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Schwab v. E*Trade Financial Corp.

United States District Court, S.D. New York

January 22, 2018



          John G. Koeltl United States District Judge

         The lead plaintiff, Craig L. Schwab, brought this case on behalf of a proposed class of clients of E*TRADE Securities LLC ("E*TRADE") who placed securities trade orders with E*TRADE between July 12, 2011 and July 22, 2016 (the "Class Period"}. In Count I, 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"), E*TRADE's parent corporation (collectively, the "corporate defendants"). In Count II, the plaintiff asserts control person liability under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t (a), against Paul T. Idzik and Karl A. Roessner (collectively, the "individual defendants"). Idzik is a former director and Chief Executive Officer of E*TRADE Financial, and Roessner is the former General Counsel and a current director and Chief Executive Officer of E*TRADE Financial.

         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., 248 F.Supp.3d 497, 506 (S.D.N.Y. 2017), appeal docketed, No. 17-1487 (2d Cir. May 8, 2017) ("E*TRADE I"). In an Opinion dated July 10, 2017, this Court dismissed the Second Amended Complaint (the "SAC"} in this action without prejudice for failure to plead adequately the reliance and scienter elements of the plaintiff's Section 10(b) and Rule 10b-5 claim, upon which the plaintiff s claim for control person liability was premised. See Schwab v. E*TRADE Fin. Corp., 258 F.Supp.3d 418 (S.D.N.Y. 2017) ("E*TRADE II"). Familiarity with those decisions and the underlying facts of the case are presumed.

         On August 9, 2017, the plaintiff filed the Third Amended Complaint (the "TAC"}, the plaintiffs fourth pleading in this case. The defendants have moved to dismiss the TAC for failure to state a claim pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.

         For the following reasons, the motion is granted.


         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 plaintiff's 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 plaintiff has 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 (2007). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant[s] [are] liable for the misconduct alleged." Ashcroft v. Igbal, 556 U.S. 662, 678 (2009). While factual allegations should be construed in the light most favorable to the plaintiff, "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 contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." ATSI Commons, 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 plaintiff relied on in bringing suit and that are either in the plaintiff's possession or that the plaintiff 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), 2017 WL 1157138, at *l-2 (S.D.N.Y. Mar. 27, 2017) .


         The following facts are undisputed or accepted as true for purposes of the defendants' motion to dismiss. Facts are repeated from E*TRADE II only as necessary.

         E*TRADE Financial is a Delaware corporation, with its principal place of business in New York City, that provides brokerage and related services primarily to individual retail investors. TAC ¶ 18. E*TRADE is a Delaware limited liability company that is a wholly-owned subsidiary of E*TRADE Financial.[1]Id. ¶ 19. 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. Id.

         Idzik was the CEO and a director of E*TRADE Financial from January 22, 2013 until his departure on September 12, 2016. Id. ¶ 20.

         From May 2009 to September 12, 2016, Roessner served as the Executive Vice President and General Counsel of E*TRADE. Id. ¶ 21. On September 12, 2016, Roessner became the CEO and a director of E*TRADE Financial, and the President of E*TRADE Bank, a subsidiary of E*TRADE Financial. Id. ¶¶ 19, 21.

         Brokers, such as E*TRADE, can route orders for execution to third-party venues, such as exchanges and market makers. Id. ¶¶ 22, 24. 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. Id. ¶ 24. The TAC alleges that "over 95 percent of orders placed with E*TRADE are non-directed." Id.

         E*TRADE generates revenue from both the commissions that its customers pay in exchange for routing orders and from the payments for order flow ("Payments for Order Flow" or "PFOF") that it receives from venues under the "maker-taker" model. Id. ¶¶ 7, 34. Under the maker-taker model, venues pay brokerage firms for "making" a market or adding liguidity 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. Id. ¶ 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 E*TRADE I, 248 F.Supp.3d at 501. 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." Financial Industry Regulatory Authority ("FINRA") Rule 5310(a)(1)[2]; see also TAC ¶¶ 39-48. In its Customer Agreement, E*TRADE purports to take a number of factors into consideration in determining where to rout customers' orders, including:

the speed of execution, price improvement opportunities (executions at prices superior to the then prevailing inside market), automatic execution guarantees, the availability of efficient and reliable order handling systems, the level of service provided, the cost of executing orders, whether it will receive cash or ...

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