Southern District Of New York Dismisses Putative Class Action, Holding That Claims Are Precluded By SLUSA
On April 1, 2017, District Judge John G. Koeltl of the United States District Court for the Southern District of New York dismissed a putative class action against brokerage firm E*TRADE Financial Corporation and E*TRADE Securities LLC (collectively, “E*Trade”). Rayner v. E*TRADE Financial Corporation et al, No. 1:16-cv-7129 (S.D.N.Y. Apr. 1, 2017). Plaintiff brought claims for breach of fiduciary duty, unjust enrichment, and declaratory judgment, alleging that E*Trade selected third-party trading venues for the execution of trading orders based on the amount of rebates those venues paid or “kicked back” to E*Trade rather than selecting the most efficient or cost-effective trading venue for E*Trade’s clients that plaintiff contends is required by the duty of best execution. The Court dismissed all of the claims, holding that they were precluded by the Securities Litigation Uniform Standards Act (the “SLUSA”), which prohibits class actions based on state law claims that rely on allegations that defendant made a misrepresentation or omission of material fact, or employed any manipulative or deceptive device, in connection with the purchase or sale of a covered security.
At the outset, plaintiff conceded three of the elements necessary for a finding of SLUSA preclusion: that the complaint is a covered class action, based on state law, regarding covered securities. The Court’s decision on the motion to dismiss, therefore, focused on whether plaintiff’s claims (i) were grounded in misrepresentations or omissions, alleged manipulation and deceit and (ii) were made in connection with a security transaction. Regarding the first issue, plaintiff argued that the action only challenged E*Trade’s underlying practices regarding its selection of venues when routing orders and accordingly did not rely on any allegations concerning misrepresentations or omissions. The Court disagreed, finding that the action was predicated on material misrepresentations allegedly designed to induce clients to execute the type of trade that granted E*Trade flexibility to select the trading venue of its choosing—even though E*Trade allegedly had no intention of fulfilling its purported fiduciary obligations—and thus could not “be disentangled from the misrepresentations or omissions.” The Court reasoned that plaintiff’s claims “necessarily challenge what E*Trade told the plaintiff” about its selection of trading venues and the nature of E*Trade’s obligations to the plaintiff, and, accordingly, those claims rested on plaintiff’s showing that E*Trade committed false conduct, thereby further precluding these claims under SLUSA. The Court also noted that the Securities and Exchange Commission has taken the position that the failure to provide “best execution” is a possible manipulative, deceptive, or otherwise fraudulent device, further supporting the Court’s finding that plaintiff’s claims based on allegations that E*Trade routed orders to “maximize kickback revenue in violation of its duty of best execution” were precluded by SLUSA.
Turning to the issue of whether the alleged fraud was made “in connection with” a securities transaction, the Court found that the alleged fraud “plainly coincided with the securities transactions at issue” because the plaintiff took positions in covered securities through E*Trade and his purchase or sale decisions were materially affected by E*Trade’s allegedly false promises of best execution. Notably, after finding that the claims were precluded by SLUSA, the Court pointed out that plaintiff’s counsel had made clear at oral argument that plaintiff did not wish to proceed in the event that the claims were precluded by SLUSA, and had acknowledged that he already is a member of the proposed class in a related securities class action pending in the same court alleging violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 against E*Trade and several individual defendants. See Schwab v. E Trade Financial Corporation, et al., No. 16-cv-5891 (JGK) (S.D.N.Y). Accordingly, the Court dismissed plaintiff’s claims in their entirety.
The decision reinforces the limits imposed by SLUSA on a plaintiffs’ ability to plead state law class actions relating to alleged disclosure violations.