Legent Group v. Axos Financial, Inc.

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

LEGENT GROUP, LLC, COR )
ADVISORS LLC, ST. CLOUD )
CAPITAL PARTNERS II, L.P., and )
CARLOS P. SALAS )
)
Plaintiffs and )
Counterclaim-Defendants, )
)
v. ) C.A. No. 2020-0405-KSJM
)
AXOS FINANCIAL, INC., AXOS )
SECURITIES, LLC (as successor in )
interest to Axos Clearing, LLC), AXOS )
CLEARING, INC. (as successor in )
interest to Axos Clarity MergerCo, )
Inc.), and AXOS CLEARING LLC )
)
Defendants and )
Counterclaim-Plaintiffs. )

POST-TRIAL MEMORANDUM OPINION

Date Submitted: May 29, 2025
Date Decided: November 7, 2025

Thomas E. Hanson, Jr., William J. Burton, BARNES & THORNBURG LLP,
Wilmington, Delaware; Mona Z. Hanna, Todd H. Stitt, MICHELMAN & ROBINSON,
LLP, Irvine, California; Seth E. Darmstadter, Matthew R. Lasky, RAINES
FELDMAN LITTRELL LLP, Chicago, Illinois; Counsel for Plaintiffs and
Counterclaim Defendants Legent Group, LLC, COR Advisors LLC, St. Cloud Capital
Partners II, L.P., and Carlos P. Salas.

Michael C. Heyden, Jr., GORDON REES SCULLY MANSKUHANI, LLP,
Wilmington, Delaware; Polly Towill, Jay T. Ramsey, David M. Berger, SHEPPARD,
MULLIN, RICHTER & HAMPTON LLP, Los Angeles, California; Counsel for
Defendants and Counterclaim Plaintiffs, Axos Financial, Inc., Axos Clearing, Inc.,
Axos Securities, LLC, and Axos Clearing LLC.

McCORMICK, C.
This post-trial decision resolves buyers’ claim to indemnification under a

merger agreement. The defendant-buyers acquired a clearing firm from the plaintiff-

sellers. A few weeks after the merger closed, a trader got caught in a short squeeze

that cost the clearing firm $15.2 million. The buyers demanded indemnification from

the sellers, claiming that the loss resulted from pre-merger defects in the risk-

management systems of both the clearing firm and the trader’s brokerage firm. The

buyers claim that these defects rendered two representations in the merger

agreement inaccurate—a legal-compliance representation and a counterparty-breach

representation. Based on their claim of indemnification, the buyers withheld from

sellers payments due under notes comprising a portion of the merger consideration.

The sellers then filed this action seeking a declaratory judgment that they are not

obligated under the merger agreement to indemnify the buyers for the $15.2 million.

At trial, the buyers bore the burden of proving that the representations on which they

relied were inaccurate and that those inaccuracies caused the loss. They failed to

prove the inaccuracy of either the legal-compliance or the counterparty-breach

representations. They also failed to prove causation. This post-trial decision enters

judgment for the sellers.

I. FACTUAL BACKGROUND

Trial took place over four days. The record comprises 239 trial exhibits, live

testimony from four fact and four expert witnesses, testimony by video deposition
from two fact witnesses, testimony by deposition transcript of six witnesses, and 13

stipulations of fact. These are the facts as the court finds them after trial.1

A. Clearing And Its Risk-Management System

COR Clearing LLC is a securities clearing firm that became Axos Clearing

through the merger. For simplicity, this decision refers to COR Clearing and Axos

Clearing as “Clearing,” or the “Company.”

Securities clearing firms are FINRA-regulated businesses that serve as

intermediaries in securities transactions. Clearing firms perform custody, clearing,

and settlement services for the securities trades of their customer broker-dealers,

known as introducing broker-dealers (“IBDs”).

1 This decision cites to: C.A. No. 2020-0405-KSJM docket entries (by docket “Dkt.”

number); trial exhibits (by “JX-” number); the trial transcript, Dkts. 320–23 (“Trial
Tr.”); and stipulated facts set forth in the Parties’ Stipulation and Pre-Trial Order,
Dkt. 309 (“PTO”). The parties called the following fact witnesses: Michael Barth
(COR Clearing Chief Risk Officer) (by video), Gregory Garrabrants (Axos Financial
CEO), Andrew Micheletti (Axos Financial CFO), Carlos Salas (COR Clearing CEO),
Jeff Sime (COR Clearing President) (by video), and John Tolla (Axos Financial Chief
Risk Officer). The parties called the following expert witnesses: Jeffrey Abramczyk
(Axos Risk Expert), Colleen Diles (COR Clearing FINRA Expert), Craig McCann
(COR Clearing Securities Trading and Economics Expert), and Thomas Selman (COR
Clearing FINRA Expert). The parties submitted the deposition transcripts of the live
witnesses and called the following witnesses by deposition only: Eshel Bar-Adon
(Axos Financial Chief Legal Officer), George Lindner (Spartan Senior Trader), Ron
Pitters (Axos Bank Chief Information Officer), David Lopez (Spartan Chief
Compliance Officer), Steven Sugarman (COR Securities Holdings CEO), and Derrick
Walsh (Axos Financial Chief Accounting Officer). The transcripts of the witnesses’
respective depositions are cited using the witnesses’ last names and “Dep. Tr.” If a
witness sat for multiple days of deposition, the day is identified (e.g., “Day 1”). The
decision also notes in citation form where a witness was designated to testify under
Rule 30(b)(6).

2
Most IBDs that work with Clearing “trade through” the Company, which

means that the IBDs use Clearing’s services to execute transactions. Trades through

Clearing are routed through “Beta,” Clearing’s centralized order management

system.2 Beta allows the Company to monitor and block trades using pre-trade

controls.3

Some IBDs “trade away” from Clearing, which means that they maintain their

own relationships with execution centers and execute trades directly with those

firms.4 IBDs that trade away provide their completed transactions to Clearing for

settlement.5 Having IBD customers that trade away introduces risk for Clearing.

Because IBDs that trade away from Clearing use their own order management

systems, Clearing lacks the ability to directly monitor the trades through its own

system. 6 Yet Clearing must settle the trades.7

Before the merger, Clearing’s risk department consisted of three employees.8

The risk department required IBDs that traded away to give Clearing administrative

access to their order management systems if available, which allowed Clearing to

monitor the IBD’s pre-trade controls.9

2 PTO ¶¶ 6–7; Trial Tr. at 436:5–7 (Garrabrants).

3 Trial Tr. at 46:11–22, 47:11–48:4 (Tolla).

4 PTO ¶ 6.

5 Id. ¶ 6.

6 Sime Day 1 Dep. Tr. at 21:1–6.

7 Id. at 21:7–12.

8 Trial Tr. at 772:8–12, 801:10–14 (Salas).

9 JX-8 at 1.

3
The risk department monitored trade-away activity using two systems that

assessed trading activity relative to size limits set by Clearing for each IBD: the

NASDAQ ACT Risk Monitoring (“ACT”) system and the Depository Trust & Clearing

Corporation (“DTCC”) system. The ACT system monitors individual trades, alerting

clearing firms if an unsettled transaction exceeds an established size limit.10 The

DTCC system monitors the trading size of IBDs on an aggregate basis.11 Both

systems monitor trading in terms of notional value—the market price of the stock at

the time of purchase, multiplied by the number of shares in the position.12 This

means that the systems monitor the market-facing value of the position. They do not

account for leverage or consider margin requirements set for IBD customers.13 The

ACT and DTCC systems are post-trade monitoring systems; they issue alerts after

transactions are completed.14

The risk department also received intraday “drop copies,”15 or real-time reports

generated by an IBD’s order-management system. For executed trades, drop copies

provide the quantity, price, the number of shares, and the exchange where the trade

10 Id. at 556:6–17 (Abramczyk).

11 Sime Day 1 Dep. Tr. at 35:4–6.

12 Trial Tr. at 43:16–44:1, 77:13–78:9 (Tolla).

13 Id.; id. at 556:3–557:7 (Abramczyk).

14 Id. at 43:18–22 (Tolla); JX-188, at 2.

15 Trial Tr. at 94:2–95:4 (Tolla).

4
was executed.16 Drop copies do not report on a trade’s impact on the IBD’s aggregate

activity and risk profile.17

Each of the reports received by Clearing provided inputs for a risk assessment,

which was ultimately conducted manually. In this way, Clearing’s risk-management

system depended on Clearing’s small risk team. Clearing’s risk employees would

monitor risk events and, using their professional judgment, escalate matters to senior

management on a discretionary basis.18 Carlos Salas, Clearing’s CEO before the

merger, was in constant contact with Clearing President Jeffrey Sime on sizable risk

events that had been escalated to senior management.19

Along with the risk team, Clearing had a credit and risk committee that met

weekly to review Clearing’s relationships with IBD customers. Risk employees

collected materials for review by the credit and risk committee, including Company

interactions with an IBD client and regulatory actions taken against the IBD.20 The

committee reviewed a subset of IBD customers each week with the goal of reviewing

every customer once annually.21 The committee also met ad hoc to address sensitive

events.22 The committee was empowered to make adjustments to Clearing’s

16 Id. at 550:9–551:2 (Abramczyk); id. at 94:8–9 (Tolla).

17 Id. at 772:8–12, 801:10–14 (Salas).

18 Id. at 801:15–802:5 (Salas); see also id. at 826:21–827:7, 828:14–22 (Salas).

19 Id. at 802:6–11 (Salas).

20 Id. at 751:23–752:10 (Salas).

21 Id. at 751:3–17 (Salas).

22 Id. at 750:13–751:7 (Salas).

5
relationship with an IBD, which could include raising deposit requirements, lowering

trading limits, and terminating the relationship.23

When warranted, Clearing could take immediate action to stop a trade-away

IBD’s activity. Clearing could call the market center that executes the trades to

terminate sponsorship of the customer firm.24 Clearing could call the IBD’s own order

management system operator and notify it that the IBD’s orders are not authorized.25

Or Clearing could immediately halt the activity by using Clearing’s administrative

access to the IBD’s order management system and hitting the “kill switch.” The kill

switch allowed Clearing to shut down trading for a specific position or a specific

trader.26

Clearing could also reduce its exposure to an IBD’s trading by buying itself out

of a risky position. If Clearing’s risk managers or senior leadership felt that Clearing

was overexposed to a short position, Clearing could buy stock to balance its

exposure.27

Clearing issued margin calls to manage risk. Clearing’s IBD customers

maintain accounts with Clearing intended to cover their trading positions.28 Based

23 Id. at 752:11–753:10 (Salas).

24 Id. at 749:2–19 (Salas).

25 Id. at 666:10–14 (Abramczyk); id. at 746:22–748:8 (Salas); Sime Day 2 Dep. Tr. at

211:1–9.
26 JX-8 at 1; Trial Tr. at 47:23–48:11, 74:7–19 (Tolla).

27 Salas Rule 30(b)(6) Dep. Tr. at 106:9–108:6, 111:20–113:3.

28 Trial Tr. at 35:2–36:16 (Tolla).

6
on price movements of a trading position’s underlying security, Clearing requires

IBDs to either add additional funds to its account with Clearing or reduce its trading

position.29 If the IBD does not respond to a margin call, Clearing could close the

position.30 Clearing issues margin calls before an IBDs’ trading exposure exceeds the

funds in its account.31

Of course, Clearing also receives margin calls from the market centers based

on the trading positions of its IBD customers. Clearing is independently obligated to

fund those calls irrespective of the IBD’s response.32 This creates liquidity risk for

Clearing.33

In sum, Clearing maintained a small risk department that relied on a handful

of reports and human decision-making to identify and escalate trading risks. For the

most part, this system worked. Clearing never suffered a significant trading loss in

the seven years that Salas led Clearing.34

B. FINRA Recommends Changes To Clearing’s Trade-Away Risk-
Management Procedures.

FINRA conducts annual cycle examinations of FINRA-regulated businesses

like Clearing to ensure compliance with FINRA rules and federal securities laws.35

29 Id. at 764:19–765:2 (Salas).

30 Id. at 759:5–11 (Salas).

31 Id. at 764:19–765:2, 758:1–6 (Salas).

32 Id. at 765:3–8 (Salas).

33 Id.

34 Id. at 698:20–23, 702:11–24 (Salas).

35 JX-160 at 1.

7
FINRA also conducts “cause” examinations on an event basis, such as after a trading

loss or customer complaints.36

After an examination, FINRA may issue a report with exceptions and

recommendations for the FINRA member.37 The report requires a response from the

member firm discussing how the firm will address the exceptions noted in the report,

and FINRA then resolves the matter through an “Examination Disposition Letter.”38

There are three types of Examination Disposition Letters: “No Further Action”

letters, which FINRA issues when it does not find a violation; “Cautionary Action”

letters, which FINRA issues to warn a member firm that a similar violation may

result in formal disciplinary action; and a “Compliance Conference,” which is a more

serious informal action that involves a meeting between FINRA and management.39

FINRA published the “2017 Cycle Examination” report of Clearing on March

19, 2018.40 The report listed exceptions, where FINRA noted Clearing’s non-

compliance with a FINRA rule, as well as recommendations. The report

recommended that Clearing increase oversight of limit breaches, noting that some

trade-away transactions were not adequately “review[ed,] approv[ed]” or “escalat[ed]

to senior management.”41 The report’s recommendations raised concerns regarding

36 Trial Tr. at 895:12–24 (Diles).

37 JX-163 at 7.

38 Id.

39 Id.

40 JX-35.

41 Id. at 5–6.

8
the absence of real-time monitoring of certain IBDs trading away.42 The report also

suggested that Clearing document the reason for credit limits higher than what

Clearing’s policies proscribed.43

The Company responded to the FINRA report on May 4, 2018. The response

stated that the Company had “amended its procedures to incorporate the

recommendations detailed” by FINRA addressing trade-away IBDs. The response

identified three changes in Company procedure and policy.

First, the Company implemented “new procedures for review and approval of

. . . limit breaches” that generated DTCC alerts.44

Second, the Company began designing a new risk monitoring system:

. . . COR is designing a new risk monitoring system which
includes, among other things, risk monitoring displays that
focus on certain correspondent customer balances and
activities. These risk monitoring systems will use real-
time execution or NSCC clearing record drop copies to
display in real-time records that measure key balances and
activity. These risk tools will provide broad monitoring of
all correspondent customers whether they trade away or
trade through COR’s systems.45

Third, the Company “created a process to document the review and approval

of trading limits.”46

42 Id.

43 Id. at 7.

44 JX-19 at 6; Barth Dep. Tr. at 42:17–24.

45 JX-19 at 6.

46 Id.

9
FINRA sent a Cautionary Action letter to Clearing on May 14, 2018 (the “2018

Cautionary Action Letter”).47 As to the exceptions in the report, the letter cautioned

Clearing of its “violations of securities rules and regulations,” and warned that if a

repeat violation occurred, FINRA would consider the 2018 Cautionary Action Letter

when deciding what action to take.48 But the letter also stated that the Company did

not need to disclose the letter in the Company’s public registration filings, and that

FINRA’s decision “not to take action” should have no “evidentiary weight in any

mediation, arbitration, or judicial proceeding.”49

C. Axos Offers To Acquire Clearing.

Axos became interested in acquiring Clearing in 2015 and began conducting

diligence into Clearing in August 2017.50 That month, Clearing CEO Salas and

Clearing President Jeff Sime met with Axos representatives. Axos Financial’s Head

of Risk, John Tolla, led the diligence effort into compliance and risk management.51

Axos Financial’s CFO, Andrew Micheletti, and Chief Accounting Officer, Derrick

Walsh, led financial diligence.52

Moelis & Company advised Clearing in the sale process. Moelis prepared a

confidential information presentation, or “CIM,” that discussed Clearing’s trade-

47 JX-36.

48 Id. at 2.

49 Id.

50 Garrabrants Rule 30(b)(6) Dep. Tr. at 47:17–48:4.

51 Trial Tr. at 132:8–10 (Tolla).

52 See JX-148, at 1; Walsh Dep. Tr. 19–25; Trial Tr. at 371:6–12 (Garrabrants).

10
away IBDs.53 Clearing provided the CIM to Axos during an August 2017 meeting.54

In addition to the detail provided in the CIM, Salas and Sime told Axos that Clearing

examined trade-away IBDs’ order management systems to ensure they enforced daily

trade limits and maintained administrative access to trade-away IBDs’ order

management terminals.55

On October 2, 2017, Axos issued a non-binding proposal to acquire Clearing.56

The proposal listed the following three areas as “remaining due diligence items”: (i)

technology and infrastructure; (ii) regulatory and legal; and (iii) financial and

accounting.57 Remaining diligence items in the technology and infrastructure

category comprised: “[l]ist of IT projects – ongoing and projected over the next 24

months – including costs, staffing and projected completion dates; [p]rocess and

procedures for IT development projects; [r]eview of software code and custom

software and hardware integrations.”58 The offer did not specifically identify risk

management as a topic for remaining diligence.

53 Trial Tr. at 391:10–22 (Garrabrants); id. at 728:3–7 (Salas); JX-18 at 57.

54 Trial Tr. at 291:3–16 (Micheletti); JX-18 at 57.

55 Trial Tr. at 141:6–17 (Tolla); id. at 292:3–293:21, 294:16–295:22 (Micheletti); JX-

18 at 57.
56 JX-14.

57 Id. at 2.

58 Id. at 5.

11
D. Axos Conducts Diligence.

1. Clearing’s Risk-Management System

Axos’s diligence of Clearing began in earnest in early 2018.59 At the start of

diligence, Axos Financial CEO Gregory Garrabrants tasked Tolla with assessing

Clearing’s compliance and risk management and alerted Tolla to the elevated risk

profile of IBD customers that traded away.60

Tolla conducted diligence on Clearing’s order management systems and

controls.61 Tolla went to Clearing’s Omaha headquarters several times for diligence

matters. He conducted firsthand tests on Beta when there.62 Tolla did not conduct

tests on any systems for IBDs that traded away from Clearing. According to Tolla,

the Clearing team told him that the Company had administrative access to the order

management systems of IBDs that traded away,63 and the Axos team continued to

discuss the August 2017 Moelis CIM with Clearing.64

Clearing provided the contents of the 2017 Cycle Examination report,

Clearing’s response, and the 2018 Cautionary Action letter to Tolla during diligence.65

59 See Trial Tr. at 185:19–186:7 (Tolla).

60 Id. at 132:8–17 (Tolla).

61 Id. at 185:3–6 (Tolla).

62 Trial Tr. at 133:4–6, 193:21–194:18 (Tolla); id. at 435:23–436:10 (Garrabrants).

63 See, e.g., Trial Tr. at 142:9–11 (Tolla).

64 Id. at 285:14–16 (Micheletti), id. at 391:10–21 (Garrabrants); Tolla Dep. Tr. at

42:7–11.
65 PTO ¶ 11.

12
And Tolla reviewed these materials.66 He asked about the Company’s response in

diligence calls and meetings with Mark Bell, then-Chief Legal & Compliance Officer

of Clearing, and Efren Cleofe, a member of Bell’s team.67 According to Tolla, Bell and

Cleofe confirmed that Clearing’s responses were accurate and that the project to

“design a new risk monitoring system” was completed.68

After completing diligence, Tolla recommended the merger to Axos. He felt

that the risk-management system was “well-configured” and compliance oversight of

IBDs was “adequate.”69

2. The Barth Plan

In response to FINRA’s 2017 Cycle Examination, Clearing hired Michael Barth

as its Chief Risk Officer in March 2018.70

Barth sent proposals for improving Clearing’s risk-management system to

Sime on May 2, 2018, two days before Clearing responded to FINRA’s examination

report. Barth’s proposals included moving Clearing to a real-time monitoring system

by using intraday drop copies and implementing a pre-trade risk gateway that could

66 Trial Tr. at 142:24–143:11, 146:9–19, 189:3–10 (Tolla).

67 See JX-18.

68 Id. at 148:1–21, 149:13–150:9 (Tolla).

69 Id. at 169:14–170:2 (Tolla).

70 Barth Dep. Tr. at 22:1–5; JX-37 at 2.

13
stop trades from a third party based on aggregate risk inputs.71 Barth emphasized

the importance of transitioning to real-time monitoring in his proposal.72

Clearing took no action on Barth’s proposal until late November 2018 (after

executing the merger agreement but before closing) when Barth was authorized to

hire a vendor to implement the IT components of his proposal.73 Barth felt like he

was “being blown off.”74

E. Axos Acquires Clearing.

On September 28, 2018, Legent Group, LLC, COR Securities Holdings Inc.,

COR Advisors LLC, St. Cloud Capital Partners II, L.P., and Carlos P. Salas (together,

“Sellers”) agreed to sell the Company to Axos Clearing, LLC and Axos Clarity

MergeCo., Inc. (together, “Buyers”), under an Agreement and Plan of Merger (the

“Merger Agreement”).75 The transaction (the “Merger”) closed on January 29, 2019

(the “Closing Date”).76

Buyers paid $80 million in cash for Clearing.77 Buyers withheld $7.5 million

of the sale price in the form of subordinated notes issued to Buyers by Axos Financial,

71 JX-37 at 2; Trial Tr. at 126:8–16, 248:13–18 (Tolla); id. at 471:22–472:8
(Garrabrants).
72 JX-38.

73 Barth Dep. Tr. at 104:10–15; JX-41.

74 Barth Dep. Tr. at 100:16–18.

75 JX-9 (“Merger Agr.”); JX-11.

76 PTO ¶ 10.

77 Merger Agr. § 2.2(a).

14
Inc. (“Notes”).78 A subordinated loan agreement set the terms of the Notes.79 Under

the Merger Agreement, the Notes are Buyers’ sole source of recovery for an

indemnification claim.80

Article 8 of the Merger Agreement provides that Sellers will indemnify Buyers’

entities (defined in the Merger Agreement as “Parent Indemnified Parties”) for “any

and all damage . . . arising out of or resulting from . . . the failure of any of the

representations or warranties of Company set forth in Article III to be true and

correct” at signing or closing.81

Two Article III representations are relevant to this litigation. Section 3.12(a)

represents that the Company “has complied in all material respects with all

applicable Laws and Orders” (the “Legal-Compliance Representation”).82 Article

3.13(b) represents that, for Clearing’s “Material Contracts,” “there exists no default

or event of default or event, occurrence, condition or act . . . to the Knowledge of the

Company, with respect to any other contracting party, which . . . would become a

default or event of default[.]” (the “Counterparty-Breach Representation”).83 This

decision quotes both provisions in the legal analysis.

78 Id. § 2.4.

79 JX-12.

80 PTO ¶ 5; Merger Agr. §§ 8.2(a), 8.5(d).

81 Merger Agr. § 8.2.

82 Id. § 3.12(a).

83 Id. § 3.13(b).

15
The Merger Agreement also contains an anti-reliance provision—a

representation by Buyers stating that they did not rely on any representations Sellers

made other than those in the Merger Agreement.84

F. Axos Removes Clearing’s CEO.

The Merger closed on January 28, 2019, and Clearing became Axos Clearing.85

Salas agreed to remain Clearing’s CEO for a six-month transition period.86 But

during the last week of February 2019, Garrabrants asked Salas to resign.87

Although Salas expressed concern about an apparent lack of transition plan,

Garrabrants felt that Salas’s presence was unnecessary.88 Axos did not immediately

fill the CEO position. President Sime reported directly to Garrabrants after Salas’s

departure.89

G. Clearing Incurs The Reynolds Loss.

Spartan Securities Group, Ltd. (“Spartan”) was one of Clearing’s trade-away

IBDs.90 An April 8, 2013 agreement governed the relationship between Spartan and

Clearing (the “Spartan Agreement”).91 The Spartan Agreement placed “exclusive

responsibility” on Spartan for compliance with the agreement and all applicable SEC

84 Id. § 4.10.

85 JX-11.

86 JX-13 at 2.

87 Trial Tr. at 792:22–793:4 (Salas).

88 Id. at 461:21–462:10 (Garrabrants); id. at 793:14–23 (Salas).

89 Trial Tr. at 460:17–461:15 (Garrabrants).

90 PTO ¶ 9; JX-6.

91 JX-6.

16
and FINRA rules.92 Spartan represented that it would maintain compliance with all

applicable net capital requirements.93

The Spartan Agreement incorporated by reference an inventory lending

agreement that established trading limits.94 Spartan also imposed internal limits on

its traders, but Spartan primarily relied on human oversight of trading activity to

enforce both the contractual and internal limits.95 It is unclear whether Clearing had

administrative access to Spartan’s order management system.

Clearing issued margin calls to Spartan four times in 2018, including once

after Clearing signed the Merger Agreement.96 It was not unusual to issue margins

calls to IBDs at this frequency.97

On March 6, 2019, Scott Reynolds, a principal at Spartan, acquired a short

position in BioPath Holdings, Inc., a microcap biotech security. After Biopath’s stock

price rose unexpectedly, Reynolds got caught in what is called a “short squeeze”—a

situation where a trader must close their short position on a security in response to

a sudden and unexpected increase in the security’s price. Reynolds did not do so.

Instead, Reynolds doubled down and increased his short position. Reynolds tried to

92 JX-6 §§ 2.1.6, 3.4.

93 Id.

94 Id. § 2.1.6; JX-107 at 15.

95 See, e.g., JX-102 at 1–2; see also Lopez Dep. Tr. at 57:18–58:24, 99:18–100:17;

Lindner Dep. Tr. at 37:24–38:18.
96 JX-26; JX-28; JX-29; JX-30.

97 Trial Tr. at 204:22–205:20 (Tolla); id. at 758:15–19 (Salas).

17
cover up the exposure by creating a “wooden ticket”98— a strategy involving fictitious

trade entries that looked like they would close his position out. The events unfolded

as follows:

• In the morning of March 6, 2019, Reynolds had a marked-to-market
short position of -$9,264.99

• Before the market opened on the morning of March 6, 2019, Reynolds
increased his short position to -$1,046,570.100 Reynolds began spoofing
the Spartan system by acquiring long positions and quickly cancelling
them.101 It thus appeared to Spartan that he was shrinking his short
position.102 Before the market opened, Reynolds’s true short position
exceeded Spartan’s trading limits.103

• By 9:30 a.m. ET when the market opened, Reynolds had a marked-to-
market position of -$1,747,005.104

• By 10:15 a.m. ET, Reynolds had a marked-to-market position of
-$3,012,635. By this time, employees at Spartan had become aware that
Reynolds was concealing his true short position and David Lopez,
Spartan’s Chief Compliance Officer, resolved to close out Reynolds’s
position the next day.105

• By 11:00 a.m. ET, Reynolds had a marked-to-market position of
-$5,659,822.106 Lopez began texting Reynolds about the short position.
He urged Reynolds to close out the position because Spartan did not

98 Lindner Dep. Tr. at 39:6–43:14.

99 JX-158 at 50; JX-22 at 7. The position is “marked-to-market” by multiplying the
net shares in the position by the market price of the security. JX-158 at 50.
100 JX-158 at 50.

101 Trial Tr. at 221:4–24 (Tolla).

102 Lindner Dep. Tr. at 38:25–42:15.

103 JX-158 at 32.

104 Id. at 50.

105 Lindner Dep. Tr. at 42:9–46:17.

106 JX-158 at 50.

18
have the capital to support it. Reynolds assured him the position would
recover.107

• At 11:09 a.m. ET, Clearing’s ACT system generated an alert informing
Clearing that Spartan was approaching or exceeding 70% of its
proscribed notional value limit.108 Spartan’s limit was $10 million, so
the alert informed Clearing that Spartan’s position exceeded $7 million
in notional value. It is unclear whether any employee at Clearing
viewed the alert when it issued. Clearing took no action at this time.109

• By 11:45 a.m. ET, Reynolds had a marked-to-market position of
-$7,899,596.110

• By 12:30 p.m. ET, Reynolds had a marked-to-market position of
-$11,440,460.111 Around that time, Clearing’s DTCC system generated
an alert stating that Spartan had surpassed a net notional value of $7.5
million.112 Clearing’s risk team had reviewed the DTCC alert when it
issued. By that time, they had also reviewed the ACT alert.113

• At 1:07 p.m. ET, the DTCC system’s settlement arm, National Securities
Clearing Corporation, issued a margin call to Clearing for over $3
million.114 Clearing’s treasury department wired the funds to National
Securities Clearing Corporation and notified management of the wire.115

• By 1:15 p.m. ET, Reynolds had a marked-to-market position of
-$11,365,734.116 Sometime between 1:07 p.m. ET and 1:54 p.m. ET,

107 JX-99 at 1–2.

108 JX-22 at 7; JX-158 at 50.

109 JX-22 at 7, Trial Tr. at 107:17–108:5 (Tolla).

110 JX-158 at 50.

111 Id.

112 JX-22 at 7.

113 Id.

114 Id.; Trial Tr. at 108:10–109:3 (Tolla).

115 JX-22 at 7.

116 JX-158 at 50.

19
Clearing’s risk team escalated the matter to Chief Risk Officer Barth
and President Sime.117

• By 1:45 p.m. ET, Reynolds had a marked-to-market position of
-$10,552,954.118 Minutes later, Clearing’s risk team contacted Spartan
for the first time. The Clearing team demanded that Spartan close
Reynolds’s position.119

• By 2:00 p.m. ET, Reynolds had a marked-to-market position of
-$9,114,459.120 Five minutes later, Reynolds responded to Clearing on
behalf of Spartan, stating that Spartan would cover a majority of the
position. Over the next two hours, Spartan worked on covering the short
before market close.121 Clearing did not take further action outside of
receiving updates from Spartan.122

• By market close at 4:00 p.m. ET, Reynolds had a marked-to-market
position of -$7,789,035.123 Spartan told Clearing that it had been unable
to cover the short and would continue to try to buy Biopath shares
during extended hours trading.124

• The following morning around market open, Sime contacted
Garrabrants, asking if Clearing should close Spartan’s position or wait
for Spartan to close the position itself.125 Garrabrants said he would
need to think about it and did not instruct Sime to close Reynolds’s
position.126 But Biopath’s stock price had risen overnight.127 Trading
became so volatile on March 7 that NASDAQ paused trading of Biopath
15 times.128 Spartan managed to close out Reynolds’s position by 1:30

117 JX-22 at 7; Sime Day 2 Dep. Tr. at 112:7–114:4; Barth Dep. Tr. at 117:19–119:12.

118 JX-158 at 50.

119 JX-22 at 8; Trial Tr. at 109:15–23 (Tolla).

120 JX-158 at 50.

121 JX-22 at 8.

122 JX-99 at 3.

123 JX-158 at 50.

124 JX-22 at 8.

125 Sime Day 1 Dep. Tr. at 252:2–9.

126 Sime Day 2 Dep. Tr. at 118:5–19.

127 JX-22 at 10; Sime Day 2 Dep. Tr. at 117:21–22.

128 JX-22 at 10.

20
p.m. ET. At no point did anyone at Clearing instruct employees to close
out Spartan’s position.129

In the end, Clearing suffered a loss of $16.6 million.130 Spartan covered $1.4

million of the loss, leaving a net loss of $15.2 million (the “Reynolds Loss”).131 For the

Company to maintain sufficient net capital, Axos Financial had to wire $15 million

to Clearing.132

H. FINRA Issues A Cautionary Action Letter Regarding Clearing’s
Risk-Management System.

Following the Reynolds Loss, FINRA conducted a cause examination at

Clearing (the “2019 Cause Examination”).133 FINRA issued a report on November

26, 2019, with an exception stating that Clearing “was not in compliance with”

FINRA Rule 3110 and FINRA Rule 4210(d).134

On January 10, 2020, Clearing provided a written response to the 2019 Cause

Examination report disputing FINRA’s findings.135 Clearing argued that the report

“fail[ed] to take into account the fact that the loss was the result of a fraud

perpetrated by Scott Reynolds . . . which was accomplished by his intentional

circumvention of [] Clearing’s controls[.]”136 Despite Reynolds’s fraud, Clearing

129 Sime Day 2 Dep. Tr. at 118:20–21; Barth Dep. Tr. at 119:7–12.

130 JX-158 at 3.

131 Id.

132 Trial Tr. at 313:14–314:16 (Micheletti); JX-23.

133 JX-2.

134 Id. at 3.

135 JX-3 at 1.

136 Id. (emphasis omitted).

21
maintained that its “controls, including its intraday controls were adequate on March

6, 2019.”137 Clearing also expressed its commitment to “enhanc[ing]” its risk controls

and described plans for strengthened pre-trade risk procedures, comprehensive

intraday trade monitoring, and decreased limits for IBDs that trade away.138

In response, FINRA sent the Company an Examination Disposition Letter on

February 11, 2020 (the “2020 Cautionary Action Letter”), which was substantively

similar to the 2018 Cautionary Action Letter.139

I. Axos Demands Indemnification.

Four months after the Reynolds Loss, Buyers tendered a demand for

indemnification to Sellers, alleging a breach of the Legal-Compliance Representation,

the Counterparty-Breach Representation, and a representation regarding net capital

that is not at issue. The demand stated that Sellers breached the representations by

causing the Company to violate FINRA rules and by failing to disclose Spartan’s

existing default on the Spartan Agreement.140

J. A FINRA Arbitration Panel Finds Reynolds Solely Responsible
For The Reynolds Loss.

On August 13, 2019, Clearing brought FINRA arbitration claims against

Reynolds for fraudulent misrepresentation, negligent misrepresentation, fraudulent

137 Id. at 6 (cleaned up).

138 Id. at 6–7.

139 JX-4 at 1; see JX-36.

140 JX-201.

22
failure to disclose, tortious interference, breach of contract, and unjust enrichment.141

In the arbitration, Clearing took the position that it had the ability to close out

Reynolds’s position but relied on Reynolds’s promise that he would close out the

position.142 In May 2021, the FINRA panel found Reynolds “solely responsible” for

the Company’s losses and ordered Reynolds to pay over $17 million to Clearing.143 As

of the trial date, this sum had not been paid.

K. Sellers File This Litigation.

The Notes became due and payable on April 28, 2020.144 When the outstanding

sums were not paid, Sellers filed this suit on May 27, 2020, seeking a declaratory

judgment that: (1) they do not have a duty to indemnify Buyers under the Merger

Agreement; (2) there is no basis to reduce principal due under the Notes; and (3) Axos

must pay the outstanding principal under the Notes.145 Sellers also sought damages

for the amount of allegedly unpaid principal under each Note, plus costs and

attorneys’ fees.146 The court denied Buyers’ motion to dismiss Sellers’ declaratory

judgment claim but dismissed Sellers’ claims for damages under the Notes for lack of

subject-matter jurisdiction based on the Notes’ arbitration provisions.147

141 JX-232 at 24–32; JX-106 at 2.

142 JX-236 at 4204:23–4205:16.

143 JX-106 at 8.

144 JX-12 § 1(a).

145 Dkt. 1.

146 Id. at 19–25.

147 Dkt. 30.

23
Sellers amended their complaint on February 17, 2021 to remove the counts

over which the court lacked subject matter jurisdiction.148 On March 12, 2021, Buyers

filed an answer and asserted a counterclaim for declaratory relief.149 The court

granted Sellers’ motion for leave to file a Second Amended Complaint over Buyers’

opposition.150 Sellers filed the Second Amended Complaint on October 12, 2021.151

The Second Amended Complaint contains two counts: In Count I, Sellers seek

three declarations: First, Sellers have no duty to indemnify Clearing and Buyers.

Second, there is no basis to reduce principal due under the Notes. And third, Axos

must make full payment of the outstanding principal under the Notes. In Count II,

Sellers claim that Buyers breached Section 8.2(a) of the Merger Agreement by

wrongfully asserting their indemnification demands.152

Buyers moved to dismiss and strike the Second Amended Complaint on

October 26, 2021.153 Sellers moved for judgment on the pleadings with respect to

Buyers’ counterclaim, arguing that findings in the FINRA arbitration stating that

Reynolds was solely responsible for Clearing’s losses collaterally estopped Buyers’

arguments here.154 On July 11, 2023, the court dismissed the claim in Count II

148 Dkt. 38.

149 Dkt. 42.

150 Dkt. 109.

151 Dkt. 118 at 35.

152 Id. at 36–37.

153 Dkt. 124.

154 Dkt. 94.

24
against Axos Financial, Inc. and otherwise denied the motion to dismiss.155 The court

denied the motion for judgment on the pleadings.156

Sellers did not press Count II as to Axos Securities and Buyers did not

expressly pursue their counterclaim, which sought mirror-image relief to that

requested by Sellers. The parties went to trial on Count I of the Second Amended

Complaint.

The court held a four-day trial from April 29, 2024 through May 2, 2024. The

parties completed post-trial briefing on January 17, 2025,157 and the court heard post-

trial argument on May 8, 2025.158

II. LEGAL ANALYSIS

The parties’ post-trial dispute centers on whether Buyers are entitled to

indemnification. Subject to a basket not implicated at this stage, Sellers agreed in

Section 8.2(a) of the Merger Agreement to indemnify Buyers:

for any and all damage, loss and expense . . . to the extent
actually suffered or incurred by a Parent Indemnified
Party arising out of or resulting from [] the failure of any
of the representations or warranties of Company set forth

155 Dkt. 191.

156 Dkt. 191; see Dkt. 194 at 29:11–14, 35:18–23.

157 Dkt. 355.

158 Dkt. 364. On the eve of trial, Sellers filed an emergency motion to compel the
production of the FINRA arbitration transcripts and documents that Buyers had
previously stated were protected from discovery because they were confidential. Dkt.
316. After trial, Sellers filed a motion for sanctions due to Buyers’ discovery conduct.
The court resolves the sanctions motion in a separate letter decision.

25
in Article III to be true and correct on June 1, 2018 or at
and as of the Closing Date[.]159

For a representation to give rise to indemnification under Section 8.2(a), it

must have been inaccurate as of June 1, 2018, or the January 29, 2019 Closing Date,

and it must be the cause (“arising out of or resulting from”) of the damages, loss, or

expense actually incurred.

Buyers argue that neither the Legal-Compliance Representation nor the

Counterparty-Breach Representation were true and correct as of the Closing Date.160

Buyers further argue that each inaccuracy was an independent cause of the Reynolds

Loss.

Buyers bear the burden of proving that the representations on which they rely

were inaccurate when the Merger closed.161 They also bear the burden of proving

causation.162

The court’s task is to interpret the Merger Agreement in a way that carries out

the parties’ intent.163 Absent ambiguity, the court “will give priority to the parties’

intentions as reflected in the four corners of the agreement, construing the agreement

as a whole and giving effect to all its provisions.”164 The contract terms will be given

159 Merger Agr. § 8.2(a).

160 Id.

161 AB Stable VIII LLC v. Maps Hotels & Resorts One LLC, 2020 WL 7024929, at *49

(Del. Ch. Nov. 30, 2020), aff’d, 268 A.3d 198 (Del. 2021).
162 Id.

163 Lorillard Tobacco Co. v. Am. Legacy Found., 903 A.2d 728, 739 (Del. 2006).

164 In re Viking Pump, Inc., 148 A.3d 633, 648 (Del. 2016) (quoting Salamone v.
Gorman, 106 A.3d 354, 368 (Del. 2014)).

26
“plain, ordinary meaning.”165 “[T]he meaning which arises from a particular portion

of an agreement cannot control the meaning of the entire agreement where such

inference runs counter to the agreement’s overall scheme or plan.”166 The court must

“reconcile all the provisions of the instrument” if possible.167

A. Legal-Compliance Representation

Section 3.12(a) of the Merger Agreement states, in relevant part:

Except as set forth in Section 3.12(a) of the Disclosure
Schedule, since June 30, 2015, Company and each of its
Subsidiaries . . . has complied in all material respects with
all applicable Laws and Orders . . . .168

This language contains the Legal-Compliance Representation—that, since June 30,

2015, Clearing has complied in all material respects with all applicable Laws and

Orders. Again, to support Buyers’ claim for indemnification, the Legal-Compliance

Representation must be inaccurate as of the Closing Date. This language also

contains a carveout: “[e]xcept as set forth in Section 3.12(a) of the Disclosure

Schedule” (the “Carveout”). The phrase “except as set forth” indicates that the Legal-

Compliance Representation does not cover items in Section 3.12(a) of the Disclosure

Schedule.

165 Alta Berkeley VI C.V. v. Omneon, Inc., 41 A.3d 381, 385 (Del. 2012) (citing City

Investing Co. Liquid. Tr. v. Cont’l Cas. Co., 624 A.2d 1191, 1198 (Del. 1993)).
166 E.I. du Pont de Nemours & Co. v. Shell Oil Co., 498 A.2d 1108, 1113 (Del. 1985);

accord. HUMC Holdco, LLC v. MPT of Hoboken TRS, LLC, 2020 WL 3620220, at *6
& n.40 (Del. Ch. July 2, 2020); Great Hill Equity P’rs IV, LP v. SIG Growth Equity
Fund I, LLLP, 2018 WL 6311829, at *50 & n.648 (Del. Ch. Dec. 3, 2018).
167 Elliott Assocs. v. Avatex Corp., 715 A.2d 843, 854 (Del. 1998).

168 Merger Agr. § 3.12(a).

27
To prevail on their Legal-Compliance Representation theory, therefore, Buyers

must prove both that Clearing was in violation of “Laws and Orders” on the Closing

Date and that the violation is not covered by the Carveout. Buyers have proven

neither.

1. The Representation

“Laws and Orders” include FINRA rules,169 and Buyers claim that Clearing

violated two FINRA Rules: Rule 3110 and Rule 4210(d).170 As of the Closing Date,

Rule 3110 required that each FINRA member firm have a system that is “reasonably

designed to achieve compliance with applicable securities laws and regulations, and

with applicable FINRA rules.”171 Rule 4210(b) established specific requirements for

new transactions, requiring that members establish procedures to: “(1) review limits

and types of credit extended to all customers; (2) formulate their own margin

requirements; (3) review the need for instituting higher margin requirements, mark-

to-markets and collateral deposits than are required by this Rule for individual

securities or customer accounts.”172 Read together, FINRA Rules 3110 and 4210(b)

require that a clearing firm’s risk system be reasonably designed to achieve

compliance with FINRA rules, including Rule 4210(b).173

169 See id. § 3.3(b).

170 Defs.’ Post-Trial Opening Br. at 8; see also JX-166; JX-167.

171 JX-167 at 1.

172 JX-166 at 5.

173 Sellers deny that these rules should be read together in this way.
Pls.’ Post-Trial
Opening Br. at 48–51. But the language of the FINRA rules is unambiguous.

28
The “reasonably designed” standard affords clearing firms a great deal of

flexibility in designing their risk system. As Buyers acknowledged in briefing, there

is no “precise set of controls that must be in place.”174

Sellers called individuals who worked at Clearing before the Closing Date who

credibly testified about aspects of Clearing’s compliance. Chief Risk Officer Barth,

whom Buyers describe as a “highly credible” and “neutral” witness, testified several

times that the risk systems at issue complied with FINRA rules.175 CEO Salas

testified that Clearing engaged industry-leading consulting firms to evaluate

Clearing’s controls and propose changes (which were implemented). 176 According to

Salas, at the time of the Merger, Clearing’s controls were “technology solutions that

were broadly accepted in the industry,” and were “good controls” for “a clearing firm

of [Clearing’s] size.”177

Sellers also relied on evidence of FINRA’s 2017 Cycle Examination, which

found no rule violations relevant to Buyers’ claims.178 Sellers further note that even

Buyers contended that Clearing’s system complied with applicable regulations when

174 Defs.’ Post-Trial Opening Br. at 14 (emphasis in original); see also Trial Tr. at

902:12–17 (Diles); id. at 1075:18–1076:12 (Selman).
175 Barth Dep. Tr. at 57:9–15, 127:16–128:4.

176 Trial Tr. at 719:22–722:4 (Salas).

177 Id. at 767:15–23 (Salas); see also Sime Day 2 Dep. Tr. at 195:20–24 (testifying that

there was no violation of FINRA rules).
178 JX-35.

29
it was convenient for them, describing Clearing’s compliance in a letter to FINRA

dated January 10, 2020.179

In the face of this general evidence of compliance, Buyers proffer a more

specific definition of “reasonable.” Buyers say that, at a minimum, a reasonably

designed risk system must contain an appropriate “mix of preventative, detective,

and responsive controls and procedures” for extending credit to IBDs that traded

away.180 Buyers further argue that Clearing’s risk system lacked any of the minimum

requirements on the Closing Date.

Buyers rely foremost on testimony from their expert on what a reasonably

designed risk system should include. They also point to FINRA’s 2019 Cause

Examination report and the 2020 Cautionary Action Letter, and fact testimony from

Chief Risk Officer Barth detailing his proposed improvements to Clearing’s risk

system.

These three categories do not show, independently or taken together, that the

Legal-Compliance Representation was inaccurate on the Closing Date.

a. Expert Testimony

Buyers called Jeffrey Abramczyk to provide an expert opinion on what

constitutes a reasonably designed supervisory system.181 Abramczyk is highly

179 JX-3 at 6.

180 Defs.’ Post-Trial Opening Br. at 10 (cleaned up) (citing JX-158 at 22–25); id. at 15.

181 JX-158 at 3.

30
qualified. He has over 30 years of experience in auditing, finance, risk management,

and compliance at major financial institutions, including broker-dealers.182

Abramczyk opined that Clearing’s risk systems lacked technological and

bureaucratic infrastructure. According to Abramczyk, Clearing’s supervisory risk

systems were inadequate in three areas: setting trading limits; monitoring trades

through administrative access to order management systems; and establishing

detailed procedures to respond to risk events.183 Abramczyk testified that the four or

five clearing firms that he had worked with all had those three fundamentals, though

each firm had a bespoke system suited to its business.184

All three inadequacies Abramczyk identified at Clearing correlate to an

absence of technological controls that effectively “hard-code” risk-management

procedures.185 Per Abramczyk, Clearing was not setting or enforcing trade limits and

had to rely on Spartan’s internal discretion in monitoring high-risk trades.186 His

proposed solution was to access IBDs’ trading systems to impose and verify

technological controls.187 Clearing’s reliance on alerts from the ACT and DTCC

systems to monitor trading activity was insufficient, said Abramczyk, because those

182 Id. at 11.

183 Id. at 20–25; see also Trial Tr. at 598:14–600:7 (Abramczyk).

184 Trial Tr. at 597:17–600:7 (Abramczyk).

185 To “hard code” a procedure is to fully automate a process such that no human

decision-making is required. See, e.g., Trial Tr. at 242:3–18 (Tolla).
186 JX-158 at 22–23.

187 Id. at 23.

31
systems report on the notional value of trading positions. They are not tailored to

margin limits or specific characteristics of certain securities or accounts. 188 So his

proposed solution was to deploy additional technological controls with real-time

monitoring capabilities.189 Also, Clearing had sparse written procedures that only

required that the risk department “investigate[] alerts it receive[d]” and “tak[e] action

when necessary.”190 Abramczyk’s faulted Clearing for not adopting additional

procedures that tell risk managers what to do without relying on those managers’

professional judgment.191

Put simply, Abramczyk opined that for a risk system to be reasonably

designed, it must contain automatic technological controls to prevent or identify a

limit breach. And if a limit was breached, a risk manager must automatically resolve

the matter or escalate the situation under more specific written procedures.

Sellers called Thomas M. Selman and Colleen Diles to rebut Abramczyk’s

report. Both experts are also highly qualified. Selman served in regulatory,

operations, and examination roles at FINRA for nearly 25 years,192 and he personally

participated in decisions on whether to administer letters of caution to member firms

and whether to refer infractions to FINRA’s enforcement department. Diles worked

188 Trial Tr. at 556:6–17, 556:23–557:7 (Abramczyk); Sime Day 1 Dep. Tr. at 35:4–6.

189 JX-158 at 24; Trial Tr. 599:17–24 (Abramczyk).

190 JX-158 at 25; JX-173 at 9.

191 Trial Tr. at 552:14–553:7, 554:10–16, 600:4–7 (Abramczyk); JX-158 at 25.

192 JX-159 at 2.

32
for FINRA for over 20 years, where she led cycle examinations and cause

examinations.

Selman and Diles each argued that Abramczyk erred in his assessment that a

risk system like Clearing’s, which prioritized human discretion and professional

judgment over technological controls and bureaucracy, was unreasonable. Selman

opined that Abramczyk overstated the necessity of technological controls. Selman

found that some of the technologies and procedures that Abramczyk proposed would

help certain clearing firms, but FINRA rules do not require them.193 And FINRA

rules contain no absolute mandates, because each clearing firm navigates a different

risk environment and is only required to develop practices and procedures that are

tailored to its own activities.194 Diles discussed the “human element” of risk—even

with robust technological controls, a firm’s ability to emerge from a risk event

unscathed depends on a “sum of decisions” by employees.195

Sellers’ expert witnesses rebut the notion that clearing firms are required to

adopt every technology and risk-management practice that is available. They can

have mix of technological controls and human-dependent processes and still comply

with FINRA rules.196 Indeed, having the right mix of automated and manual controls

193 Id. at 12.

194 Id. at 11.

195 JX-164 at 4, 6; Trial Tr. at 951:5–952:5 (Diles).

196 See, e.g., Trial Tr. at 704:12–19, 801:23–802:11, 818:9–20, 827:19–22, 828:14–22

(Salas); id. at 710:21–711:15, 958:2–22, 1017:8–22 (Diles).

33
allows clearing firms to adapt to risk events that appear in unexpected ways.197 CEO

Salas testified that “risk is a hydra”: “some measure of flexibility” is required “because

[clearing firms] can’t understand all the risks that [they] face” at any given time.198

This testimony was compelling.

Clearing’s particular mix of controls relied substantially on the discretion of its

risk employees and senior management. Abramczyk attacked this approach by

identifying automated controls that could have helped Clearing, but that does not

show that Clearing’s mix of controls put it in violation of FINRA rules on the Closing

Date.

b. Barth Testimony

Buyers also argue that Chief Risk Officer Barth’s testimony discussing his

experience and proposals for Clearing demonstrate that Clearing’s systems were not

reasonably designed. In his deposition, Barth described the new risk system he had

designed in response to FINRA’s concerns from the 2017 Cycle Examination.199 But

Barth’s testimony as a fact witness describes improvements that Clearing could have

made but did not. Barth does not state, nor does his testimony show, that Clearing’s

system was not reasonably designed or that Clearing was in breach of FINRA rules.200

197 See id. at 820:1–9 (Salas).

198 Id. at 710:21–711:7; 820:1–9 (Salas).

199 Barth Dep. Tr. at 43:1–44:7.

200 Pls.’ Post-Trial Answering Br. at 39; Barth Dep. Tr. at 43:1–44:10, 76:6–14.

34
c. FINRA Letters

That leaves the 2019 Cycle Examination report and the resulting 2020

Cautionary Action Letter.201 The 2020 Cautionary Action Letter states Clearing

violated FINRA rules.202 And since Clearing’s risk system during the 2019 Cycle

Examination was the same system deployed pre-closing, Buyers argue that Clearing

was in breach on the Closing Date.203

Aspects of the 2019 Cause Examination report and 2020 Cautionary Action

Letter help Buyers. In an exception, the report expressly states that Clearing was

not compliant with FINRA Rule 3110 and FINRA Rule 4210(d). The exception’s

“Detail” section states:

In a correspondent clearing relationship trade supervision
rests with the correspondent broker-dealer; however, as a
clearing broker the firm also has a responsibility to
establish controls to prevent the endangerment of its
capital. The firm’s credit limits and supervisory process
were not adequate to monitor credit exposure to its
correspondent, Spartan Securities Group, LTD, in order to
prevent the endangerment of the firm’s capital.204

After Clearing provided a response contesting the findings, FINRA issued the

2020 Cautionary Action Letter. The letter cautions Clearing concerning the

201 See Defs.’ Post-Trial Opening Br. at 22–26.

202 JX-2 at 3.

203 Defs.’ Post-Trial Opening Br. at 22 & n.4.

204 JX-2 at 3.

35
“violations of securities rules and regulations” described in the 2019 Cause

Examination report’s noted exception.205

These statements, however, do not independently prove that Clearing’s system

violated FINRA rules. Like the 2018 Cautionary Action letter, the 2020 Cautionary

Action Letter contains a disclaimer that FINRA’s decision “not to take action” has no

“evidentiary weight in any mediation, arbitration, or judicial proceeding.”206

Sellers introduced expert testimony contextualizing the FINRA disclaimer.

Sellers’ experts Diles and Selman explained that a cautionary action letter is an

“informal” means of concluding a FINRA examination and that the issuance lacks

due process and the hallmarks of a formal legal proceeding.207

Diles opined that there is a general absence of legal process in the issuance of

a cautionary action letter. Cautionary action letters are “generally not drafted,

reviewed, or approved by FINRA attorneys, and the firm has no right to appeal

them.”208 This makes the cautionary action letter process distinct from formal

disciplinary actions, which Selman explains are governed by extensive procedural

requirements including: sufficient allegations in FINRA’s complaint; proper service

on the member firm; rights to a hearing; rules governing discovery; and the right to

205 JX-4 at 1.

206 Id.

207 JX-159 at 17; JX-163 at 9–10 (citing FINRA, Sanction Guidelines – FAQ).

208 JX-163 at 9.

36
an appeal.209 Informal actions involve none of this procedural rigor.210 According to

Selman, the process for cautionary action letters is scant by design: FINRA does not

want its examination teams to turn into de facto rulemaking bodies.211 It is thus

unsurprising that FINRA staff repeatedly characterize cautionary action letters as

addressing “minor” or “run of the mill” issues, and explicitly disclaim the letters’ legal

significance.212

Moreover, the Company’s risk controls did not change between FINRA’s 2017

Cycle Examination and FINRA’s 2019 Cause Examination.213 And FINRA found no

relevant violations in the 2017 Cycle Examination.214 This inconsistency amplifies

the letters’ lack of reliability.

Were this a pleading-stage decision, the 2019 Cause Examination report and

the 2020 Cautionary Action Letter might give rise to a reasonable inference of a rule

violation. And had Buyers’ other evidence demonstrated a violation of FINRA rules,

the 2019 Cause Examination report and the 2020 Cautionary Action Letter would

lend support to that evidentiary finding. But standing alone, the documents lack the

evidentiary value that Buyers place on them. They do not prove that Clearing was

in breach of a FINRA rule on the Closing Date.

209 JX-159 at 16–17.

210 Id.

211 Trial Tr. at 1087:12–23 (Selman).

212 See JX-163 at 10; JX-159 at 16–17; JX-4 at 1.

213 See Defs.’ Post-Trial Opening Br. at 22 n.4

214 See JX-35.

37
2. The Carveout

Any violation that Buyers seek to show is also carved out of the Legal-

Compliance Representation. Section 3.12(a) of the Disclosure Schedule lists 43

matters to be excepted from the Legal-Compliance Representation.215 Item 37 states

that Clearing has “been the subject of the following examinations by FINRA or the

SEC that are currently closed and, in each case, FINRA or the SEC, as the case may

be, made certain findings in respect of [Clearing’s] compliance with applicable

Law.”216 Item 37 then lists 25 FINRA or SEC matters, including cycle examinations,

cause examinations, and inquiries.217

One matter listed in Item 37 is the FINRA 2017 Cycle Examination and the

resulting 2018 Cautionary Action Letter.218 Taken together with the introductory

language of Item 37 and the Legal-Compliance Representation, this means that the

Legal-Compliance Representation does not apply to issues identified in the FINRA

2017 Cycle Examination or the resulting 2018 Cautionary Action Letter.

As discussed above, the Company’s risk controls did not change between the

FINRA’s 2017 Cycle Examination and FINRA’s 2019 Cause Examination.219 Sellers’

expert Diles explained that the issues identified in the 2019 Cause Examination are

215 Of those, 36 are litigation, arbitration, or investigatory matters. JX-10
(“Disclosure Schedule”) at 18–21. And Items 38 through 43 incorporate other
documents by reference. Id. at 21.
216 Id. at 20.

217 Id. at 20, 21.

218 Id. at 21.

219 See Defs.’ Post-Trial Opening Br. at 22 n.4.

38
the same as those identified in the 2017 Cycle Examination.220 So Sellers argue that

the regulatory vulnerabilities highlighted by the 2019 Cause Examination in the

wake of the Reynolds Loss are carved out of the Legal-Compliance Representation

because the same vulnerabilities were disclosed in the 2017 Cycle Examination.221

Buyers contend that items in the Disclosure Schedule are only excepted to the

extent that they identify a violation of applicable Laws and Orders, and because the

2017 Cycle Examination does not find a violation, no violation is carved out of the

representation.222 Further, Buyers say there is no way to know what FINRA

investigates during cycle examinations. So there is no way to know that FINRA

examined the same vulnerabilities in 2017 and 2019.223 Sellers respond that the facts

disclosed in the Disclosure Schedule are carved out regardless of whether there was

a “legal conclusion” of a violation.224

At least with respect to the circumstances on the Closing Date, Sellers have

the better of the argument here. Delaware courts review disclosures for the realities

that are revealed to parties rather than the specific terms used.225 Parties are free

220 JX-163 at 12–14.

221 Pls.’ Post-Trial Opening Br. at 51–52.

222 Defs.’ Post-Trial Opening Br. at 55.

223 Id. at 51–52.

224 Pls.’ Post-Trial Answering Br. at 44–45; see also id. at 52.

225 DCV Hldgs., Inc. v. Conagra, Inc., 2005 WL 698133, at *7–8 (Del. Super. Ct. Mar.

24, 2005), aff’d, 889 A.2d 954 (Del. 2005).

39
to carve out “items or issues” from a disclosure schedule.226 When a seller lists certain

items or issues on a disclosure schedule, a “buyer will not be able to claim an

inaccuracy that would give the buyer . . . a potential right to recover damages,” even

if the seller is unsure whether the listed items truly implicate the representation.227

Furthermore, “even where material facts must be disclosed, negative inferences or

characterizations of misconduct need not be articulated” by the seller.228

The 2017 Cycle Examination covered aspects of Clearing’s risk systems at

issue here. The examination report notes FINRA’s concern regarding Clearing’s

procedures for escalating risk events, the Company’s limitations in monitoring the

activity of IBDs trading away, and the Company’s documented processes for

reviewing credit limits.229 The report suggests, and Diles credibly testified,230 that

the vulnerabilities identified in the 2017 Cycle Examination report are the same as

those that Buyers argue caused the Reynolds Loss.

Buyers also argue that, taken together, the note in Item 37 highlighting that

the examinations were “closed” and the assurances given during diligence negated

226 See Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347, at *80 (Del. Ch. Oct. 1,

2018), aff’d, 198 A.3d 724 (Del. 2018).
227 See Akorn, 2018 WL 4719347, at *78 (citing Lou R. Kling et al., 2 Negotiated

Acquisitions of Companies, Subsidiaries and Divisions § 10.02); see also Level 4 Yoga,
LLC v. CorePower Yoga, LLC, 2022 WL 601862 (Del. Ch. Mar. 1, 2022), aff’d, 287
A.3d 226 (Del. 2022) (stating that representations and warranties “define[] the scope
and nature of post-closing indemnification claims available to the buyer”).
228 See DCV, 2005 WL 698133, at *8 (citing Loudon v. Archer-Daniels-Midland Co.,

700 A.2d 135, 143 (Del. 1997)).
229 JX-35 at 6–7.

230 See JX-163 at 12.

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the carve-out.231 But Item 37 highlights that the examinations were closed, not that

underlying issues were resolved.232 And Buyers disclaimed reliance on extra-

contractual statements in the Merger Agreement.233 The Carveout therefore applies

to the violation that Buyers seek to prove.

B. Counterparty-Breach Representation

Buyers fare no better in proving an inaccuracy of the Counterparty-Breach

Representation, which provides:

[T]here exists no default or event of default or event,
occurrence, condition or act, with respect to Company or its
Subsidiaries or, to the Knowledge of Company, with
respect to any other contracting party, which, with the
giving of notice, the lapse of time or the happening of any
other event or condition, would become a default or event
of default under any Material Contract . . . .234

This representation states that the Company had no Knowledge that a

counterparty to any of its Material Contracts was in default of the contract. The

representation also means that the Company had no Knowledge of any circumstances

that could cause a counterparty to a Material Contract to default. As to Sellers, the

231 Defs.’ Post-Trial Opening Br. at 55–56.

232 Disclosure Schedule at 20.

233 Merger Agr. §§ 4.10, 10.6; see Pilot Air Freight, LLC v. Manna Freight Sys., Inc.,

2020 WL 5588671, at *23 (Del. Ch. Sep. 18, 2020) (quoting Abry P’rs V, L.P. v. F & W
Acq. LLC, 891 A.2d 1032, 1058 (Del. Ch. 2006)).
234 Merger Agr. § 3.13(b)

41
Merger Agreement defines “Knowledge” as the knowledge of either Salas or Sime,

after “due inquiry of direct reports.”235

Buyers argue that the Counterparty-Breach Representation was inaccurate on

the Closing Date because the Spartan Agreement was a “Material Contract” in

default when the Merger closed.236 According to Buyers, Spartan breached the

Spartan Agreement by failing to comply with FINRA rules that required Spartan to

maintain a reasonably designed supervisory system.237

Sellers respond that the Spartan Agreement was not a Material Contract.

They advance other arguments—that Spartan was not in breach of the Spartan

Agreement and that the Company had no Knowledge of any breach—but this decision

does not reach them, because the Spartan Agreement is not a Material Contract.

Section 3.13(a) of the Merger Agreement defines “Material Contract” as

follows: “Except as set forth in Section 3.13(a) of the Disclosure Schedule, neither

Company nor any of its Subsidiaries is a party to or bound by, as of June 1, 2018, any

of the following” eleven categories of contracts. The list of eleven categories is

introduced by a parenthetical stating that “each contract, arrangement, commitment

235Id. § 10.10; Disclosure Schedule at 41. This means that the Company has
Knowledge of a fact if Salas or Sime knew of the fact or would have known if they or
their direct reports made a reasonable inquiry.
236 Defs.’ Post-Trial Opening Br. at 57.

237 Id. at 59.

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or understanding of the type described in this Section 3.13(a), whether or not set forth

in the Disclosure Schedule, is referred to as a “Material Contract.”238

The Spartan Agreement is not among the eleven types of agreements listed in

Section 3.13(a), as Buyers concede.239 Instead, Buyers argue that the definition of

Material Contracts includes contracts on the Disclosure Schedule by operation of the

“whether or not” clause italicized in the preceding paragraph. Buyers also argue that

the Spartan Agreement is covered by the Disclosure Schedule because it is in the

same form as the Fully Disclosed Clearing Agreement, which is mentioned in Section

3.13(a) of the Disclosure Schedule.240

Buyers are correct that the Spartan Agreement is covered by the Disclosure

Schedule, but that fact does not help them, because the term “Material Contract” is

defined to disregard the contracts on the Disclosure Schedule. The phrase “whether

or not set forth in the Disclosure Schedule” in the definition of “Material Contract”

does not mean that the definition “includes those contracts described in the disclosure

schedule,” as Buyers argue.241 Rather, the definition describes “Material Contracts”

as contracts falling within the categories listed in Section 3.13(a) of the Merger

Agreement, and the “whether or not” clause commands that a reader disregard the

238 Merger Agr. § 3.13(a) (emphasis added).

239 See Defs.’ Post-Trial Opening Br. at 57–58; Dkt. 285 at 14.

240 Defs.’ Post-Trial Opening Br. at 58; Disclosure Schedule at 24–25.

241 Defs.’ Post-Trial Opening Br. at 58; see also Defs.’ Post-Trial Answering Br. at 53.

43
Disclosure Schedule for purposes of the definition.242 Disregarding the Disclosure

Schedule means that only those contracts listed in Section 3.13(a) of the Merger

Agreement are Material Contracts.

For that reason, the Spartan Agreement is not a Material Contract under the

Counterparty-Breach Representation.

C. Causation

Even if either of the representations at issue were inaccurate, Buyers also

failed to prove that the failure of either representation caused the Reynolds Loss.

According to the Merger Agreement, Buyers have a right to indemnification

for damages “arising out of or resulting from” the failure of any representations and

warranties.243 This means that the failure of the representations and warranties

must be the cause of the damages to Buyers.244 The “arising out of or resulting from”

language invokes Delaware’s common law standard for causation, allowing damages

for contractual breach only where the claimant proves a but-for relationship between

242 The Chicago Manual of Style ¶ 5.254 (18th ed. 2024) (“The or not [in the phrase

‘whether or not’] is necessary . . . when you mean to convey the idea ‘regardless of
whether’. . . .”).
243 Merger Agr. § 8.2(a).

244 The phrase “arising out of or resulting from” is narrower than the phrase “relating

to,” which appears elsewhere in the Merger Agreement but not in the indemnification
provision. Compare Merger Agr. § 8.2(a), with id. § 10.7 (“Each party . . . waives . . .
any right such party may have to a trial by jury in respect of any proceeding directly
or indirectly arising out of or relating to this Agreement[.]” (emphasis added)). See
Fla. Chem. Co., LLC v. Flotek Indus., Inc., 262 A.3d 1066, 1083 (Del. Ch. 2021).

44
the harm and the breach.245 Buyers thus must show that Sellers’ breach was the

“direct cause without which the [harm] would not have occurred.”246

Sellers demonstrated that Clearing’s failure to promptly respond to alerts

generated by Clearing’s risk-management system caused the Reynolds Loss.

Clearing received ACT and DTCC alerts in the morning and afternoon of March 6

and became aware of Reynolds’s trading position by 12:30 p.m. at the latest.247

Clearing had the ability to stop Reynolds’s trading at this time—Clearing could have

hit the kill switch, and Clearing could have called the market center or Spartan’s

order management operator to revoke authorization.248

Clearing also could have bought Biopath stock to limit its exposure to the short

position.249 Sellers called expert Craig McCann to opine on this issue. McCann is

245 Culver v. Bennett, 588 A.2d 1094, 1097 (Del. 1991) (quoting Chudnofsky v.
Edwards, 208 A.2d 516, 518 (Del. 1965)); In re Dura Medic Hldgs., Inc. Consol. Litig.,
333 A.3d 227, 255–56 (Del. Ch. 2025) (citing eCommerce Indus., Inc. v. MWA Intel.,
Inc., 2013 WL 5621678 (Del. Ch. Sept. 30, 2013)). Buyers cite Pacific Insurance Co.
v. Liberty Mutual Insurance Co., 956 A.2d 1246 (Del. 2008), to argue that the harm
only needs to have a “meaningful linkage” to the breach, but that standard is limited
to insurance contracts. See Defs.’ Post-Trial Opening Br. at 43; see, e.g., Pacific
Insurance, 956 A.2d at 1256; ACE Am. Ins. v. Guaranteed Rate, Inc., 305 A.3d 339,
347 (Del. 2023).
246 Culver, 588 A.2d at 1097 (quoting Chudnofsky, 208 A.2d at 518).

247 JX-22 at 7.

248See JX-8 at 1; Trial Tr. at 47:23–48:11, 74:7–19 (Tolla); id. at 666:10–14
(Abramczyk); id. at 746:22–749:9 (Salas); Sime Day 2 Dep. Tr. at 211:1–9.
249 Salas Rule 30(b)(6) Dep. Tr. 106:9–107:14; 111:20–113:3.

45
highly qualified; he has worked as an economist and consultant for over 30 years and

has held positions as a financial economist at the SEC.250

McCann testified that Clearing could have mitigated losses by reducing its

exposure to Reynolds’s short by acquiring Biopath stock. This was achievable given

the high trading volume of Biopath on March 6.251 McCann assumed that buying

enough shares of Biopath to cover Reynolds’s position would have taken no more than

two hours.252 McCann analyzed the cost to Clearing of closing Reynolds’s position at

four times on March 6: when the ACT alert was received; when the DTCC alert was

received; when the National Securities Clearing Corporation issued a margin call to

Clearing; and when Clearing contacted Spartan for the first time.253 At each point,

the cost to Clearing of purchasing Biopath stock within the two-hour window, less

any realized proceeds from Reynolds’s short position, would have resulted in losses of

about $2.4 million, $2.8 million, $2.8 million, and $3 million, respectively.254

According to McCann, if Clearing had taken action at any point on March 6, the loss

to Clearing would have been $3.5 million or less.255

250 JX-156, App. 1.

251 Trial Tr. at 1101:15–1103:17 (McCann).

252 See Trial Tr. at 1098:5–1099:2 (McCann)

253 JX-231 at 2.

254 Trial Tr. at 1097:17–24 (McCann); JX-156 at 12. These figures do not account for
Spartan’s ability to contribute to the loss, which would result in even smaller losses
to Clearing. See JX-156 at 14.
255 JX-156 at 12–14; JX-231 at 2. The losses to Clearing jumped by $14 million
between March 6 and March 7, resulting in realized losses of $16.6 million ($15.2
million after Spartan’s contribution). Trial Tr. at 1100:12–20 (McCann); JX-231 at 4;

46
Buyers do not provide a consistent narrative on why Clearing chose not to act

during the developing short on March 6. Sellers provide an answer: professionals at

Clearing decided not to. Clearing President Sime testified that he had the ability to

shut down Reynolds’s position on March 6.256 He knew he had the authority to do

so.257 But Sime waited “to have a discussion with Garrabrants,” his new supervisor,

because closing the position had “implications to the parent company,” Axos

Financial.258 In the meantime, Clearing “rel[ied] on Reynolds’s commitments [and]

allowed Reynolds and Spartan to keep the . . . position . . . open[.]”259 Sime took no

action on March 6 and called Garrabrants on March 7, which is when the losses to

Clearing jumped substantially.260 Garrabrants said he would need to think about

whether to close the position and the two kept in contact over the course of the day.261

Garrabrants testified at a FINRA arbitration hearing that “Clearing [] has a

way of closing everything . . . from a mechanical perspective,” and could “take [an]

offsetting position in the market.”262 So Garrabrants too could have shut down

JX-158 at 3. Buyers do not dispute McCann’s findings. See Defs.’ Post-Trial Opening
Br. at 30 n.7.
256 Sime Day 2 Dep. Tr. at 211:1–9; see also id. at 746:22–748:8, 749:2–19 (Salas).

257 Sime Day 2 Dep. Tr. at 61:17–62:2.

258 Id. at 58:5–60:17, 62:1–6.

259 JX-252 at 25; see JX-235 at 3991:10–16, 3992:6–17.

260 Sime Day 1 Dep. Tr. at 253:4–12; Sime Day 2 Dep. Tr. at 70:14–71:2; see JX-231

at 4.
261 Sime Day 2 Dep. Tr. at 118:5–12.

262 JX-235 at 3991:3–9.

47
Reynolds’s trading and closed the position, but he chose not to take any action after

he was told of Reynolds’s position on March 7.263

Faced with evidence that Clearing’s risk system generated the appropriate

alerts that Clearing’s personnel failed to act on, Buyers fault Sellers for failing to

implement a clearer procedure for responding to risk. They say that if more

comprehensive risk procedures were in place, Clearing’s risk employees would have

been alerted earlier, would have had more direction on how to respond, and would

have reacted appropriately, eliminating or limiting the loss.264 But this is a weak

fallback. There were several discretionary calls made on March 6 and 7 that caused

or contributed to the Reynolds Loss. Sime chose to rely on Reynolds’s promise. Sime

chose to consult Garrabrants before acting. Garrabrants chose not to act. And these

decisions all followed Salas’s removal from Clearing, which extinguished a familiar

line of communication between Sime and senior leadership.265 Buyers do not show

that any change in procedure would have eliminated the discretionary calls that led

to the Reynolds Loss.

This is consistent with Buyers’ position in the FINRA arbitration against

Reynolds that Clearing could have closed Reynolds’s position “within five minutes” at

263 Sime Day 2 Dep. Tr. at 118:5–19; see also Trial Tr. at 503:6–504:10 (Garrabrants).

At trial, Garrabrants claimed that he decided not to act in part because Clearing
could not hit the kill switch on Reynolds’s trading. Id. But his testimony during
Clearing’s FINRA arbitration against Reynolds suggests otherwise. JX-235 at
3991:3–9.
264 Defs.’ Post-Trial Opening Br. at 46–47.

265 Trial Tr. at 792:22–793:18, 802:6–11 (Salas).

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any time during Reynolds’s trading but chose to “rel[y] on Reynolds’s

misrepresentations by refraining from taking over and closing out the position

itself.”266

Ultimately, Buyers identified no missing controls that would have prevented

the Loss. And Buyers could have prevented the Loss using the controls in place but

affirmatively chose to not do so. Buyers fail to prove that any lack of procedures or

controls caused the Reynolds Loss.

III. CONCLUSION

Judgment on Count I is entered in favor of Sellers. The parties are ordered to

submit a form of order or competing forms of order implementing this decision within

ten business days.

266 JX-236 at 4205:7–12; JX-233 at 15; see JX-232 at 20; JX-236 at 4204:23–4205:16;

Trial Tr. at 504:4–10 (Garrabrants).

49