In the past year, several class action lawsuits have been filed in California claiming that broker-dealer employee trading policies—which generally require employees to maintain their personal brokerage accounts in-house—violate Section 450 of the California Labor Code, which prohibits employers from compelling their employees' patronage. In Bloemendaal v. Morgan Stanley Smith Barney, the Central District of California granted summary judgment to Morgan Stanley Smith Barney (MSSB), holding that federal securities law preempts the application of Section 450 to such policies.
The putative class in Bloemendaal alleged that a provision of MSSB's employee trading policy requiring employees with brokerage accounts to maintain their accounts with MSSB (subject to an exceptions process) violates Labor Code Section 450 because it constitutes compelled patronage. MSSB moved for summary judgment on the grounds that its employee trading policy is mandated by its supervisory obligations under federal securities laws, FINRA and the NYSE, thereby preempting the California Labor Code.
Based on the record before the court, it was undisputed that MSSB is subject to extensive federal regulation and oversight by the SEC and multiple self-regulatory organizations (SRO) such as the FINRA and the NYSE, all of which require MSSB to supervise its employees to prevent insider trading. Furthermore, it was undisputed that MSSB could better prevent, detect, and investigate insider trading by having employees conduct personal trading in-house. Plaintiffs' sole contention was that simultaneous compliance with both the California Labor Code and federal securities laws was possible by either (a) allowing outside accounts so long as employees properly provide duplicate statements and confirmations or (b) not charging employees for in-house accounts. MSSB contended that federal law and SRO rules grant brokerage firms discretion to design employee trading polices to best prevent and detect insider trading and other securities abuses, and that this discretion cannot be restricted by the application of state law.
Judge Dale Fischer of the Central District agreed with MSSB and granted summary judgment. The Court acknowledged that Supreme Court precedent defines conflict preemption to include state laws that "stand as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress." She also found that rules promulgated by SROs that have been approved by the SEC carry the same preemptive effect as federal law. After examining the legislative history of the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA) and an SEC report from 1990 acknowledging that most broker-dealers utilized policies requiring employees to trade in-house, the Court found that plaintiffs' proposed application of the California Labor Code would frustrate the Congressional goals of the Exchange Act and the ITSFEA. As the Court noted, the ITSFEA provides that the broker-dealer maintain policies "reasonably designed" to prevent insider trading and "Defendant implemented a policy expressly suggested by Congress. To hold that such a policy is unreasonably designed would be nonsensical." Moreover, the Court held that NYSE Rule 407(b), which requires employees of member firms to obtain their firm's consent to open a brokerage account at another firm, precluded plaintiffs' interpretation of the California Labor Code, which would allow outside accounts simply upon notification rather than consent.
The following day, Judge Fischer granted MSSB's motion to dismiss in the related case of Hanson v. Morgan Stanley Smith Barney, which raised similar claims. Judge Fischer's well-reasoned decision, the first to address this topic, appeared to be influential in convincing two other federal judges in similar cases against Bank of America and Wells Fargo to reach the same conclusion. Plaintiffs in the MSSB and Bank of America cases have filed notices of appeal with the Ninth Circuit.