurring within the market. 73. Further, during May and June 2005, the volatility of June 2005 Treasury Note futures contract prices greatly increased. 74. From May 18 until May 25, the open interest in the June contract fell 53 percent. From May 18 until June 1, 2005 the open interest fell 78 percent. The “specialness” of the February 2012 note, the inflation of its price relative to other notes, the “fails” in the note, the inflation of the June futures contract price relative to other benchmarks, and the increased volatility all coincided with PIMCO’s highly unusual conduct and the tipping point when the open interest in the June contract began to decline. 75. May 31, 2005 was the first delivery notice day, June 1 was the first delivery day, and June 21, 2005 was the last trading day in the June contract. As at June 1, 2005, notwithstanding the high prices of the June contract relative to other contracts, PIMCO had failed to liquidate and still held an enormous June contract long position. 76. During June 2005, PIMCO took unusually large deliveries on its June contract rather than liquidating most of its June contracts. 77. Also, during June 2005, PIMCO engaged in the highly unusual conduct of largely failing to make the CTD note available to other market participants notwithstanding the premium prices and attractive revenues PIMCO could have gained from such sales or loans. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 15 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 16 of 32 16 78. On June 21, 2005, due to the cumulative effect of PIMCO’s many highly unusual acts, there was a very large open interest in the June contract of 151,000 contracts. 79. This compares, for example, to the last day of trading of the September 2005 contract, when only 66,000 contracts were open. 80. The March 2005 contract had an unusual end of trading yet even it only had 115,000 open contracts as at the end of trading. 81. On June 29, 2005, the CBOT announced that it was amending CBOT Regulation 425.01 to establish a 50,000 contract position limit during the last 10 trading days of the Ten Year Treasury Note contract beginning with the December 2005 expiration cycle. 82. This maximum limit of 50,000 contracts is extraordinarily large but was less than 33 1/3% of PIMCO’s known June contract long position. 83. During June-September 2005, many market participants claimed that some one had squeezed the ten year June Ten Year Treasury Note contract and the CTD note thereunder. In response, PIMCO, per its CEO (Mr. Gross), asserted that one reason that PIMCO purchased the highly unusual large amount of February 2012 notes is that PIMCO was going to continue to hold such note for investment. 84. In fact, by September 30, 2005, PIMCO sold out all of its huge holding of this Note. PIMCO’s conduct contradicts the statements by PIMCO’s CEO that PIMCO would continue to hold the cheapest to deliver notes after the expiration of the June contract. Such conduct strongly suggests that PIMCO originally took the deliveries for reasons other than responsible financial investment. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 16 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 17 of 32 17 85. In August 2005, PIMCO, per its CEO, stated that another reason that PIMCO took deliveries on the June contract was that PIMCO did not like the prices required to roll into the September 2005 Ten Year Treasury Note futures contract. To “roll”, for a long like PIMCO, means to sell an existing long position and buy a later maturing futures contract, like the September or December 2005 contract. 86. However, first, the June contract was, on an absolute basis, much more expensive than the September contract for large parts of the Class Period. PIMCO could have “rolled” forward to September at a handsome absolute profit during this time had PIMCO truly wanted to roll forward instead of manipulating and exacerbating the conditions in the June contract. 87. Second, the September contract called for delivery of a more valuable cheapest to deliver note. Therefore, on a relative basis, the roll forward from the June contract to the September contract was attractive at additional other times during the Class Period. 88. Third, the September futures contract was the most liquid instrument that could be traded. But the cheapest to deliver note on the June contract was a very illiquid instrument. PIMCO would incur higher transaction costs to trade out of the June note (as it in fact did). 89. Fourth, given the relative maturities and time periods, the cheapest to deliver note on the June contract could no longer be delivered on the September contract. In other words, even if PIMCO’s sole choices were to take delivery on the June contract or roll forward to September (and PIMCO had many more choices than simply these two), PIMCO chose to do the following: it took an unprecedented highly concentrated position of enormous proportions in an illiquid note that was about to lose its value rather than rolling forward into the most liquid instrument, the September futures contract as to which the deliverable instrument was more valuable. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 17 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 18 of 32 18 90. Fifth, there were many ways for PIMCO to maintain exposure to treasury notes or treasury note futures other than rolling into the September futures. Such ways included rolling into the December futures contract, purchasing other liquid cash notes in diversified and liquid, tradable amounts, selling the June contract, and other commercially reasonable and financially responsible steps. 91. These steps, along with simply liquidating the June futures or selling the cheapest to deliver notes on the June futures while the prices were high, were all more attractively priced than taking huge deliveries of the illiquid cheapest deliver note that would soon no longer be deliverable in the futures contract. But PIMCO took none of the foregoing steps. Thus, PIMCO’s conduct further contradicts the attempted explanation by PIMCO’s CEO for PIMCO’s highly unusual series of highly unusual actions that cornered the cheapest to deliver note. C. Motive And Intent 92. The motive and intent for the foregoing manipulative acts was to increase financial return, including but not limited to, the return from the sale of Treasury note futures positions at the artificially high prices created by manipulation. This increased assets under management (directly and indirectly) and increases in assets under management increase PIMCO’s fees. 93. As a direct, proximate and foreseeable result of defendants’ foregoing unlawful conduct, plaintiff and members of the Class have suffered damage. Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 18 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 19 of 32 19 V. CLASS ACTION ALLEGATIONS 94. Plaintiffs, identified in paragraphs 15-18 herein, bring this action on their own behalf and as a class action under Rules 23(a), (b)(2), and (b)(3) of the Federal Rules of Civil Procedure on behalf of: All persons who purchased, between May 9, 2005 and June 30, 2005 (“Class Period”), inclusive, a June 10-year Treasury note futures contract in order to liquidate a short position, or who delivered on the June 2005 futures contract in order satisfy a short position (the “Class”). Excluded from the class is defendant and any affiliated or associated party of the defendant. 95. This action is properly maintainable as a class action. The members of the Class are so numerous and geographically dispersed that joinder of all Class members is impracticable. On information and belief, there are in excess of 1,000 members in the Class and they reside in various places throughout the United States. 96. Questions of law and fact common to the members of the Class exist, and predominate over questions, if any, that may affect only individual members, because defendants have acted on grounds generally applicable to the entire Class. The questions of law and fact common to the Class include, but are not limited to: (a) whether defendants’ conduct violated the CEA, as amended, 7 U.S.C. §1 et seq.; (b) whether prices of the 10-year Treasury notes, and June 10-year Treasury note futures contracts were artificially high during the Class Period due to defendant’s conduct; (c) what was the amount and timing of the defendants’ purchases and holdings of 10-year Treasury notes and June 10-year Treasury futures contracts during the Class Period; Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 19 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 20 of 32 20 (d) whether and to what extent a person who liquidated their June Contract during the Class Period was injured; and (e) whether plaintiff and the members of the Class suffered damages as a proximate result of defendants’ unlawful conduct. 97. Plaintiffs’ interests are typical of, and not antagonistic to the interests of, the Class. 98. The plaintiffs have retained competent counsel who are experienced in class actions and commodity futures litigation. Plaintiffs intend to prosecute this action vigorously. 99. Defendants have acted on grounds generally applicable to the plaintiffs and the Class. Prosecution of separate actions by individual members of the Class would create the risk of inconsistent or varying adjudications with respect to individual members of the Class which would establish incompatible standards of conduct for the defendants. 100.There are no difficulties likely to be encountered in the management of this class action that would preclude its maintenance as a class action, and no superior alternative exists for the fair and efficient adjudication of this controversy. COUNT I MANIPULATION IN VIOLATION OF THE COMMODITYS EXCHANGE ACT 101. Plaintiffs repeat and re-allege the previous allegations as if fully set forth herein. 102. Defendant’s activities alleged herein created, and exacerbated conditions and artificial prices and constitute manipulation of the price of June Contracts, and the price of the CTD Treasury notes underlying those contracts, in violation of Sections 9(a) and 22(a) of the CEA, 7 U.S.C. §§ 13(a), 25(a). Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 20 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 21 of 32 21 103. Plaintiffs and members of the Class purchased one or more June Contracts in order to liquidate their short positions during the Class Period or make deliveries on such contract, and were injured as a result of defendants’ manipulation of the price of those contracts and the price of the notes underlying those contracts, in violation of the CEA, 7 U.S.C. § 1, et seq. 104. Defendants knowingly aided, abetted, counseled, induced, and/or procured the violations of the CEA alleged herein. 105. Defendants willfully intended to assist the manipulation in violation of Section 22(a)(1) of the CEA, 7 U.S.C. § 25(a)(1). 106. Defendants and other unnamed parties including affiliates and associates of Defendants knowingly aided, abetted, counseled, induced, and/or procured or are responsible as control person for violations of the CEA alleged herein. Does 1-100 and other unnamed parties, including affiliates and associates of Defendants, knew of Defendants’ manipulation and willfully intended to assist the manipulation in violation of Section 22(a)(1) of the CEA, 7 U.S.C. § 25(a)(1). 107. Plaintiffs and members of the Class are each entitled to actual damages for the violations of the CEA alleged herein. PRAYER FOR RELIEF WHEREFORE, plaintiffs pray for relief as follows: (A) That the Court determine that this action may be maintained as a class action under Rules 23(a) and (b)(3) of the Federal Rules of Civil Procedure, that plaintiffs be denominated as Class representative and plaintiff’s counsel be appointed counsel for the Class; (B) That plaintiffs and the Class recover actual damages, as provided by law, Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 21 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 2 of 32 22 determined to have been sustained for violations of the CEA, and that judgment be entered against defendants on behalf of plaintiffs and the Class; (C) That plaintiffs and the Class recover their costs of the suit, including attorney’s fees; and (D) For such other relief as the Court may deem just and proper. JURY DEMAND Plaintiffs hereby demand a trial by jury on all issues so triable. Respectfully Submitted, Dated: May 30, 2005 By /s/ Christopher Lovell Christopher Lovell, Esq. Robert W. Rodriguez, Esq. Ian T. Stoll, Esq. Craig Essenmacher, Esq. Ryan Long, Esq. LOVELL, STEWART HALEBIAN, LLP 500 Fifth Avenue New York, New York 10110 Telephone: (212) 608-1900 Facsimile: (212) 719-4677 Lead Counsel By:/s/ Marvin A. Miller Marvin A. Miller, Esq. Anthony F. Fata, Esq. MILLER FAUCHER AND CAFFERTY LLP 30 North La Salle Street Suite 3200 Chicago, Illinois 60602 Telephone: (312) 782-4880 Facsimile: (312) 782–4485 Designated Local Counsel Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 22 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 23 of 32 23 Geoffrey Horn, Esq. LOWEY DANNENBERG BEMPORAD & SELINGER, P.C. 747 Third Avenue New York, N.Y. 10017 Telephone: (212) 759-1504 Facsimile: (212) 593-0201 Louis F. Burke, Esq. LOUIS F. BURKE, P.C. 460 Park Avenue New York, New York 10022 Telephone: (212) 682-1700 Facsimile: (212) 808–4280 Counsel for Plaintiffs Case 1:05-cv-04681 Document 80 Filed 05/30/2006 Page 23 of 23 Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 24 of 32 Exhibit B Case 1:06-mc-00489-CKK Document 13-2 Filed 12/13/2006 Page 25 of 32 -_.- ~-_._,..._~ Special Accounts 1151 3559) INSTRUCTIONS FOR PREPARING AND FILING REPORTS ON CFTC FORM '01 INSTRUCTIONS FOR PREPARING AND FILING REPORTS ON CFTC FORM '01 (SH R".,/O .."it CO"'''odil)' Enl.. Aci) Public reporting burden for this Collection of information is estimated to average 5 minutes pe rese. including the time for reviewing instructions, serching existing data source, gatheing and maintaining the data need. and completing and reviewing the cOOletion of intormation. Send comments regarding this burden estimate or any other ast of this cofletion of information, including suggestions for reucing this, to Agecy Clearance Oficer, Administrative Services, Commodity Futures Trading Comiriiiion, 20 K St. NW, Washington, DC 201; and to the Ofice of Information and Reguiatory Aftaira. Ofce of Management and Budget, Washington, DC 20. WHO SHOULD REPORT: Each futures commiiiion merchant and foreign broker carring a future account for others (including officers and partners of the cerrying firm) and each clearing member clearin~ their own trade whose open contract in suh acunt equal or excee the amount fixed for reprting in anyone future of a comodity. (Se regulation 15.03 for reprting levels of all commoditie). TO DETERMiNE IF AN ACCOUNT IS REPORTABLE:. Combine all llunls owne or controlle by a trader and treat them as a single accont of that trader. For eah acnt, determine the net long or short position or the gross long and gros short poitio op in each future of a commodity on anyone contract market as of the clos of th market on the day of the report. Net open long or short positions should be us except for the following poitions which should be gross: ,. Positions in an omnibus account 2. Positions in accounts owned or held jointly with another person or persons; 3. Positions in multiple accounlS subject to trading control by the trader. and 4. Positions in accounts reported gross long and gros short to the clearinghouse of any contract market for the purpose of celculating open iriterest. A poition is reprtable if the quantity of open contracts reaches the quantitie fixed for reing in setion 15.03 of the regulations. WHEN TO REPORT: Daily, after the clos of the market each busines dey and no later than 9:00 A.M. on the following busine day. Reprt may be mailed by forein broker and futures commisson merchants locted outside the city where reps are to be fied. . but not later then the day covered by the report. WHAT TO REPORT: File a serate form for each exchange and report poition, delive notice and exchange of futures for ceh (XFCs-also kno as EFPS) as fol: t. Position information. Show each net or gross reportable poition. 2. Deivery notices. Report delivery notice iss or stoppe by an accont in future for which a poition is reported. Whe repong deliv noticø If th noic ha ben iaued by the clearingho Of a contrac market prior to th cloe of a maet on anyone day, the notice should be shown on that day's report. If th noic Is issue by the cleringhouse on any day after the market ha clos (and th no is stopp that day or the next), th notice should be repoed on the aub8uet day's report. 3. XFCa. Show the transctions (buy and sell) involved with exchang of ca for eah poition that is rertble. In addition, a rep showing poition size, delivery noic laa or stoppe or XFCa must also be file for the first day a poition goe beow the rertbl iev. . IDENTIFICATION OF ACCOUNTS: Deignate eah account by th numbe 88 by you to tht acount. U.. CFTC Form 102 for identifying the acount number whic 8J for the firat tima on your report. Transmit such identification to the Commiaon in a serate sele envelope marked "Confidentia"" II sho"ld accmpay th '01 fo on which the acount is reported for the first time. Do not chage an iint numbe or asgn it to any other trader without prior approval of the Commi8io. , WHERE TO REPORT: The Commodity Futures Trading Commission offic In th cit whre the market is locted or, if more convenient, the re may be sub!:it to the Commisson', Ne York or Chicago office. 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Mason CASE NUMBER 05 C 4681 DATE 12/8/2006 CASE TITLE Hershey vs. PIMCO DOCKET ENTRY TEXT As stated in further below, Plaintiffs' Motion To Compel Rule 45 Discovery From The Chicago Board Of Trade [160] is granted in part and denied in part. The Chicago Board of Trade must produce responsive discovery before 12/29/06 subject to Hershey and the CBOT entering into a protective order. O[ For further details see text below.] Notices mailed by Judicial staff. STATEMENT This matter is before the Court pursuant to a Motion to Compel (“Motion”) Rule 45 Discovery from the Board of Trade of the City of Chicago (“CBOT” or “Board”) [160] filed on behalf of Plaintiffs Breakwater Trading LLC and Richard Hershey (collectively, “Hershey” or “plaintiffs”). After reviewing the Motion, Response and Reply briefs, the Motion is granted in part and denied in part. In a subpoena issued to the CBOT on March 3, 2006, Hershey sought production of materials in response to Request no. 1 and a portion of Request no.6. Request no.1 seeks production of all large trader report forms (“large trader reports”) related to the June 2005 U.S. Ten Year Treasury Note futures contract for the period between April 30 through July 10, 2005. A portion of Request no. 6 seeks written complaints and notes and memos reflecting oral complaints received by the CBOT from May 1 through June 30, 2005 that the June contract was being manipulated or squeezed (“complaints”). We note that in the Reply brief, Hershey limited the discovery requests that it seeks to those set forth above. The Board is a non-governmental organization and is not a party to this action. The disputed discovery is sought for discovery purposes in connection with plaintiffs’ allegations that the defendants manipulated prices of June 2005 U.S. Ten Year Treasury Note futures contracts on the CBOT and the cheapest to deliver U.S.Treasury Note underlying the June 2005 contract in violation of Sections 9(a), 22(a) and 22(a)(1) of the Commodity Exchange Act, 7 U.S.C. §§13(a), 25(a) and 25(a)(1). The Board resists producing the large trader reports and the complaints and argues that the discovery Hershey seeks is overbroad and burdensome to produce. Aside from conclusory statements, the Board has failed to adequately articulate why the discovery requests are overbroad or burdensome to produce. Accordingly, CBOT’s objections are overruled. Courtroom Deputy Initials: KF Case 1:05-cv-04681 Document 203 Filed 12/08/2006 Page 1 of 3 Case 1:06-mc-00489-CKK Document 1 -2 Filed 12/13/2006 Page 30 of 32 05C4681 Hershey vs. PIMCO Page 2 of 3 STATEMENT (CONT.) The CBOT also argues that the discovery is subject to the qualified investigatory privilege. See Apex Oil v. DiMauro, 110 F.R.D. 490 (S.D.N.Y. 1985); Ross v. Bolton, 106 F.R.D. 22 (S.D.N.Y. 1985). A governmental body asserting the investigatory privilege must make a specific showing before the court will consider the privilege to have been asserted properly. In re Sealed Case, 272 U.S. App. D.C. 314, 856 F.2d 268, 270 (D.C. Cir. 1988) (explaining that in order for the SEC to sustain a claim of investigatory privilege: “(1) there must be a formal claim of privilege by the hand of the department having control over the requested information; (2) assertion of the privilege must be based on actual personal consideration by that official; and (3) the information for which the privilege is claimed must be specified, with an explanation why it properly falls within the scope of the privilege.”) (citing Black v. Sheraton Corp. of America, 184 U.S. App. D.C. 46, 564 F.2d 531, 542-43 (D.C. Cir. 1977)); Friedman v. Bache Halsey Stuart Shields, Inc., 238 U.S. App. D.C. 190, 738 F.2d 1336, 1341-42 (D.C. Cir. 1984)). Where a non-governmental self-regulatory entity has asserted the investigatory privilege on the basis of the public interest in preserving the ability of self-regulatory bodies to function effectively, these requirements appear to have been applied less rigorously, if at all. DGM Invs., Inc. v. N.Y. Futures Exchs., Inc., 224 F.R.D. 133, 139-140 (S.D.N.Y. 2004) (citing In re NASD, 1996 U.S. Dist. LEXIS 10101, No. 96-0518, 1996 WL 406826, at *2 (E.D. La. July 18, 1996) (weighing the NASD’s assertion of privilege against the movants’ need without addressing any of the factors identified in Sealed Case concerning the adequacy of the assertion of privilege); Ross, 106 F.R.D. at 24 (reaching the merits and balancing the competing interests without evaluating the sufficiency of the NASD’s claim of privilege); cf. In re Adler, Coleman, Clearing Corp., 1999 WL 1747410, at *3 (S.D.N.Y. 1999) (reciting the prerequisites established in Sealed Case but proceeding to a determination without explicitly considering whether the requirements had been met)). Hershey contests the adequacy of the CBOT’s assertion of privilege. In this case, the CBOT asserted that the large trader reports and the complaints are protected by the investigatory privilege because they are obtained in the course of its market surveillance responsibilities. The Board claims that it is crucial to maintain the confidentiality of the information that it obtains in connection with market surveillance in order to encourage market participants to cooperate in providing information to the Board. The CBOT claims that disclosure would hinder the CBOT’s ability to obtain the information that it needs from market participants-which is essential to its ability to conduct effective surveillance of its markets. The CBOT additionally argues that Hershey has failed to show an extraordinary need to obtain the disputed discovery or that the disputed discovery is not available from other sources. There is a “strong public interest in maintaining the integrity of effective industry self-regulation.” Ross, 106 F.R.D. at 24. This proposition justifies the limited protection for investigative files relating to ongoing investigations, and the rationale for this protection rests in great part on the notion that protection is necessary to encourage cooperation with internal investigations in general, see, e.g., Apex Oil, 110 F.R.D. at 496, and to prevent the premature disclosure of factual information or investigative strategy related to a particular ongoing investigation. See, e.g., In re Adler, 1999 WL 1747410 at *5. Even if we consider market surveillance to be the equivalent of an ongoing investigation or disciplinary proceeding, the CBOT has not demonstrated why this rationale ought to extend to the large trader reports. Indeed, the CBOT has failed to establish that harm might result as to future investigations if the large trader reports are produced to Plaintiffs, particularly because the reports are not voluntary, but required to be submitted to the CBOT and the CFTC. (Hershey’s Reply, p.2, CBOT’s Response, p.5). Accordingly, the CBOT has not established that the large trader reports are protected from discovery by the qualified investigatory privilege. Case 1:05-cv-04681 Document 203 Filed 12/08/2006 Page 2 of 3 Case 1:06-mc-00489-CKK Document 1 -2 Filed 12/13/2006 Page 31 of 32 1As this Court understands it, the large trader reports contain data not analysis or opinion. 05C4681 Hershey vs. PIMCO Page 3 of 3 STATEMENT (CONT.) Hershey has demonstrated that they have a particularized need for the large trader reports.1 Given the magnitude of this case, the large trader reports will help identify other potential class members and help plaintiffs’ experts in the development and preparation of class-wide damage models. Hershey has narrowed the time period of the requested large trader reports to those received by the CBOT from April 30 through July 10, 2005. Although Hershey could obtain the same information by issuing subpoenas to approximately 87 CBOT clearing firms, compelling the CBOT to disclose the large trader reports will streamline the discovery process given the short time left to complete discovery. Therefore, Hershey’s Motion is granted as to the large trader reports subject to Hershey and the CBOT entering into a protective order. CBOT must produce the large trader reports before 12/29/06. As to the complaints, CBOT argues that it is crucial to maintain the confidentiality of the information that it obtains in connection with market surveillance in order to encourage market participants to cooperate in providing information to the Board and to cooperate with internal investigations in general. This argument is persuasive. The CBOT has an interest in both encouraging cooperation and in preventing the premature disclosure of factual information that may jeopardize its efforts in connection with market surveillance. See, e.g., In re Adler, 1999 WL 1747410, at *5. We will not compel the CBOT to disclose copies of any written complaints or copies of notes or memos of oral complaints. The Motion is denied as to the complaints. Case 1:05-cv-04681 Document 203 Filed 12/08/2006 Page 3 of 3 Case 1:06-mc-00489-CKK Document 1 -2 Filed 12/13/2006 Page 32 of 32