On January 20, 2018, Judge John Koeltl of the United States District Court for the Southern District of New York dismissed a putative class action under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder filed against E*TRADE Securities LLC (“E*TRADE”), E*TRADE Financial Corporation (“E*TRADE Financial”), and one current and one former officer of E*TRADE Financial. Schwab v. E*TRADE Fin. Corp., --F. Supp. 3d --, 2018 WL 502787 (S.D.N.Y. 2018). Plaintiff alleged that E*TRADE falsely represented that it would execute clients’ orders consistent with its duty of “best execution”—which requires it to use “reasonable diligence” to obtain the most favorable price for a customer under “prevailing market conditions”—because E*TRADE allegedly executed orders in consideration of only two factors—its order-handling agreements with venues and the maximization of payments for order flow. In prior decisions, the Court dismissed common law claims as precluded by the Securities Litigation Uniform Standards Act (“SLUSA”), and dismissed without prejudice the second amended complaint for failure to adequately allege reliance or scienter. Addressing plaintiff’s third amended complaint, the Court again determined that plaintiff had failed to adequately plead reliance or scienter, and dismissed the action with prejudice.
With respect to reliance, plaintiff did not allege that he was aware of E*TRADE’s alleged misstatements or that the alleged misstatements affected the price of E*TRADE stock. Rather, plaintiff argued he was entitled to the presumption of reliance established in Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972), which held that where a defendant has a duty to disclose and omits a material fact, the investor to whom the duty was owed need not provide specific proof of reliance. The Court previously held that plaintiff did not qualify for the Affiliated Ute presumption because the second amended complaint primarily alleged misrepresentations, rather than omissions. The third amended complaint repeated the same allegations involving misrepresentations, and merely added an allegation that E*TRADE “fail[ed] to disclose its actual order routing practices.” 2018 WL 502787, at *5. Applying the Second Circuit’s opinion in Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017), the Court held that this purported “omission” failed to implicate Affiliated Ute because it was “simply the inverse” of the alleged misrepresentation. 2018 WL 502787, at *6. Judge Koeltl also rejected plaintiff’s invocation of Crago v. Charles Schwab & Co., Inc., No. 16–cv–03938, 2017 WL 6550507 (N.D. Cal. Dec. 5, 2017), in which the Northern District of California recently applied Affiliated Ute based on allegations that the plaintiffs in that case “could not have known that the defendant executed trades in a way inconsistent with the defendant’s duty of best execution.” 2018 WL 502787, at *6. Judge Koeltl found Crago “not persuasive” on the Affiliated Ute issue, because its reasoning that the difference between omissions and misrepresentations was often “illusory” was inconsistent with the Second Circuit’s guidance in Waggoner.
With respect to scienter, the Court similarly held that the third amended complaint still failed to cure the deficiencies in the prior complaint. Rather, plaintiff merely added conclusory allegations that the individual defendants must have known because of their positions and responsibilities that E*TRADE was failing to deliver best execution, and further that the individual defendants had an alleged motive to commit fraud because failing to deliver best execution led to higher executive bonuses and inflated the value of stock compensation. The Court rejected these allegations, holding that conclusory allegations based solely on corporate positions or responsibilities, or a generic profit motive, are insufficient to establish an inference of scienter. Id. at *8-9.
This decision highlights that the level of scrutiny a court employs in analyzing a plaintiff’s efforts to characterize misrepresentation claims as omission claims can be critical in arguably close cases. It also underscores that adequately pleading scienter requires particularized allegations rather than allegations based merely on corporate status or a profit motive.