In the past year, several class action lawsuits have been filed in California claiming that employee trading policies of broker-dealers, which require employees to generally maintain their personal brokerage accounts in-house, violates a California law that prohibits employers from forcing employees to patronize the employer. In related cases of first impression issued this week, a California federal district judge upheld these types of trading policies, holding that federal securities law preempts the application of the California state law in this context.
On May 23, in Bloemendaal v. Morgan Stanley Smith Barney, an Orrick team of employment and securities litigators obtained summary judgment for Morgan Stanley Smith Barney ("MSSB"). In that case, the putative class alleged that a provision of MSSB's employee trading policy requiring employees who choose to have brokerage accounts to generally maintain those accounts with MSSB (subject to an exceptions process) violates Section 450 of the California Labor Code, which makes it illegal for an employer to force its employees to patronize the employer. MSSB moved for summary judgment on the grounds that its employee trading policy was mandated by its supervisory obligations under federal securities laws, FINRA and the NYSE, therefore 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 statement and confirmations or (b) not charging employees for in-house accounts. MSSB contended that federal law and SRO rules grants brokerage firms discretion to design employee trading polices that it determines will best prevent and detect insider trading and other securities abuses, and that this discretion cannot be restricted by 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 the 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.
Accordingly, Judge Fischer granted MSSB's motion for summary judgment in the Bloemendaal case. 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.
Several similar putative class actions are still outstanding against other broker-dealers, many with motions under submission raising similar federal preemption arguments. Judge Fischer's well-reasoned decision, the first to address this topic, may be influential in convincing the judges in the remaining cases to reach the same conclusion, thereby providing broker-dealers with ample leeway to craft employee trading polices without state law interference.