Shearman & Sterling LLP | Securities Litigation Blog | Eighth Circuit Reverses Class Certification Of Securities Fraud Claims Against Brokerage Firm, Holding That Common Issues Do Not Predominate<br >  
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  • Eighth Circuit Reverses Class Certification Of Securities Fraud Claims Against Brokerage Firm, Holding That Common Issues Do Not Predominate

    On April 23, 2021, the United States Court of Appeals for the Eighth Circuit reversed the certification of a class pursuing securities fraud claims against a brokerage firm for retail investors (“the Company”).  Ford v. TD Ameritrade Holding Corp., et al., No. 18-3689 (8th Cir. April 23, 2021).  Plaintiff, on behalf of a putative class of investors who purchased and sold securities through the Company, brought securities fraud claims under the Securities Exchange Act of 1934, alleging the Company’s order routing practices violated its “duty of best execution” by systematically sending orders to trading venues that benefited the Company, rather than to venues that provided the best outcome for customers.  The Court held that the predominance and superiority requirements of Federal Rule of Civil Procedure 23(b)(3) were not satisfied because determining economic loss, in this case, would entail a trade-by-trade individualized inquiry.  Having found that the district court abused its discretion in certifying the class, the Court reversed the district court’s order and remanded for further proceedings.

    The Court of Appeals first noted that the alleged economic loss under the “duty of best execution” is the difference between “the price at which [customers’] trades were executed and the ‘better’ price allegedly available from an alternative trading source,” and stated that plaintiffs must establish the alleged “better” price in a manner “consistent with the predominance requirement of Rule 23.”  On this issue, the Court found persuasive the Third Circuit’s decision in Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 259 F.3d 154, 173 (3d Cir. 2001).  In Newton, the Third Circuit affirmed the denial of class certification in a “best execution” case, observing that “[w]hether a class member suffered economic loss from a given securities transaction would require proof of the circumstances surrounding each trade, the available alternative prices, and the state of mind of each investor at the time the trade was requested,” and that, because the alleged harm arose out of the execution of “hundreds of millions” of trades, “[d]etermining which class members were economically harmed would require an individual analysis into each trade and its alternatives,” thereby resulting in individual determinations “overpowering” common issues.

    The Court of Appeals rejected plaintiff’s attempt to distinguish Newton.  Plaintiff contended that Newton was inapposite because it involved different technology and plaintiff’s expert had purportedly developed an advanced algorithm that can calculate injury and damages on a class-wide basis.  The Court concluded that, even with the new proposed algorithm, determining economic loss in this case would require an individualized inquiry.  Plaintiff contended that whereas in Newton, the plaintiffs were challenging the execution at trades at the National Best Bid and Offer (“NBBO”) price (“the highest price a buyer was willing to pay, and the lowest price a seller was willing to accept, for a particular stock at a given time”), here plaintiff alleged that the at-issue trades were all below the NBBO price.  The Court noted, however, that plaintiff’s expert’s analysis of a limited set of plaintiff’s own trades showed that a substantial majority were executed at a price better than or equal to the NBBO price.  Further, the Court held that execution of other trades at prices inferior to the NBBO price would not necessarily result in economic loss, because there could be circumstances in which a trade legitimately might execute at a price inferior to the NBBO price, such as when the order size exceeds the number of shares available at the NBBO price at the time of the order.  The parties agreed that certain transactions would need to be excluded from the algorithm to account for instances where the Company could not have prevented execution at a price inferior to the NBBO but disagreed as to which transactions to exclude.  The Court found that determining which transactions would need to be excluded would require a trade-by-trade analysis because there is no definitive list of unusual market conditions that account for transactions that depart from the best available price.  Accordingly, whether a class member was provided with the best price “depend[s] on the facts of each trade.”  Moreover, the Court noted that “the state of mind” of each investor at the time of trade was relevant to the economic loss determination, and the algorithm could not “account for each individual customer’s trading strategy.”  Therefore, the Court held that “individual issues predominate over common ones.”

    Finally, the Court noted the independent issue that the putative class amounted to “an impermissible ‘fail-safe class.’”  The class certified by the district court consisted of “[a]ll clients of TD Ameritrade . . . who placed orders that did not receive best execution, in connection with which TD Ameritrade received either liquidity rebates or payment for order flow, and who were thereby damaged.”  The Court of Appeals held that “[b]y defining the class to include only those customers who were harmed,” the district court “certified a class in which membership depends upon having a valid claim on the merits.”  Such a definition would “allow[] putative class members to seek a remedy but not be bound by an adverse judgment,” which is impermissible under Rule 23. 

    The Court of Appeals accordingly reversed the district court’s order certifying the class and remanded for further proceedings.