A class of institutional investors saw their suit against the New York Stock Exchange, NASDAQ and other major exchanges revived by the U.S. Court of Appeals for the Second Circuit Tuesday, over the alleged creation of a two-tier trading system in favor of so-called “flash boys” high frequency traders.

The class plaintiffs, led by the city of Providence, Rhode Island, and other investors, brought the suit against the security exchanges over what they claimed were the creation of special products that allowed high frequency trading firms a leg up on the rest of the market.

The class suit, brought under the anti-market manipulation and deceptive conduct statutes, claimed the exchanges' creation of proprietary data feed products, trading server co-location services, and special complex trading order opportunities that were targeted and sold to high frequency traders knowingly gave them an unfair competitive advantage.

In August 2015, U.S. District Judge Jesse Furman of the Southern District of New York ruled in favor of the defendant exchanges. He determined they were correct in arguing that they retained, as quasi-regulatory bodies, absolute immunity against the action, as well as finding the plaintiffs failed to state a claim.

The panel of U.S. Circuit Judges John Walker Jr., José Cabranes and Raymond Lohier Jr. disagreed.

The panel first tackled the issue of the court's subject matter jurisdiction. Furman ruled that the district court retained jurisdiction, and the panel agreed. While defendant exchanges argued that the U.S. Securities and Exchange Commission's regulatory purview controlled in this instance, the court found the allegations in the suit, being a private cause of action for fraud, provided the court the ability to review.

However, the panel found the district court erred in conceding absolute immunity to the security exchanges. In this instance, the panel noted, the exchanges ceased to be a stand-in for the SEC's role over the market—acting in a regulatory role. In that framing, a whole host of actions by the exchanges, usually over the actions of exchange members, were able to avoid being litigated.

In this instance, though, the specific acts under review—the co‐location services and the proprietary data feeds—weren't part of the exchanges' regulatory powers. Instead, the exchanges were engaging in conduct with the market, rather than oversight of it. In doing so, they went from regulators to the regulated, and lost their claim to immunity, the panel found.

Likewise, the panel reversed course on the district court's failure to state a claim ruling. Furman specifically said plaintiffs failed to sufficiently allege manipulated market activity by the exchanges, nor that they committed a “primary”—rather than simply aiding and abetting—Securities Act violations.

The panel disagreed, siding with the plaintiffs, who argued that the products themselves sold to the high frequency traders helped them manipulate the market, while the exchanges failed to notify the rest of the market to the potential effect.

The panel pointed to the example of one of the complex order product offered to the traders that allowed them to place orders that remained hidden from the market until the stock reached a certain price, at which point the order would jump to the top of the trade queue. The panel went on to dismiss defendants' claims that actual trading activity was required to sufficiently make a claim, noting in numerous case law that it was “market activity” that was required.

On the issue of primary manipulation requirements, the panel went back to its earlier point that the exchanges selling these products to the market changed their relationship to the market. They became co-participants with the firms in the alleged manipulative scheme, for the purposes of sufficiency's sake.

“The exchanges sold products and services during the class period that favored HFT firms and, in return, the exchanges received hundreds of millions of dollars in payments for those products and services and in fees generated by the HFT firms' substantially increased trading volume on their exchanges,” the panel wrote.

Robbins Geller Rudman & Dowd partner Joseph Daley led the firm's appellate efforts on behalf of the plaintiff investors. In a statement, firm name attorney Darren Robbins said the firm and its clients were pleased with the decision, specifically noting the panel's reversal on absolute immunity.

“As the court recognized, lead plaintiffs have sufficiently pled that the exchanges created a fraudulent scheme that benefited high frequency trading firms and the exchanges and failed to adequately disclose that scheme to investors,” Robbins said. “We look forward to presenting the case to a jury, showing that implementing discriminatory trading mechanisms is fraudulent and manipulative conduct [that] violates the federal securities laws.”

Gibson, Dunn & Crutcher partner Douglas Cox led the exchanges' legal team. He could not be reached for comment.