On October 26, 2018, the United States Court of Appeals for the Second Circuit affirmed the dismissal of a putative securities class action under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 against a financial services company, its broker-dealer (the “Company”), and one current and one former officer of the financial services company. Schwab v. E*TRADE Fin. Corp. et al, 1:18-cv-461 (2d Cir. Oct. 26, 2018). Plaintiff alleged that the Company failed to disclose that it was purportedly violating the duty of “best execution,” which requires broker-dealers to use “reasonable diligence” to obtain the most favorable price for a customer under “prevailing market conditions.” Earlier this year, the United States District Court for the Southern District of New York dismissed plaintiff’s third amended complaint with prejudice after finding that plaintiff had failed to adequately allege reliance, among other elements. The Second Circuit affirmed the judgment, reiterating that the Affiliated Ute presumption of reliance does not apply where the claim is primarily based on misrepresentations rather than on omissions.
In the district court, plaintiff alleged that the Company failed to disclose that it (i) entered into agreements with third parties that resulted in the Company failing to deliver best execution, and (ii) focused on maximizing revenue rather than delivering best execution. Plaintiff also alleged that the Company made numerous statements during the class period in which it affirmed its commitment to executing orders in compliance with the duty of best execution. Despite these affirmative statements, plaintiff argued that it adequately pleaded reliance under Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972), which held that a plaintiff is entitled to a presumption of reliance if the plaintiff adequately alleges an omission of material fact by a person with a duty to disclose. The district court rejected that argument, stating that plaintiff could not establish the Affiliated Ute presumption of reliance by couching what is in essence a misrepresentation claim as an omission claim.
The Second Circuit agreed and affirmed the dismissal. It explained that the Affiliated Ute presumption is appropriate in cases involving “primarily a failure to disclose, where a defendant both (1) had a duty to disclose and (2) omitted a material fact.” Plaintiff’s complaint, however, alleged specific statements defendants made regarding their compliance with the duty of best execution, which plaintiff alleged was misleading. The Court stated that a claim of misrepresentation could not be converted into a claim of omission where the purported “omissions” are simply the inverse of the alleged misrepresentations. The Court further explained that the Affiliated Ute presumption applies only when the original rationale for the Affiliated Ute is present: “when there are ‘no positive statements,’ and ‘reliance as a practical matter is impossible to prove.’” When there are alleged misrepresentations, however “reliance [is not] impossible to prove.” (Alterations in original.) The Court found that, because plaintiff had alleged that defendants made “many affirmative misstatements directly relating to [the] claims of fraud,” the rationale for the Affiliated Ute presumption did not apply.