On July 31, 2018, the United States Court of Appeals for the Second Circuit unanimously affirmed the dismissal of a putative class action asserting state-law claims for breach of fiduciary duty, unjust enrichment, and declaratory relief. As discussed in our prior post
, plaintiff’s claims were all based on the allegation that defendant violated its duty of best execution by routing customer trades—specifically, limit orders—to trading venues that were willing to pay the largest rebates to E*TRADE. Rayner v. E*TRADE Fin. Corp.
, --.3d--, 2018 WL 3625378 (2d Cir. 2018). The Second Circuit held that plaintiff’s claims were precluded by the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) because they alleged fraudulent misrepresentations even though framed as claims for breach of fiduciary duty.
SLUSA precludes covered class actions based on state law claims alleging that defendants made a “misrepresentation or omission of material fact” or used a “manipulative or deceptive device or contrivance” in connection with the purchase or sale of covered securities. Id.
at *2. Plaintiff argued that his complaint did not allege fraud in the form of a misrepresentation or omission of a material fact or the use of a manipulative or deceptive device or contrivance, and, separately, did not allege fraud “in connection with” the purchase or sale of covered securities. Id.
The Second Circuit, “emphasiz[ing] substance over form,” concluded that “the gravamen” of the complaint was that “E*TRADE made material misrepresentations and omissions that were designed to induce clients to execute non‐directed, standing limit orders with E*TRADE even though E*TRADE allegedly had no intention of fulfilling its purported fiduciary obligations.” Id.
at *3. Although plaintiff argued that his fiduciary duty claim was based on defendant’s breach of a “non-fraud” based fiduciary duty, the Court noted that plaintiff could not escape SLUSA by artfully characterizing a claim as dependent on a theory other than falsity when falsity was essential to the claim. Here, for example, E*TRADE on its website stated that it would “do everything possible to seek best execution each and every time you trade” in order to deliver “the right blend of execution price, speed, and price improvement.” Id.
Moreover, the fact that E*TRADE’s trade routing practices led to less optimal execution was allegedly not known to plaintiff, and therefore plaintiff was “induced by an omission of a material fact” to purchase and sell securities. Id.
The Court also noted that its conclusion was consistent with the holdings of the Eighth and Ninth Circuits that best execution claims alleging misrepresentations and omissions related to the routing of trades to take advantage of “kickbacks” from trading venues satisfied the “misrepresentation or omission” element of SLUSA. See Zola v. TD Ameritrade, Inc.
, 889 F.3d 920, 923–25 (8th Cir. 2018); Lewis v. Scottrade, Inc.
, 879 F.3d 850, 854–55 (8th Cir. 2018); Fleming v. Charles Schwab Corp.
, 878 F.3d 1146, 1154-55 (9th Cir. 2017).
The Second Circuit also rejected plaintiff’s argument that the alleged fraudulent conduct did not arise “in connection with” the purchase or sale of covered securities. Here, the Court found that the alleged fraud would have “allegedly caused Rayner and other E*TRADE clients to purchase and sell securities at unfavorable prices and at lower volumes than expected” and therefore arose “in connection” with a purchase or sale. Rayner
, 2018 WL 3625378, at *4. The Court also observed that it was “frivolous to suggest that negatively influencing the price and quantity at which clients may buy and sell securities would not make a significant difference to someone’s decision to purchase or to sell a covered security.” Id.
The Court further rejected plaintiff’s argument that the fraud did not arise “in connection” with a purchase or sale within the meaning of SLUSA because E*TRADE was technically the party that decided to buy or sell the security (which in some instances resulted in the order not being placed); the Court held because E*TRADE’s clients were trying to take an ownership position—regardless whether E*TRADE was the entity filling the order—the allegations were subject to SLUSA. Id.
This decision reinforces that courts will analyze the factual substance of a plaintiff’s claim, regardless of the legal theory plaintiff purports to pursue, in analyzing SLUSA preclusion.