Guice v. Charles Schwab & Co., Inc.

• Decision Date: 17 October 1996
• Citation: 89 N.Y.2d 31,674 N.E.2d 282,651 N.Y.S.2d 352
• Court: New York Court of Appeals Court of Appeals
• Parties: , 674 N.E.2d 282, 65 USLW 2268 Kenneth H. GUICE, Respondent, v. CHARLES SCHWAB & CO., INC., Appellant. Frank J. EVANGELIST, Jr., Respondent, v. FIDELITY BROKERAGE SERVICES, INC., Appellant.

Page 352

651 N.Y.S.2d 352

89 N.Y.2d 31, 674 N.E.2d 282, 65 USLW 2268

Kenneth H. GUICE, Respondent, v. CHARLES SCHWAB & CO., INC., Appellant.

Frank J. EVANGELIST, Jr., Respondent, v. FIDELITY BROKERAGE SERVICES, INC., Appellant.

Court of Appeals of New York.

Oct. 17, 1996.

Morgan, Lewis & Bockius LLP, New York City (Catherine A. Ludden, John E. Failla, Thomas R. Stritter and Elizabeth A. Cronin, of counsel), for appellant in the first above-entitled action.

Milberg, Weiss, Bershad, Hynes & Lerach LLP, New York City (Richard M. Meyer and Stephen H. Schwartz, of counsel), for respondent in the first and second above-entitled actions.

O'Melveny & Myers LLP, New York City (Donald T. Bliss, Bruce A. Hiler, Joseph C. Lombard, James H. Bolin, Jr., and Brian P. Brooks, of the District of Columbia Bar, admitted pro hac vice, of counsel), and Stuart J. Kaswell, of the District of Columbia Bar, admitted pro hac vice, for Securities Industry Association, amicus curiae in the first above-entitled action.

Brown & Wood, New York City (A. Robert Pietrzak and Robert C. Reuland, of counsel), for appellant in the second above-entitled action.

OPINION OF THE COURT

LEVINE, Judge.

The plaintiffs in these appeals are former retail customers of defendants Charles Schwab & Co., Inc. (Schwab) and Fidelity Brokerage Services, Inc. (Fidelity). Schwab and Fidelity are "discount" stock brokerage houses, operating nationwide, who charge reduced commissions for effecting securities transactions for their clientele and hold themselves out as offering quicker executions of orders on behalf of customers who have already decided upon what securities to buy or sell. Plaintiffs have brought these class actions on behalf of all similarly situated (unrestricted by geographical location) clients of the defendants who used their brokerage services during the 1990-1994 putative class period.

In their respective complaints, which are identical in all pertinent respects, plaintiffs seek a return of commissions, compensatory and punitive damages, an accounting and injunctive relief based on common-law theories of breach of fiduciary duty and conversion arising out of the agent/principal relationships between defendants and the putative class members, and upon alleged statutory violations. ¹

All of the plaintiffs' causes of action arise out of defendants' receipt of what is known in the securities industry as "order flow payments." The practice of order flow payment consists of remuneration in the form of monetary or other benefits given to retail securities broker-dealers for routing customers' orders for execution to wholesale dealers or other market makers in the subject securities. Paying for order flow originated many years ago in the over-the-counter (OTC) market, when regional broker-dealers were paid a fee by wholesale market makers in the OTC security bought or sold, for directing orders to them for execution. ² With the advent of computer technological advances capable of providing an entirely automated market system independent of the floor of any stock exchange (such as the National Association of Securities Dealers Automated Quotation System), and automated trading systems permitting accelerated execution of orders by regional exchange specialists, OTC market makers and member firms of the regional stock exchanges could compete for orders in listed stocks with the national New York and American Stock Exchanges. ³ Thus, routing orders in listed stocks to OTC market makers and regional exchange specialists has more recently become a major source of order flow payments to retail broker-dealers. ⁴

Plaintiffs' complaints allege that the defendants' acceptance of order flow payments breached the fiduciary relationship between them and their customers in the plaintiff member classes under common-law agency principles. Plaintiffs also allege that the acceptance of order flow payments itself is illegal and actionable because it violates a broker's duty to obtain the "best execution" (i.e., execute the transaction under the most favorable possible terms) of its customers' orders. They also allege illegality of the acceptance of order flow payments as a form of commercial bribery (citing Penal Law § 180.05) and a violation of State securities law (the Martin Act) (citing General Business Law § 352-c).

Schwab and Fidelity moved to dismiss the complaints on grounds, inter alia, that enforcing plaintiffs' State common-law and statutory causes of action would violate the United States Constitution's Commerce Clause (U.S. Const., art. I, § 8) and Supremacy Clause (id., art. VI, cl. [2] ), and interfere with the primary jurisdiction of the Securities and Exchange Commission (SEC). In each case, the complaint was dismissed by Supreme Court under the Supremacy Clause, on the ground that plaintiffs' causes of action were preempted by the Securities Exchange Act of 1934, as amended, and the SEC regulations promulgated thereunder.

The Appellate Division modified in each case (Guice v. Schwab & Co., 214 A.D.2d 53, 630 N.Y.S.2d 317; Evangelist v. Fidelity Brokerage Servs., 224 A.D.2d 211, 637 N.Y.S.2d 392). The Court in Guice noted that plaintiff "as limited by his brief, does not seek to bar totally the practice of payments for order flow, 'except where, as here, "full and frank disclosure" has not been made' " (214 A.D.2d, at 55, 630 N.Y.S.2d 317). The Court concluded that, upon that basis, plaintiff Guice's causes of action were not preempted by Federal law and that the primary jurisdiction doctrine was not a bar. Accordingly, the Court reinstated all of plaintiff's causes of action (except that based upon the Martin Act) and remitted to Supreme Court to determine the remaining grounds for defendant's motion to dismiss. The subsequent decision of the Appellate Division in Evangelist largely followed the reasoning of the Court in Guice. ⁵ The Appellate Division granted Schwab and Fidelity leave to appeal in each case upon the certified question of whether its order of modification was properly made.

We reverse, concluding that the plaintiffs' remaining common-law causes of action, even as limited by plaintiffs as being based solely on inadequate or absent disclosure of receipt of order flow payments, are preempted by the 1975 amendments to the Securities Exchange Act and implementing SEC regulations.

The Supremacy Clause of the United States Constitution, directing that Federal laws "shall be the supreme Law of the Land * * * any Thing in the Constitution or Laws of any State to the Contrary notwithstanding" (U.S. Const., art. VI, cl. [2] ), thereby vests in Congress the power to supersede not only State statutory or regulatory law but common law as well (see, Freightliner Corp. v. Myrick, 514 U.S. 280, 287, 115 S.Ct. 1483, 1487, 131 L.Ed.2d 385; International Paper Co. v. Ouellette, 479 U.S. 481, 496, 107 S.Ct. 805, 813-814, 93 L.Ed.2d 883). The preemption question is ultimately one of congressional intent (see, Barnett Bank of Marion County v. Nelson, 517 U.S. 25, ----, 116 S.Ct. 1103, 1107, 134 L.Ed.2d 237; California Fed. Sav. & Loan Assn. v. Guerra, 479 U.S. 272, 280, 107 S.Ct. 683, 689, 93 L.Ed.2d 613). As recapitulated most recently in Barnett Bank supra, 517 U.S., at ----, 116 S.Ct., at 1107-1108, congressional preemptive intent may be shown from express language in the Federal statute; it may also be established implicitly because the Federal legislation is so comprehensive in its scope that it is inferable that Congress wished fully to occupy the field of its subject matter ("field preemption"), or because State law conflicts with the Federal law. Implied conflict preemption may be found when it is impossible for one to act in compliance with both the Federal and State laws, or when "the state law * * * 'stan[ds] as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress' " (id., 517 U.S., at ----, 116 S.Ct., at 1108, quoting Hines v. Davidowitz, 312 U.S. 52, 67, 61 S.Ct. 399, 404, 85 L.Ed. 581; City of New York v. Job-Lot Pushcart, 88 N.Y.2d 163, 170, 643 N.Y.S.2d 944, 666 N.E.2d 537).

Moreover, Federal administrative agency regulations, promulgated pursuant to congressional delegation of discretionary quasi-legislative authority to effectuate congressional purposes, may also preempt State law (see, Capital Cities Cable v. Crisp, 467 U.S. 691, 699-700, 104 S.Ct. 2694, 2700-2701, 81 L.Ed.2d 580). "When the administrator promulgates regulations intended to pre-empt state law, the court's inquiry is * * * limited: 'If [h]is choice represents a reasonable accommodation of conflicting policies that were committed to the agency's care by the statute, we should not disturb it unless it appears from the statute or its legislative history that the accommodation is not one that Congress would have sanctioned' "(Fidelity Fed. Sav. & Loan Assn. v. de la Cuesta, 458 U.S. 141, 154, 102 S.Ct. 3014, 3023, 73 L.Ed.2d 664, quoting United States v. Shimer, 367 U.S. 374, 383, 81 S.Ct. 1554, 1560, 6 L.Ed.2d 908 [brackets in the original] ).

The potential collision here of plaintiffs' State law causes of action with Federal law arises out of the 1975 amendments to the Securities Exchange Act of 1934 (see, Pub L 94-29, 89 U.S. Stat. 97, codified at 15 U.S.C. § 78a et seq.) and the implementing regulations of the SEC. The 1975 amendments were enacted in response to a congressional perception of "the securities industry's languor in the face of great change and great opportunity" (Sen. Rep. No. 94-75, Senate Comm. on Banking, Housing and Urban Affairs, 94th Cong., 1st Sess. 1, reprinted in 1975 U.S.Code Cong. & Admin. News 179, 180 [summarizing the 1973 Securities Industry Study Report of the Subcommittee on Securities] ). Congress identified the causes of that languor to include "price fixing [of] commission rates; artificial * * * [and] unjustified barriers to access to markets and market makers; opposition to...