In re Series 7 Broker Qualification Exam Scoring

• Decision Date: 07 September 2007
• Docket Number: Misc. Action No. 06-355 (JDB).,MDL NO. 1772.
• Citation: 510 F.Supp.2d 35
• Parties: In re SERIES 7 BROKER QUALIFICATION EXAM SCORING LITIGATION. This Document Relates To: All Cases.
• Court: U.S. District Court — District of Columbia

510 F.Supp.2d 35

In re SERIES 7 BROKER QUALIFICATION EXAM SCORING LITIGATION.

This Document Relates To: All Cases.

Misc. Action No. 06-355 (JDB).

MDL NO. 1772.

United States District Court, District of Columbia.

September 7, 2007.

MEMORANDUM OPINION

JOHN D. BATES, District Judge.

This multidistrict litigation is the result of a mistake in the scoring of a broker qualification examination that led a number of individuals to believe erroneously that they had failed when in fact they had obtained a passing score. Plaintiffs have each brought an action for money damages on behalf of a putative class consisting of members who were notified incorrectly that they had failed the exam. Currently before the Court are motions to dismiss filed by defendants National Association of Securities Dealers ("NASD"),¹ a self-regulatory organization ("SRO") under securities laws, and Electronic Data Systems Corporation ("EDS"), a corporation that provided technology services to NASD. The Court concludes that all of plaintiffs' claims, although pled in the form of common-law causes of action, are displaced by the Securities Exchange Act, which envisions Securities and Exchange Commission ("SEC") oversight rather than private damages actions as the sole means of monitoring an SRO's exercise of the regulatory duties that defendants allegedly breached.

BACKGROUND

Any individual wishing to buy, sell, or solicit securities products must first take and pass an entry-level examination known as the Series 7. Consol. Class Action Compl. ¶ 12. The computerized exam, which is administered by defendant NASD, consists of approximately 250 multiple choice questions of varying difficulty. Id. ¶¶ 11, 12. Immediately after an applicant takes the examination, a software program developed by defendant EDS scores the exam and notifies the applicant whether they received a passing score of 70% or above. Id. ¶¶ 12, 18. Because each examination is composed of a unique set of questions randomly chosen from a larger pool, the "`passing score of 70 percent is subject to minor statistical adjustments based on the overall difficulty of each individual's examination.'" Id. ¶ 24 (quoting NASD news release).

On January 6, 2006, NASD issued a news release acknowledging that a "limited number of individuals" who took the Series 7 exam between October 1, 2004, and December 20, 2005, had been incorrectly notified that they received a failing grade. Id. ¶ 23. According to NASD, an error occurred in the process used to weigh the difficulty level of 213 questions that had been introduced to the examination-question pool in October 2004. Id. ¶ 24. As a result, the scaled scores for those individuals whose examinations included any of the affected questions were incorrectly calculated. Id. In all, 1882 tests that should have received a marginally passing score received a marginally failing score instead. Id. ¶ 27. The faulty scoring allegedly resulted from human error by an EDS maintenance technician who "inadvertently switched two of the three difficulty variables" when coding the difficulty level of the questions. Id. Plaintiffs believe that the coding error was the result of either the use by EDS of outdated software that did not provide a means of verifying the coding, or the failure of EDS to perform quality control. Id. ¶ 30. They further allege that NASD failed either to supervise. EDS with respect to the coding of exam questions or to ensure that EDS was undertaking adequate quality control measures. Id. ¶ 31.

Plaintiffs are members of a putative class that includes individuals who took the Series 7 examination between October 1, 2004, and December 20, 2005, and who were informed immediately after taking the exam that they had failed when, in fact, they had passed. Id. ¶ 7. During that time period, plaintiffs notified their sponsoring agencies or member firms that they had failed the Series 7 qualification exam; as a result, they experienced adverse employment consequences that resulted in "substantial damages." Id. ¶ 21. The harm they allegedly suffered included loss of employment, wages, employment benefits, and employment opportunities. Id. ¶ 4. Plaintiffs and their sponsoring agencies and member firms were notified by NASD in January 2006 that their failing scores were reported in error and that they had actually passed the Series 7 examination. Id. ¶ 22.

The first lawsuit seeking damages for the Series 7 scoring error was filed in the Middle District of Tennessee on February 3, 2006. See Plunkett v. Nat'l Ass'n of Sec. Dealers, Inc., No. 3:06-cv-89 (M.D.Tenn.). Numerous others soon followed in districts across the country. On June 27, 2006, the Judicial Panel on Multidistrict Litigation transferred nine actions to this Court and consolidated them for pretrial purposes as MDL No. 1772, In re Series 7 Broker Qualification Exam Scoring Litigation. With the addition of subsequent tag-along cases, this multidistrict litigation now consists of nineteen pending actions. Dismissal has been effected for two other cases that were transferred to this Court after a notice of voluntary dismissal had already been filed in the transferor court. See Hester v. Nat'l Ass'n of Sec. Dealers, No. 06-cv-1321 (D.D.C.); Cutler v. Nat'l Ass'n of Sec. Dealers, No. 06-cv-1322 (D.D.C.).

Plaintiffs filed a consolidated class complaint on October 31, 2006. The consolidated complaint incorporates all of the parties subject to the MDL proceeding but does not supplant or supersede the complaints filed by plaintiffs in each individual case. Consol. Class Action Compl. ¶ 2. For ease of discussion, the Court in this memorandum opinion will refer exclusively to the consolidated class action complaint. Plaintiffs have asserted four causes of action. First, they claim that NASD breached an implied contract that existed between NASD and plaintiffs by virtue of their taking the Series 7. Id. ¶¶ 44-48. Second, they allege that EDS breached its contract with NASD, for which plaintiffs claim to be third-party beneficiaries. Id. ¶¶ 49-53. The third cause of action is asserted against both defendants for negligence in (1) designing, manufacturing, and testing the software used to score the Series 7; (2) failing to properly score the Series 7; (3) failing to properly supervise contractors; and (4) failing to ensure that plaintiffs did not receive incorrect exam results. Id. ¶¶ 54-57. Finally, plaintiffs assert a negligent-misrepresentation claim against defendants based on the reporting to plaintiffs and their employers that plaintiffs had failed the Series 7. Id. ¶¶ 58-61. Now pending before the Court are motions to dismiss filed by NASD and EDS. Argument was heard on April 25, 2007. For the reasons provided below, the Court grants defendants' motions and dismisses each of the underlying actions.

STANDARD OF REVIEW

All that the Federal Rules of Civil Procedure require of a complaint is that it contain "`a short and plain statement of the claim showing that the pleader is entitled to relief,' in order to `give the defendant fair notice of what the ... claim is and the grounds upon which it rests.'" Bell Atl. Corp. v. Twombly, 550 U.S. ___, 127 S.Ct. 1955, 1964, 167 L.Ed.2d 929 (2007) (quoting Conley v. Gibson, 355 U.S. 41, 47, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)); accord Erickson v. Pardus, 551 U.S. ___, 127 S.Ct. 2197, 2200, 167 L.Ed.2d 1081 (2007) (per curiam). "A Rule 12(b)(6) motion tests the legal sufficiency of a complaint." Browning v. Clinton, 292 F.3d 235, 242 (D.C.Cir.2002). Thus, the complaint's "[f]actual allegations must be enough to raise a right to relief above the speculative level, on the assumption that all the allegations in the complaint are true (even if doubtful, in fact)," Bell Atl. Corp., 127 S.Ct. at 1965 (citations omitted), and after drawing all inferences in plaintiffs' favor, Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974).

ANALYSIS

Defendants offer a panoply of theories upon which to dismiss plaintiffs' complaints. They primarily, urge this Court to find NASD, and by extension EDS, absolutely immune for all acts taken in furtherance of NASD's so-called regulatory functions as a self-regulatory organization ("SRO"). Defendants frame their second theory for dismissal in terms of a lack of a private right of action by plaintiffs to enforce the securities laws and the SEC and NASD rules promulgated thereunder. Third, defendants rely on the liability-release clause in the Form U4, which was signed by all plaintiffs prior to taking the Series 7 exam. Finally, defendants strike at perceived weaknesses on the merits of each claim.

A basic understanding of the role that SROs play in the securities industry is necessary to properly evaluate defendants' arguments. NASD is a registered national securities association under the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78o-3(b) (2000), and therefore qualifies as an SRO pursuant to 15 U.S.C. § 78c(a)(26). See Nat'l Ass'n of Sec. Dealers v. SEC, 431 F.3d 803, 804, 806 (D.C.Cir.2005). As an SRO, NASD "serves as a quasi-governmental agency" in the exercise of its "`delegated government power ... to enforce ... the legal requirements laid down in the Exchange Act.'" Id. at 804 (omissions in original) (quoting Merrill Lynch v. Nat'l Ass'n of Sec. Dealers, Inc., 616 F.2d 1363, 1367 (5th Cir.1980)). The SEC retains close oversight of SROs. For example, the Commission approves of all SRO rule changes, however minor, 15 U.S.C. § 78s(b), and may amend the SRO rules itself if deemed necessary, § 78s(c). If an SRO does not comply with the Exchange Act, the SEC rules, or its own rules, as required by § 78s(g), it faces the suspension or revocation of its SRO registration, as well as other sanctions. § 78s(h).

One of NASD's essential functions as a registered national securities association and SRO is to act as a gatekeeper to participation in the securities industry. The Exchange Act...