United States District Court, D. Nebraska
GERALD J. KLEIN, Plaintiff,
TD AMERITRADE HOLDING CORPORATION, TD AMERITRADE, INC., and FREDRIC TOMCZYK, Defendants.
FINDINGS AND RECOMMENDATION
THOMAS D. THALKEN, Magistrate Judge.
This matter is before the court on the defendants' Motion to Dismiss Putative Amended Class Action Complaint and Request to Take Judicial Notice (Filing No. 79). The defendants filed a brief (Filing No. 80) and a corrected index of evidence (Filing No. 93) supporting the motion. The plaintiff filed a brief (Filing No. 87) and an index of evidence (Filing No. 88) opposing the motion. The defendants filed a brief (Filing No. 94) in reply. The plaintiff's request for oral argument is denied as unnecessary and for failure to comply with NECivR 7.1(d) by including the request in the brief rather than by filing a timely motion. See Filing No. 87 - Response p. 83. Similarly, the plaintiff's request for leave to amend is denied, without prejudice for failure to comply with NECivR 15.1. Id.
The plaintiff challenges the defendants' practice of routing customers' nondirected orders to trading venues that pay the defendants the largest payments (either by liquidity rebates or order flow payments) rather than to those trading venues who will fulfill its duty of best execution. See Filing No. 75 - Amended Complaint ¶¶ 8-9. The defendants provide securities broker-dealer services as a financial services company, its parent company, and Chief Executive Officer Fredric Tomczyk (Tomczyk). Id. ¶¶ 22-24. The plaintiff, who alleges he has been the defendants' client continuously throughout the class period, "purchased shares of U.S. based exchange-listed stocks in trades" during the class period, suffering damages from the defendants' unlawful conduct. Id. ¶ 19. This plaintiff purports to represent all of the defendants' clients "who placed orders in connection with which [the defendants] received either liquidity rebates or payment for order flow." Id. ¶ 106.
The plaintiff alleges four separate claims for relief: violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (1934 Act); breach of fiduciary duty; and violations of Nebraska's Uniform Deceptive Trade Practices Act (UDTPA), Neb. Rev. Stat. §§ 87-301 to 87-306. See Filing No. 75 - Amended Complaint ¶¶ 114-139. Generally, the plaintiff alleges the defendants disseminated misleading statements to the investing public by stating the defendants would provide best execution for trade orders placed by them for clients. Id. ¶¶ 6-14. The plaintiff alleges the clients relied on such statements to their detriment because the defendants engaged in self-interested order routing for the purpose of maximizing liquidity rebates and order flow payments. Id. ¶¶ 8-9. The plaintiff further alleges the orders subject to this practice lost value "in the form of economic loss due to [the clients'] orders going unfilled, underfilled, filled at a suboptimal price, and/or filled in a manner which adversely affects the order's performance post-execution." Id. ¶¶ 13-14.
The defendants filed a motion to dismiss the plaintiff's Complaint on three grounds. See Filing No. 79. Initially, the defendants assert the plaintiff's state law claims are preempted by the Securities Litigation Uniform Standards Act of 1998 (SLUSA), 15 U.S.C. §§ 77p, 78bb(f). Id. Alternatively, the defendant argues the plaintiff's state law claims are preempted by federal regulation. Id. Finally, the defendant contends the plaintiff's Complaint fails to state a claim for relief on the merits of each claim. Id.
For consideration of the motion, the defendants seek judicial notice of certain sections of the Federal Register and Code of Federal Regulations. See Filing No. 79 - Motion p. 3-4. Additionally, the defendants seek judicial notice of excerpts from a June 17, 2014, transcript for a hearing before a U.S. Senate subcommittee and other materials. Id. The plaintiff does not object to taking judicial notice of these documents, which are embraced by the Complaint. See generally Filing No. 87 - Response & p. 49 n.10. In any event, as part of the court's review of the defendants' motion, the court may consider exhibits annexed to the Complaint or incorporated by reference. See Fed.R.Civ.P. 10(c) ("A copy of any written instrument which is an exhibit to a pleading is a part thereof for all purposes."); Zayed v. Associated Bank, N.A., 779 F.3d 727, 732 (8th Cir. 2015); see also SEC v. Siebel Sys., Inc., 384 F.Supp.2d 694, 699 n.6 (S.D.N.Y. 2005) (taking judicial notice of transcripts relied upon by complaint). The court takes judicial notice of the exhibits identified not for the truth of the facts asserted therein, but solely to determine the content of the testimony and regulations.
The plaintiff's Complaint relies on sources other than the plaintiff's personal knowledge for many of the allegations. The Complaint references testimony given by Steven Quirk (Quirk), a senior executive for the defendant, and others before the U.S. Senate's Permanent Subcommittee on Homeland Security and Governmental Affairs, on June 17, 2014. See Filing No. 75 - Amended Complaint ¶¶ 59-64; see also Filing No. 88-6 Ex. 1(E). The Complaint also relies upon academic research regarding order routing practices of various brokers. See Filing No. 75 - Amended Complaint ¶¶ 81-92. The defendants oppose reliance on academic research and other information referenced by the plaintiff, arguing such materials are generic and irrelevant to the plaintiff's claims. See Filing No. 80 - Brief p. 39-44.
A. SLUSA Preemption
The court reviews dismissal of a state law claim based on SLUSA preemption as a dismissal for failure to state a claim. Kutten v. Bank of Am., N.A., 530 F.3d 669, 670 (8th Cir. 2008); see In re Kingate Mgmt. Ltd. Litig., 784 F.3d 128, 135 n.11 (2d Cir. 2015) (noting SLUSA preclusion reviewed under Rule 12(b)(6)). Congress intended SLUSA, an amendment to the Securities Act of 1933 and the Securities Exchange Act of 1934, to preempt claims by plaintiffs eluding Federal law requirements and protections by filing specified types of actions in State court. Sofonia v. Principal Life Ins. Co., 465 F.3d 873, 876 (8th Cir. 2006) (citing H.R. Rep. No. 105-803 (Oct. 9, 1998) (Conf. Rep.)). Specifically, Congress sought to curb perceived abuses of class action cases involving securities and enforce heightened pleading requirements. Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 81-82 (2006). Accordingly, SLUSA allows removal and "expressly preempts all state law class actions based upon alleged untrue statements or omissions of a material fact, or use of a manipulative or deceptive device or contrivance, in connection with the purchase or sale of a covered security." Dudek v. Prudential Sec., Inc., 295 F.3d 875, 879 (8th Cir. 2002); see 15 U.S.C. §§ 77p(b)-(c), 78bb(f)(1)-(2). The plaintiff disputes only whether the action alleges the defendants' conduct was "in connection with" the purchase or sale of a covered security. See Filing No. 87 - Response p. 66-70.
The plaintiff argues his action is not the type targeted by SLUSA, for example cases having a "nuisance value outweigh[ing] their merits." Id. at 66-67 (alteration in original) (quoting Dabit, 547 U.S. at 82). Moreover, the plaintiff contends his state law claims are based on misrepresentations surrounding the plaintiff's "determination to enter into a contract for and/or continue using TD Ameritrade's broker services.... before a single security was ever transacted." Id. at 69. Therefore, the plaintiff asserts the state law claims accrued before the defendant conducted any securities transactions, unlike claims which may stem from securities transactions. Id.
The Complaint describes the defendants as "broker[s], engag[ing] in routing... clients' orders to different venues to be executed." See Filing No. 75 - Amended Complaint ¶ 7. The Complaint alleges "this action for breach of fiduciary duties... in connection with self-interested routing of... clients' orders to venues which paid the maximum liquidity rebate and/or paid for order flow, irrespective of whether such routing would optimize execution quality." Id. ¶ 2. The state law claims explicitly rely upon the defendants "self-interestedly routing... orders to venues in order to maximize liquidity rebates and payment for order flow, thereby failing to provide best execution." Id. ¶¶ 130, 137-138.
"Under Dabit, however, it is enough that the fraud alleged "coincide" with a securities transaction-whether by the plaintiff or by someone else.'" Siepel v. Bank of Am., N.A., 526 F.3d 1122, 1127 (8th Cir. 2008) (quoting Dabit, 547 U.S. at 85) (concluding SLUSA prohibits "state-law claims that a trustee breached its fiduciary duty by failing to disclose conflicts of interest in its selection of nationally-traded investment securities"). The plaintiff contends a more narrow interpretation is required by Chadbourne & Parke LLP v. Troice, 134 S.Ct. 1058 (2014). See Filing No. 87 - Response p. 68. In Troice, the Court held, "[a] fraudulent misrepresentation or omission is not made in connection with' such a purchase or sale of a covered security' unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a covered security.'" Troice, 134 S.Ct. at 1066 (noting the Court "do[es] not here modify Dabit ").
While the plaintiff contends his decision to associate with the defendants suffered from his reliance on fraudulent misrepresentations prior to any securities' order placement, the Complaint's allegations remain based on how the order placement materially affected and in "various ways... had a harmful impact on [the defendants'] clients' trades." See Filing No. 75 - Amended Complaint ¶ 138. The plaintiff's Complaint explicitly states the proposed class "suffered damages in connection with Defendants' routing of their orders." Id. ¶ 122. In any event, the plaintiff also alleges the defendants' conduct was based on an undisclosed policy and practice, in conflict with the defendants' website statements, pre-dating the orders whereby they were automatically sent to the particular market center providing the highest financial benefit to the defendants. See, e.g., id. ¶¶ 109-113. In essence, the plaintiff relied on the defendants' alleged misstatements and omissions of information about the scheme to place the order. This case is about execution of the securities orders rather than execution of relationship between the defendants and their clients. Accordingly, in this case, as in Segal, the "allegations do not merely coincide' with securities transactions; they depend on them." Segal, 581 F.3d at 310; see Romano v. Kazacos, 609 F.3d 512, 522 (2d Cir. 2010) (defining "coincide" as broad in scope to include the claims that "necessarily allege, " "necessarily involve, " or "rest on" the purchase or sale of securities). Here, the plaintiff's allegations of misrepresentation and omission concern the best execution of the trades by routing the orders based on payment for order flow. Thus the alleged misrepresentations or omissions coincide with the purchase or sale of covered securities. As all elements have been met, the plaintiff's claims are preempted by SLUSA and should be dismissed.
B. Federal Regulation Preemption
The defendants argue resolution of the plaintiff's state law claims necessarily extends beyond the duties imposed by law to conflict with and intrude upon the federal regulatory framework governing order flow payments and order execution. See Filing No. 80 - Brief p. 60. The plaintiff denies his state law claims are preempted because no conflict exists between the federal regulations and the claims. See Filing No. 87 - Response p. 70-73 (arguing claims based on "a common law duty of best execution would not frustrate the SEC's enforcement" of federal requirements). Although the plaintiff does not dispute order flow payments are permissible, he contends the defendants allowed the amount of the payments to override all other factors when making order routing decisions, thereby breaching the fiduciary duty of best execution and deceptively misrepresenting their conduct in advertisements. Id. at ¶¶ 100, 137-138; Filing No. 87 - Response p. 48. In reply, the defendants contend the plaintiff attempts to add a motive-based standard and expand the fiduciary duty beyond the current federal regulation best execution requirements, creating a conflict between federal and state law. See Filing No. 94 - Reply p. 32-36.
"Ordinary preemption is a federal defense that exists where a federal law has superseded a state law claim. Express preemption occurs where a federal law explicitly prohibits or displaces state regulation in a given field." Johnson v. MFA Petroleum Co., 701 F.3d 243, 248 (8th Cir. 2012) (internal citation omitted). "Preemption may also be applied in situations where a state [law] directly conflicts with federal law, or in limited circumstances where a federal law completely occupies the field of regulation so that by implication there is no room for state regulation and the coexistence of federal and state regulation is not possible.'" Id. (citing Florida Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 142-43 (1963) and quoting Mo. Bd. of Exam'rs for Hearing Instrument Specialists v. Hearing Help Express, Inc., 447 F.3d 1033, 1035 (8th Cir. 2006)); see Guice v. Charles Schwab & Co., 674 N.E.2d 282, 285 (N.Y. 1996) (noting preemption applies to State statutory or regulatory law and common law) (citing Freightliner Corp. v. Myrick, 514 U.S. 280, 286-87 (1995)). "Pre-emption may result not only from action taken by Congress itself; a federal agency acting within the scope of its congressionally delegated authority may pre-empt state regulation." La. Pub. Serv. Comm'n v. FCC, 476 U.S. 355, 369 (1986).
The defendants appear to confine the challenge to conflict preemption. State law will conflict with federal law when "compliance with both federal and state regulations is a physical impossibility' or when state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.'" Qwest Corp. v. Minnesota Pub. Util. Comm'n, 684 F.3d 721, 726 (8th Cir. 2012) (quoting Hillsborough Cnty., Fla. v. Automated Med. Labs., Inc., 471 U.S. 707, 713 (1985)). Otherwise, state law may coexist with the federal regulation to the extent they are not inconsistent. Merrill Lynch, Pierce, Fenner & Smith v. Ware, 414 U.S. 117, 137 (1973).
The potential conflict exists between the plaintiff's claims and the U.S. Securities and Exchange Commission's (SEC) implementation of Securities Exchange Act regulations. Effective May 31, 2012, the SEC approved FINRA Rule 5310, known as the Best Execution Rule, which requires member firms, such as the defendant, to "use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions." FINRA Rule 5310(a) (emphasis added). Reasonable diligence is determined by examining such factors as:
(A) the character of the market for the security (e.g., price, volatility, relative liquidity, and pressure on available communications);
(B) the size and type of transaction;
(C) the number of markets checked; [and]
(D) accessibility of the quotation[.]
Id. Moreover, the members are required to conduct a "regular and rigorous" review of the execution quality. Id. Supp. Material.09.
In reviewing and comparing the execution quality of its current order routing and execution arrangements to the execution quality of other markets, a member should consider the following factors:
(1) price improvement opportunities (i.e., the difference between the execution price and the best quotes prevailing at the time the order is received by the market);
(2) differences in price disimprovement (i.e., situations in which a customer receives a worse price at execution than the best quotes prevailing at the time the order is received by the market);
(3) the likelihood of execution of limit orders;
(4) the speed of execution;
(5) the size of execution;
(6) transaction ...