Schwab v. E*trade Fin. Corp.

• Decision Date: 10 July 2017
• Docket Number: 16-cv-05891 (JGK).
• Parties: Craig L. SCHWAB, Individually and on Behalf of all others similarly situated, Plaintiff, v. E*TRADE FINANCIAL CORPORATION et al., Defendants.
• Court: U.S. District Court — Southern District of New York

258 F.Supp.3d 418

Craig L. SCHWAB, Individually and on Behalf of all others similarly situated, Plaintiff,

v.E*TRADE FINANCIAL CORPORATION et al., Defendants.

16-cv-05891 (JGK).

United States District Court, S.D. New York.

Signed July 10, 2017

Christopher James Kupka, Jonathan David Lindenfeld, Levi & Korsinsky, LLP, New York, NY, Nancy A. Kulesa, Levi & Korsinsky LLP, Stamford, CT, Nicholas Ian Porritt, Levi & Korsinsky LLP, Washington, DC, for Plaintiff.

Faith E. Gay, Julia Marie Beskin, Marc Laurence Greenwald, Renita Sharma, Richard Corey Worcester, Quinn Emanuel Urquhart & Sullivan LLP, New York, NY, for Defendant.

OPINION AND ORDER

JOHN G. KOELTL, District Judge:

This is a securities action brought by the lead plaintiff, Craig L. Schwab (the "plaintiff"), on behalf of a proposed class of clients of E*TRADE Securities LLC ("E*TRADE") who placed securities trade orders with the broker-dealer between July 11, 2011 and the present (the "Class Period"). In Count One, the plaintiff asserts violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (the "Exchange Act"), and Rule 10b–5 promulgated thereunder, 17 C.F.R. § 240.10b–5, against E*TRADE and E*TRADE Financial Corporation ("E*TRADE Financial") (collectively, the "corporate defendants"). In Count Two, the plaintiff asserts control person liability under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against Paul T. Idzik ("Idzik"), the former Chief Executive Officer of E*TRADE Financial, and Karl A. Roessner ("Roessner"), the current Chief Executive Officer of E*TRADE Financial (collectively, the "individual defendants").

In a Memorandum Order and Opinion dated April 3, 2017, this Court dismissed common law claims against E*TRADE and E*TRADE Financial that arose out of the same conduct at issue here because those claims were precluded by the Securities Litigation Uniform Standards Act (the "SLUSA"). See Rayner v. E*TRADE Fin. Corp., No. 16-CV-7129 (JGK), 248 F.Supp.3d 497, 505–06, 2017 WL 1232730, at *7 (S.D.N.Y. Apr. 3, 2017), appeal docketed, No. 17–1487 (2d Cir. May 8, 2017). Familiarity with that decision is presumed.

The defendants have moved to dismiss the Second Amended Complaint (the "SAC") for failure to state a claim pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. This Court has subject matter jurisdiction pursuant to 15 U.S.C. § 78aa and 28 U.S.C. § 1331.

For the following reasons, the motion is granted.

I.

In deciding a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, the allegations in the complaint are accepted as true, and all reasonable inferences must be drawn in the plaintiffs' favor. McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 191 (2d Cir. 2007). The Court's function on a motion to dismiss is "not to weigh the evidence that might be presented at a trial but merely to determine whether the complaint itself is legally sufficient." Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985). A complaint should not be dismissed if the plaintiffs have stated "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). "A claim has facial plausibility when the plaintiff[s] plead [ ] factual content that allows the court to draw the reasonable inference that the defendant[s] [are] liable for the misconduct alleged." Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009). While factual allegations should be construed in the light most favorable to the plaintiffs, "the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions." Id.

A claim under Section 10(b) of the Securities Exchange Act sounds in fraud and must meet the pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure and of the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u–4(b). Rule 9(b) requires that the complaint "(1) specify the statements that the plaintiff[s] contend[ ] were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007). The PSLRA similarly requires that the complaint "specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading," and it adds the requirement that "if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u–4(b)(1) ; ATSI, 493 F.3d at 99.

When presented with a motion to dismiss pursuant to Rule 12(b)(6), the Court may consider documents that are referenced in the complaint, documents that the plaintiffs relied on in bringing suit and that are either in the plaintiffs' possession or that the plaintiffs knew of when bringing suit, or matters of which judicial notice may be taken. See Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002). The Court can take judicial notice of public disclosure documents that must be filed with the SEC and documents that both "bear on the adequacy" of SEC disclosures and are "public disclosure documents required by law." Kramer v. Time Warner Inc., 937 F.2d 767, 773–74 (2d Cir. 1991) ; see also In re Eletrobras Sec. Litig., No. 15-CV-5754 (JGK), 245 F.Supp.3d 450, 456–58, 2017 WL 1157138, at *1–2 (S.D.N.Y. Mar. 27, 2017).

II.

The following facts are undisputed or accepted as true for purposes of the defendants' motion to dismiss.

E*TRADE Financial is a Delaware corporation, with its principal place of business in New York, that provides brokerage and related services to individual retail investors. SAC ¶ 21. E*TRADE is a Delaware limited liability company that is a wholly owned subsidiary of E*TRADE Financial.¹ SAC ¶ 22. Before 2014, E*TRADE was an operating subsidiary of E*TRADE Bank, which is also a subsidiary of E*TRADE Financial. SAC ¶ 22. E*TRADE is a broker-dealer registered with the United States Securities and Exchange Commission (the "SEC"), and is the primary provider of brokerage products and services to E*TRADE Financial's customers. SAC ¶ 22.

Idzik was the CEO and a director of E*TRADE Financial from January 22, 2013 through his departure on September 12, 2016. SAC ¶ 23; see also Form 8–K dated January 17, 2013.²

From May 2009 to September 12, 2016, Roessner served as the Executive Vice President and General Counsel of E*TRADE. SAC ¶ 24. On September 12, 2016, Roessner became the CEO and a director of E*TRADE Financial, and the President of E*TRADE Bank. Form 8–K dated September 12, 2016; see also SAC ¶ 24.

Brokers, such as E*TRADE, can route orders for execution to third-party venues, such as exchanges and market makers. SAC ¶ 3. A "non-directed order" is a standard type of order that a client can place with E*TRADE where E*TRADE (as opposed to the client) chooses the trading venue for the order. SAC ¶ 7. The SAC alleges that "over 95 percent of orders placed with E*TRADE are non-directed." SAC ¶ 7.

According to the SAC, E*TRADE has two primary sources of revenue: the commissions that its customers pay in exchange for routing orders and the payments for order flow ("Payments for Order Flow" or "PFOF") that it receives from venues under the "maker-taker" model. SAC ¶¶ 30, 87. Under the maker-taker model, venues pay brokerage firms for "making" a market or adding liquidity for certain types of orders, while venues charge brokers an access or "take" fee for matching a marketable order with an existing bid or offer. SAC ¶ 30. The SAC alleges that venues compete for order flow by maximizing PFOF amounts to brokers, such as E*TRADE. SAC ¶ 30.

The maker-taker model, including the receipt of PFOF, is heavily regulated by the federal securities regime. See, e.g., Regulation NMS, Exchange Act Release No. 34–51808, 2005 WL 1364545 (June 9, 2005) ; see also Rayner, 248 F.Supp.3d at 501–02, 2017 WL 1232730, at *3. There is no allegation that the receipt of PFOF is inherently wrongful; indeed, the SEC permits broker-dealers to receive PFOF subject to certain disclosure requirements. 17 C.F.R. § 240.10b–10(a)(2)(i)(C) ; see also Exchange Act Rule 606, 17 C.F.R. § 242.606 (requiring the disclosure of quarterly reports related to the receipt of PFOF).

E*TRADE has a duty of best execution, which, among other things, requires it to "use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions." FINRA Rule 5310(a)(1)³ ; see also SAC ¶¶ 39–41, 43–44.

The gist of the allegations in the SAC is that E*TRADE repeatedly assures the market that it will execute orders consistent with its duty of best execution even though it has no intention of delivering on those promises. The SAC alleges that E*TRADE is actually pursuing a routing strategy designed to maximize the receipt of PFOF, which results in the delivery of something less than best execution and thus less advantageous prices for its clients. See SAC ¶¶ 1, 41, 92.

The SAC in particular faults "predetermined routing agreements" between E*TRADE and other venues in which E*TRADE agrees to route a certain percentage of its orders to a venue in exchange for PFOF. Such agreements allegedly lock E*TRADE into providing order flow to the venue regardless of best execution considerations. SAC ¶¶ 12, 63.

The SAC alleges that E*TRADE's use of such agreements began before the Class Period. In November 2007, E*TRADE agreed to route 40% of its customer equities orders to Citadel Securities LLC, an affiliate of Citadel Investment Group ("Citadel"), for three years. SAC ¶ 66. Once the agreement (the "Citadel Agreement") expired, the SAC alleges that E*TRADE decreased the proportion of orders routed...