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From Securities Regulation Daily, January 9, 2018

SLUSA precludes another state class action over broker kickbacks

By Anne Sherry, J.D.

For the second time in as many weeks, a circuit court of appeals has dismissed state-law claims against a brokerage for violating the duty of best execution. On the heels of a Ninth Circuit decision involving Charles Schwab, the Eighth Circuit held that the Securities Litigation Uniform Standards Act (SLUSA) precluded claims against Scottrade. It was "obvious" to the court that Scottrade’s alleged misconduct in routing orders to venues that paid rebates was "in connection with" the purchase and sale of covered securities (Lewis v. Scottrade, Inc., January 9, 2018, Loken, J.).

The putative class action alleged violations of the Missouri Merchandising Practices Act, common-law breach of fiduciary duty, and unjust enrichment. According to the complaint, Scottrade violated the duty of best execution by routing customer limit orders to trading venues that pay rebates to the sending broker. Although brokers are not required to made trade-by-trade determinations as to the best trading venue for clients, the duty of best execution requires them to do so in the aggregate, considering the likelihood and speed of trade execution and opportunities for price improvement. Allegedly, in 2013 and 2014 the firm directed nearly all customer non-directed standing limit orders to the trading venues offering the largest rebates. But the district court in St. Louis dismissed the complaint, concluding that SLUSA barred the claims.

SLUSA precludes "covered class actions" based in state law alleging either a misrepresentation or omission, or a manipulative or deceptive device or contrivance, in connection with the purchase or sale of a covered security. In this case, it was undisputed that Lewis filed a "covered class action" and that Scottrade deals in "covered securities" within the meaning of the statute. The issues on appeal were whether the complaint alleged a misrepresentation, omission, or manipulative or deceptive device or contrivance that was "in connection with" the purchase or sale of a covered security.

"In connection with." The plaintiff argued that SLUSA does not apply to misconduct that induces a customer to choose one brokerage over another. But the alleged failure to provide best execution was material in every trade that the plaintiff had Scottrade execute, and it produced revenue for Scottrade each time. It was "frivolous" given Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit (U.S. 2006) to argue that the breach of the duty of best execution was not in connection with the purchase or sale. Dabit established that SLUSA has preclusive effect when the alleged fraud "coincides" with a securities transaction.

Misrepresentations or omissions. Furthermore, although the plaintiff did not specifically allege fraud or material misrepresentations or omissions, the core of the complaint was that Scottrade did not disclose that it was not seeking best execution. The plaintiff alleged that the practice of sending orders to the venues that paid rebates systematically derogated clients’ interests and enhanced Scottrade’s own profits in a way that was "immoral, unethical, oppressive, and unscrupulous." Even if the plaintiff did not allege a misrepresentation or omission, the complaint, fairly read, alleged the use of a manipulative or deceptive device or contrivance. Accordingly, SLUSA precluded the claims.

The case is No. 16-3808.

Attorneys: Timothy G. Blood (Blood Hurst & O'Reardon LLP) for Nicholas Lewis. Brandi L. Burke (Thompson Coburn LLP) for Scottrade, Inc.

Companies: Scottrade, Inc.

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