United States District Court, D. Nebraska
MEMORANDUM AND ORDER
Joseph F. Bataillon Senior United States District Judge
This matter is before the court on the plaintiffs' objections, Filing No. 53 in Case No. 8:14CV288 ("Zola"), Filing No. 53 in Case No. 8:14CV289 ("Verdieck"), Filing No. 55 in Case No. 8:14CV325 ("Lerner"), Filing No. 66 in Case No. 8:14CV341 ("Sarbacker"), Filing No. 96 in Case No. 8:14CV396 ("Klein"), to the Findings and Recommendation ("F&R") of the United States Magistrate Judge, Filing No. 52 in Zola, Filing No. 52 in Verdieck, Filing No. 54 in Lerner, Filing No. 64 in Sarbacker, and Filing No. 95 in Klein, recommending that this court grant the defendants' (collectively, "TD Ameritrade's") motions to dismiss in each of these cases, Filing No. 44 in Zola, Filing No. 44 in Verdieck, Filing No. 47 in Lerner, Filing No. 54 in Sarbacker, and Filing No. 79 in Klein. These are purported class actions alleging wrongdoing in connection with stock trades. Jurisdiction is premised on diversity of citizenship under 28 U.S.C. § 1332 in the Zola, Verdieck, Lerner, and Sarbacker cases and on a federal question under 28 U.S.C. § 1331 in the Klein case. These are purported class actions alleging wrongdoing in connection with stock trades.
In their complaints, the plaintiffs, on their own behalf and on behalf of others similarly situated, allege wrongdoing by TD Ameritrade in connection with the execution of stock trades and assert various theories of recovery. The allegations of each respective plaintiff’s complaints are summarized in the Magistrate Judge's F&Rs and need not be repeated here except as necessary to the court's opinion. See Zola, No. 8:14CV288, Filing No. 52, F&R at 1-3; Verdieck, No. 8:14CV289, Filing No. 52, F&R at 1-3; Lerner, No. 8:14CV325, Filing No. 54, F&R at 1-3; Sarbacker, No. 8:14CV341, Filing No. 64, F&R at 1-3; Klein, No. 8:14CV396, Filing No. 95, F&R at 1-5.
The record shows that defendant TD Ameritrade Holding Corporation, is the parent company and sole equity holder of TD Ameritrade, Inc.; defendant TD Ameritrade, Inc., is a financial services company that acts as a broker-dealer and is engaged in trading stocks and bonds; defendant TD Ameritrade Clearing, Inc., is a wholly-owned subsidiary that provides trade execution and clearing services; defendant Fredric Tomczyk is the Chief Executive Officer of TD Ameritrade; and defendant Paul Jiganti is alleged to be the Managing Director of Market Structure and Client Advocacy for TD Ameritrade Holding Corp. and is allegedly responsible for determining the most effective way to manage client order routing. The plaintiffs are clients and customers of TD Ameritrade who have purchased exchange-listed stocks and executed trades through TD Ameritrade as a broker. In their complaints, all of the plaintiffs allege TD Ameritrade failed to properly execute their trades, although they seek recovery under various state and federal theories.
In Zola, plaintiffs Jay Zola and Jeremiah Joseph Lowney assert only a state-law claim for breach of contract. Zola, No. 8:14CV288, Filing No. 1-1, Complaint. Verdieck asserts a state law claim for breach of fiduciary duty and seeks declaratory relief and imposition of a constructive trust. Verdieck, No. 8:14CV289, Filing No. 1, Complaint. Lerner asserts claims for breach of fiduciary duty, violations of the Nebraska Consumer Protection Act ("NCPA"), unjust enrichment, and declaratory relief. Lerner, No. 8:14CV325, Filing No. 1, Complaint. Sarbacker alleges breach of contract, fraud by intentional misrepresentation or omission, negligent misrepresentation, NCPA violations, and aiding and abetting. Sarbacker, No. 8:14CV341, Filing No. 1, Complaint. He also asserts claims for control person liability against Tomczyk and Jiganti. Id. Klein alleges violations of §§ 10(b)(5) and 20(a) of the Securities Exchange act of 1934 and asserts state-law claims for breach of fiduciary duty, and for violations of the Nebraska Uniform Deceptive Trade Practices Act ("UDTPA"), Neb. Rev. Stat. § 87-301, et seq. Klein, No. 8:14CV396, Filing No. 75, Amended Complaint. Plaintiff Klein additionally alleges that Mr. Tomczyk, as the Chief Executive Officer of TD Ameritrade, violated Section 20(a) of the Exchange Act as a control person of TD Ameritrade. See Id. Klein's complaint also contains detailed allegations relating to class-action status. See Id. at 38-42.
Essentially, all of the plaintiffs challenge TD Ameritrade's alleged practice of routing virtually all of its customers' orders and trades in contravention of its purported duties and/or contractual obligations to "best execute" the trade. All five actions were commenced by customers of TD Ameritrade and each case involves assertions that TD Ameritrade failed to seek best execution on certain customer orders because TD Ameritrade routed orders to exchanges and market centers that provided payment for order flow. Each of the plaintiffs make allegations that are substantially similar in all material respects to those that Klein asserts concerning TD Ameritrade’s order routing processes and best execution obligations. Because only the Klein action asserts a federal securities fraud claim, the court will focus on the Klein complaint.
In a 52-page Amended Complaint, the plaintiff in Klein alleges that TD Ameritrade has a practice of routing orders to various venues for execution. Id. at 2. Klein alleges that "[r]ather than route its clients’ non-directed, non-marketable limit orders to the venue(s) which would provide the best execution, TD Ameritrade instead sent such orders to the venues which would provide the highest liquidity rebates, payments made by the venues to TD Ameritrade relating to the number and size of orders that were routed." Id. at 3. He further alleges that TD Ameritrade has adopted the “maker/taker model”-through which an Exchange charges a fee to an entity that “takes” liquidity (i.e., that buys a stock) and pays a rebate to an entity that “makes” liquidity (i.e., that sells the stock) and of receiving payments for order flow. Filing No. 75, Amended Complaint at 9-10. The Amended Complaint also describes TD Ameritrade's relationships with several vendors over time, particularly with Direct Edge, whose practices were the subject of a consent settlement with the Securities Exchange Commission. Id. at 23-25.
The plaintiff alleges that TD Ameritrade stated in a press release on June 12, 2014, that it “employs sophisticated order routing technology and processes to help it meet its obligations to seek best execution for client orders.” Id. at 12. Klein also alleges that Fred Tomczyk made public statements to that effect. Id. at 12-13. Similar statements are allegedly included in TD Ameritrade's 10-K, filed Nov 22, 2103. Id. at 13. Klein alleges TD Ameritrade also made the following representations to institutional investors:
We use proprietary order execution strategies to help get the best pricing for clients. This can potentially maximize the value of portfolios and helps you meet your fiduciary responsibility.
Our strategy uses a sophisticated order router to get client orders filled completely as quickly as possible at the best price reasonably available.
Id. at 13. Klein alleges that those proprietary execution strategies were not extended to retail customers, allowing institutional investors to effectively jump the queue and "hijack price improvements" that would no longer be available to retail investors. Id. at 25.
The amended complaint contains detailed allegations concerning defendants' maximization of order routing payments. Id. at 16-19. Klein also cites academic research and industry analyses that demonstrate that TD Ameritrade's practices are not consistent with a broker's duty of best execution. Id. at 4, 32-36. Klein also alleges, based on proprietary limit order data, "that several measures of limit order execution quality (including fill rates, execution speed, and realized spreads) are negatively related to the level of an exchange's take fee." Id. at 34. The plaintiff also alleges that TD Ameritrade radically modified its routing behavior in 2011 and began routing nonmarketable limit orders to the venues that would maximize their rebates. Id. at 15-18.
Plaintiff also states that TD Ameritrade negotiated agreements providing for greater payments for order flow or liquidity rebates from venues than the amounts the venues were paying to other brokers and that by receiving higher payments for order flow that their competitors, TD Ameritrade negatively impacted its clients’ chances for price improvement. Id. at 37. Klein also alleges that by designating its clients’ orders as "retail, " TD Ameritrade creates an information asymmetry between its clients and sophisticated traders who pay for access to proprietary data feeds. Id. at 28.
Klein also states in the Amended Complaint that:
[The Financial Industry Regulatory Authority ("FINRA")] listed order routing practices and best execution of customer trades as a priority area of focus for the upcoming year. In its '2015 Regulatory and Examination Priorities Letter, ' dated January 6, 2015, FINRA reported it was 'presently conducting a sweep of firms that route a significant percentage of their unmarketable customer limit orders to trading venues that provide the highest trading rebates for providing liquidity.
Id. at 36-37. FINRA further noted its concern “that firms may receive inferior executions of their customers’ unmarketable limit orders because of market movements during the pendency of the orders, while the firm still collects a trading rebate, ” and is in the process of reviewing routing decisions and how such decisions are impacted by rebates. Id. at 36.
Plaintiff Klein alleges that TD Ameritrade's routing of orders to the venues offering the highest order flow payments amounts to a routing strategy that is inimical to best execution. Further, Klein alleges that TD Ameritrade has profited in the amount of one billion dollars as a result of improperly routing orders based on the distinction between a marketable and non-marketable order, stating that "[i]n a June 12, 2014 press release, TD Ameritrade disclosed that from 2011 through 2013, it received at least $605 million in payments for order flow alone." Id. at 4. Klein sets forth in great detail the harmful impact that TD Ameritrade’s routing practices had on its clients’ orders. See e.g., Id. at 5, 29, 31-32. He alleges that by routing orders with TD Ameritrade, retail investors suffered from information asymmetry with sophisticated traders and were denied opportunities to obtain the best price and post-execution performance. Id. at 5. The deleterious effect on order execution is demonstrated by citation to numerous studies that found that nonmarketable limit orders routed to exchanges with higher rebates were as much as 25 percent less likely to be executed and marketable limit orders placed on venues that paid higher liquidity rebates were executed at prices inferior to orders on venues with lesser/no rebates, costing investors as much as $5 billion per year, respectively. Id. at 29-34. He alleges that TD Ameritrade sacrificed speed, fill-rate, and other factors that enter into a proper best execution analysis by prioritizing TD Ameritrade's own revenue generating opportunities. Id. The plaintiff alleges that TD Ameritrade continues to route “virtually” all orders to the venue providing TD Ameritrade with the best revenue opportunities for itself. Id. at 19.
Klein also alleges that Defendant Tomczyk participated in the operation and management of TD Ameritrade, and conducted and participated, directly and indirectly, in the conduct of TD Ameritrade’s business affairs. Id. at 46. By virtue of his position as CEO, Defendant Tomczyk knew that TD Ameritrade was pursuing a policy of routing orders in order to maximize payment for order flow and the receipt of liquidity rebates at the expense of achieving best execution of its clients’ orders. Id.
In its motions to dismiss the respective complaints, TD Ameritrade asserts preemption under the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), 15 U.S.C. §77p, regulatory preemption, and failure to state a claim as grounds for dismissal of all the state-law claims. It also contends that the securities fraud claim asserted in the Klein ...