'This is а securities action brought by the lead plaintiff, Craig L. Schwab (the “plaintiff’), on behalf of a proposed class of clients of E*TRADE Securities LLC (“E*TRADE”) who placed securities trade orders with the broker-dealer between July 11, 2011 and the present (the “Class Period”). In Count One, the plaintiff asserts violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, against E*TRADE and E‘"TRADE Financial Corporation (“E*TRADE Financial”) (collectively, the “corporate defendants”). In Count Two, the plaintiff asserts control person liability under Section 20(a) of the Exchange Act, 15 'U.S.C. § 78t(a), against Paul T. Idzik (“Idzik”), the former Chief Executive Officer of E*TRADE Financial, and Karl A. Roessner (“Roessner”), the current Chief Executive Officer of E*TRADE Financial (collectively, the “individual defendants”).
In a Memorandum Order and Opinion dated April 3, 2017, this Court dismissed common law claims against E*TRADE and E*TRADE Finanсial that arose out of the same conduct at issue here because those claims were precluded by the Securities Litigation Uniform Standards Act (the “SLUSA”). See Rayner v. E*TRADE Fin. Corp., No. 16-CV-7129 (JGK),
The defendants have moved to dismiss the Second Amended Complaint (the “SAC”) for failure to state a claim pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. This Court has subject matter jurisdiction pursuant to 15 U.S.C. § 78aa and 28 U.S.C. § 1331.
For the following reasons, the motion is granted.
I.
In deciding a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, the allegations in the complaint are accepted as true, and all reasonable inferences must. be drawn in the plaintiffs! favor. McCarthy v. Dun & Bradstreet Corp.,
A claim under Section 10(b) of the Securities Exchange Act sounds in fraud and must meet the pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure and of the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4(b). Rule 9(b) requires that the cоmplaint “(1) specify the statements that the. plaintiffs] contend[ ] were fraudulent, (2) identify the speaker, (3) state where and when the statements were
When presented with a motion to dismiss pursuant to Rule 12(b)(6), the Court may consider documents that are referenced in the complaint, documents that the plaintiffs relied on in bringing suit and that are either in the plaintiffs’ possession or that the plaintiffs knew of when bringing suit, or matters of which judicial notice may be taken. See Chambers v. Time Warner, Inc.,
II.
The following facts are undisputed or accepted as trae for purposes of the defendants’ motion to dismiss.
E*TRADE Financial is a Delaware corporation, with its principal place of business in New York, that provides brokerage and related services to individual retail investors. SAC ¶ 21. E*TRADE is a Delaware limited liability company that is a wholly owned subsidiary of EATRADE Financial.
Idzik was the CEO and a director of E*TRADE Financial from January 22, 2013 through his departure on-September 12, 2016. SAC ¶23; see also Form 8-K dated January 17, 2013.
From May 2009 to September 12, 2016, Roessner served as the Executive Vice President and General ' Counsel of E*TRADE. SAC ¶ 24. On September 12, 2016, Roessner became the CEO and a director of E*TRADE Financial, and the President of E*TRADE Bank. Form -8-K dated September 12,' 2016; see also SAC ¶24.
Brokers, such as E*TRADE, can route orders for execution to third-party venues, such as exchanges and market makers. SAC ¶ 3. A “non-directed order” is a standard type of order that a client can place with E*TRADE where E*TRADE (as opposed to the client) chooses the trading venue for' the order. SAC ¶ 7. The SAC alleges that “over 95 percent of orders
According to the SAC, E*TRADE has two primary sources of revenue: the commissions that its customers pay in éx-change for routing orders and the payments for order flow (“Payments for Order Flow” or “PFOF”) that it receives from venues under the “maker-taker” model, SAC ¶¶30, 87. Under the maker-taker model, venues pay brokerage firms for “making” a market or adding liquidity for certain types of orders, while venues charge brokers an access or “take” fee for matching a marketable order with an ex: isting bid or offer. SAC ¶30. The SAC alleges that venues compete for order flow by maximizing PFOF amounts to brokers, such as E*TRADE. SAC ¶ 30.
The maker-taker model, including the receipt of PFOF, is heavily regulated by the federal securities regime. See, e.g„ Regulation NMS, Exchange Act Release No. 34-51808,
E’“TRADE has a duty of best execution, which, among other, things, requires it to “use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions;” FINRA Rule 5310(a)(1)
The gist of the allegations in the SAC is that E*TRADE repeatedly assures the market that it will execute orders consistent with its duty of best execution- even though it has no intention of delivering on those promises. The SAC alleges that E*TRADE is actually pursuing a routing strategy designed to maximize the receipt of PFOF, which results in the delivery of something less than best execution and thus less advantageous prices for its clients. See SAC ¶¶ 1, 41, 92.
The SAC in particular faults “predetermined routing agreements” between E'“TRADE and' other vеnues in which E'“TRADE agrees to route a certain percentage of its orders to a venue in exchange for PFOF. Such' agreements allegedly lock E “'TRADE into providing order flow to the venue regardless of best execution considerations. SAC ¶¶ 12, 63.
The SAC alleges that E'“TRADE’S use of such agreements began before the Class Period. In November 2007, E*TRADE agreed to route 40%. of its customer equities orders to Citadel Securities LLC, an affiliate of Citadel Investment Group (“Citadel"), for three years. SAC ¶ 66. Once the agreement (the “Citadel Agreement”) expired, the SAC alleges that E’“TRADE decreased the proportion of orders routed to Citadel Securities, which the SAC claims implicates ¿’“TRADE’S knowledge that such arrangements are inconsistent with best execution. SAC ¶¶ 100,107.
Citadel Securities’ order handling practices during this period have drawn regulatory scrutiny. See SAC ¶¶ 101-05. According to a 2017 Consent Order with the SEC, from 2007 through 2010, Citadel Securities
According to the SAC, E*TRADE has had similarly problematic routing arrangements with another wholesale market-maker, G1 Execution Services, LLC (“G1X”), that began before the Class Period and has continued through the present.
Pursuant to a director appointment provision in the Citadel Agreement, Citadel appointed its founder and CEO, Kenneth C. Griffin (“Griffin”), to E*TRADE Financial’s Board of Directors in June 2009. SAC ¶ 67. In 2012, Griffin raised concerns to the Board regarding the quality of the execution of orders routed by E*TRADE to G1X, “prompting]” E*TRADE Financial to disclose in October 2012 that it had “initiated a review of order handling practices and pricing for order flow between E*TRADE Securities LLC and [G1X] ... to ensure that E*TRADE Securities [was] providing ‘best execution’ of customer orders and dealing appropriately with [G1X] under applicable regulatory standards.” 2012 Third Quarter Form 10-Q at. 109; SAC ¶¶ 68, 70.
In February 2013, E*TRADE Financial disclosed that it had completed its review, which identified “shortcomings in [E*TRADE Financial’s] historical methods of measuring best execution quality.” 2012 Form 10-K at 17; SAC ¶ 71. E*TRADE Financial announced that it would implement recommended “additions and changes” to its “standards,' processes and procedures for measuring execution quality ” 2012 Form 10-K at 17.
In March 2013, Griffin resigned from the Board. SAC ¶ 70. In July 2013, FINRA “notified E*TRADE [] and [G1X], that it [was] conducting an examination of both firms’ routing practices.” SAC ¶ 76. FIN-RA eventually sent E*TRADE Financial a Wells Notice in 2015 “relating to the adequacy of E*TRADE Securities’ order-routing disclosures and supervisory process for reviewing execution quality during the period covered by [E*TRADE Financial’s] 2012 internal review (July 2011 — June 2012).” 2015 Second Quarter Form 10-Q at 74; SAC ¶ 77. In June 2016, FINRA announced that it had censured and fined E*TRADE Financial $900,000 (the “FIN-RA Censure and Fine”) for failing to conduct an adequate review of the quality of execution for its customers’ orders and for supervisory^ deficiencies concerning the protection of customer order information.
E*TRADE Financial sold G1X to an affiliate of the Susquehanna International Group LLP (“Susquehanna”) on February 10, 2014. Form 8-K dated February 10, 2014; SAC ¶ 74. However, the plaintiff alleges that the divestment did not end E*TRADE’s perverse entanglement with. G1X: E*TRADE Financial disclosed contemporaneous with thé sale that it and Susquehanna had “entered into an order flow agreement” (the “G1X Agreement”) to “route 70 percent of our customer equity flow to [G1X] over the next five years, subject to best execution standards.” Form 8-K dated February 10, 2014; SAC ¶ 74.
Based on E*TRADE’s disclosures pursuant to Exchange Act Rule 606, the SAC alleges that E*TRADE routes a disproportionate number of orders to G1X and other venues that pay “excessive fees and rebates” for order. flow, a practice that cannot be explained unless E*TRADE is discounting its promises to provide best execution in favor of maximizing the receipt of PFOF and its obligations under the G1X Agreement to route a certain percentage of orders to. G1X. SAC ¶¶63, 83-85, 89, 93, 98-99,120.
The allegations are bolstered by third-party industry and academic studies that have concluded that a broker-dealer’s focus on obtaining the highest amount of PFOF tends to interfere with best execution. See SAC ¶¶ 112-128. In particular, the SAC alleges that the “Battalio Study” concluded based on a multivariate- analysis of proprietary broker-dealer data that E*TRADE is a broker-dealer (among others, such as TD Ameritrade) that is routing orders with a “focus on liquidity rebates,” which is inconsistent with best execution standards. SAC ¶ 113. The plaintiff also points to testimony before Congress by industry members to the effect that routing strategies designed to maximize PFOF conflict with best‘execution. SAC -¶¶ 109, 115. As a general matter, FINRA and the SEC have expressed concerns over whether PFOF create conflicts of interest that compromise execution quality. See SAC ¶¶ 132-134.
According to the SAC, the' defendants have repeatedly misrepresented E*TRADE’s adherence to best execution standards. E*TRADE’s customer agreement — which is posted on its website and provided to each of its customers — states:
Consistent with the oyerriding principle of bést execution, E*TRADE, using a computerized system, routes orders for listed and over-the-counter equity securities and options to market centers, including regional exchanges, securities dealers who make markets over-the-counter and alternative trading systems. E*TRADE takes a number of factors intо consideration in determining where to route customers’ orders, including the speed of execution, price improvement opportunities (executions at prices superior to the then prevailing inside market), automatic execution guarantees, the availability of efficient and reliable order handling systems, the level of service provided, the cost of executing orders, whether it will receive cash or non-cash payments for routing order flow and reciprocal business arrangements,- E*TRADE regularly and rigorously reviews its order-routing practices and the execution quality ob*428 tained from market centers to which it routes orders.
SAC ¶ 51 (emphasis added); see also SAC ¶ 52. Although E*TRADE discloses that it will consider a list of factors— including the receipt of PFOF and reciprocal business arrangements — in making its order routing determinations, the SAC alleges that the list, is false and misleading because E*TRADE actually prioritizes those two factors to the exclusion of the rest. The SAC chronicles other alleged misrepresentations on E*TRADE’s website related to “The E*TRADE Best Execution Advantage.” SAC ¶48; see also, e.g., SAC ¶ 49. Similarly, on earnings calls, Idzik emphasized “[E*TRADE’s] focus on delivering the best possible execution,” SAC ¶ 56, and the company’s rigorous and regular review of data to ensure best execution adherence, SAC ¶ 55. ,
The SAC alleges that statements in the 2013 and 2014 annual reports, and by Au-dette, that E*TRADE agreed under the G1X Agreement to route order flow to G1X “subject to best execution standards,” SAC ¶¶'53-54, are false because the Agreement is not actually subject to best execution standards. The SAC also faults as misleading statements in those annual reports that E*TRADE has an Order Routing and Best Execution Committee (“ORBEC”) that is “responsible for evaluating [E*TRADE’s] execution statistics and order-routing determinations for stock and listed options and determining how, if at all, [E*TRADE] will alter its order-routing methodology to improve execution quality,” and that “also reviews order flow rates and payments received from [G1X] and other unaffiliated market centers for comparable order flow directed to them.” SAC ¶ 50.
The plaintiff is a resident of California who has been a client- of E*TRADE throughout the Class Period. SAC ¶20. The plaintiff alleges that, during the Class Period, he placed non-directed orders with E*TRADE that received worse prices than what he would have received had E*TRADE adhered to its best execution promises. SAC ¶¶ 20,149-73.
The SAC alleges that E*TRADE has generated hundreds of millions of dollars by preferring PFOF in dereliction of its best execution- promises. SAC ¶¶ 10, 86.
III.
' The defendants have moved to dismiss the 10(b) and 10b-5 claims for failure to plead reliance or scienter.
Section 10(b), as effectuated by Rule 10b-5, makes it “unlawful for any person ... [t]o make any untrue statement of a material, fact or .to omit to state a material fact necessary in order to make the statements made, in the. light of the circumstances under which they were made, not misleading.” 17 C.F.R. § 240.10b-5(b). To state a claim under Section 10(b) and Rule 10b — 5, the plaintiff must allege that the defendants, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiffs reliance on the defendants’ action caused injury to the plaintiffs. Ganino v. Citizens Utils. Co.,
A.
“Reliance by the plaintiff upon the defendant’s deceptive acts is an essential
The plaintiff argues that he should be allowed to rely on the Affiliated Ute presumption of reliance under which “if there is an omission of a material fact by one with a duty to disclose, the investor to whom the duty was owed need not provide specific proof of reliance.”
“The claims here, however, are not ‘primarily’ omission claims.” Id. The court in Crago v. Charles Schwab & Co., No. 16-CV-03938 (RS),
Moreover, the plaintiff has failed to detail any omissions in the SAC. The plaintiff therefore cannot rely on any omissions because they are not alleged with particularity. See, e.g., In re Harbinger Capital Partners Funds Inv’r Litig., No. 12-CV-1244 (AJN),
The cases cited by the plaintiff for the proposition that reliance can be presumed where a company is “silent” about its “illegal activity,” see, e.g., In re Initial Pub-Offering Sec. Litig.,
Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
The plaintiff also places great weight on the allegation that E*TRADE’s practice is “uniform” with respect to its clients, SAC ¶ 61, but that does not alter the fact that this case involves primarily misrepresentations.
Without a presumption of reliance, the plaintiff must allege reasonable reliance on the alleged misrepresentations. That pleading bar “only requires allegations that ‘but for the claimed misrepresentations or omissions, the plaintiff would not have entered into the detrimental securities transaction.’ ” ATSI,
Amazingly, the plaintiff fails to clear that threshold. The plaintiffs allegations of detrimental reliance are entirely concluso-ry, see SAC ¶¶ 14, 62, 192, and fail to show with any sort of particularity that the plaintiff was aware — whether by reading, hearing, or otherwise — of any of the challenged misstatements when he traded with E*TRADE. See Crago,
The cases cited by the plaintiff do not suggest a different result. Zola v. TD Ameritrade, Inc.,
Therefore, the plaintiffs claim in Count One for a violation of Section 10(b) and Rule 10b-5 must be dismissed without prejudice for failure to plead reliance. However, it is plain that the plaintiffs reliance on any purported misrepresentations could not be justified -after he filed this action on July 22, 2016. Any claims based on trades that occurred' after that date are accordingly dismissed with prejudice. .
B.
, The allegations are also insufficient to establish that the corporate defendants acted with corporate scienter.
The scienter rеquired to support a securities fraud claim can be “intent to deceive, manipulate, or defraud, or at least knowing misconduct.” SEC v. First Jersey Sec., Inc.,
In order to plead scienter adequately, the plaintiff must allege facts supporting a strong inference with respect to each defendant. See Plumbers & Pipefitters Local Union No. 630 Pension-Annuity Tr. Fund v. Arbitron Inc.,
To raise a strong inference of scienter through motive and opportunity to defraud, a plaintiff must allege that the defendants “ ‘benefitted in some concrete and personal way from the purported fraud.’ ” ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co.,
Where the defendants’ motive to commit fraud is not apparent, “the strength of the circumstantial allegations [that a defendant consciously or recklessly misbehaved] must be correspondingly greater.” Kalnit v. Eichler,
“When the defendant is a corporate entity, ... the pleaded facts must create a strong inference that .someone whose intent could be imputed to the corporation acted with the requisite scienter.” Teamsters Local.445 Freight Div. Pension Fund v. Dynex Capital Inc.,
The plaintiff attempts to impute scienter to the corporate defendants by alleging that Idzik and Roessner acted with scien-ter, or, in the alternative, that unidentified individuals within the corporate defendants acted with scienter.
Taken as a - whole, 'the- allegations of scienter fall short with respect to the individual defendants. •
Beginning with Idzik, the plaintiff .makes no effort to plead that he had a motive to make false best execution promises, and the allegations of reckless misbehavior are insufficient'Missing from the case is the connective tissue that could link Idzik to any information that would lead to a compelling and cogent'inference of sсienter.
The -plaintiff rests his claims on the theory that -Idzik must have known that the best execution promises were going unfulfilled, - or at least had access to best execution data that would reveal that fact, by'virtue of his position as CEO, but “boilerplate allegations that defendants knew or should have known of fraudulent conduct based solely on their board membership or executive positions are insufficient to plead scienter.” In re Sotheby’s Holdings, Inc. Secs. Litig., No. 00 CIV. 1041 (DLC),
There is similarly no allegation from which to infer that Idzik had any reason to believe that ORBEC was not regularly and rigorously reviewing order flow data to ensure that E*TRADE was complying with its best execution representations. While the SAC notes that Griffin instigated the 2012 internal review, the plaintiff does not raise that issue in his briefing. Moreover, the allegations regarding improper practices by E*TRADE occurred before Idzik’s arrival as CEO in January 2013, and there is no allegation from which to conclude that Idzik did not believe that the issues that concerned Griffin with respect to execution quality had been solved by the “additions and changes” to E*TRADE’s “standards, processes and procedures for measuring execution quality,” as disclosed in the 2012 Form 10-K. There is no allegation from which to infer that Griffin’s subsequent resignation from the Board of Directors in March 2013 was “noisy” in that it was designed to .alert an executive like Idzik that execution quality issues remained outstanding.
.For the same reason, the FINRA Censure and Fine of E*TRADE for events that occurred from July 2011 to June 2012 cannot be used to attribute scienter to Idzik. The fact that the alleged misconduct with respect to best execution predates Idzik’s arrival as CEO (indeed, much of the misconduct is alleged to' predate th¿ Class ’Period) further undermines any' inference of culpability ás to Idzik. See Shеmian v. Research In Motion Ltd., No. 11 CIV. 4068 (RJS);
Similarly, regulatory statements and notices highlighting generic concerns that a broker-dealer’s receipt of PFOF may be inconsistent with best execution do not support the leap that Idzik must have been aware that E*TRADE’s treatment of PFOF was inconsistent with its best execution obligations. See Gurfein v. Ameritrade, Inc.,
The plaintiff argues that.third-party studies at least alerted Idzik to the obvious danger that E*TRADE was not complying with best execution standards. A plaintiff may establish scienter by “specifically identifying] the reports or statements that are- contradictory to the statements-made .. .” Glaser,
The plaintiff argues that scienter may be inferred under the “core operations” doctrine. See, e.g., In re Atlas Air Worldwide Holdings, Inc. Sec. Litig.,
Applying the majority approach, and treating the core operations allegations as supplemental, the alleged regulatory and business importance of E*TRADE’s non-directed order routing business is insufficient to make the inference of scienter at least as compelling as any nonculpable inference. The importance of best execution should have heightened Idzik’s awareness to any information that would show him that E*TRADE was failing to deliver on that promise. However, the import of the alleged misrepresentations cannot substitute for allegations linking Idzik to information that would alert him that E*TRADE was delivering something less than best execution.
Considering the SAC holistically, the allegations are insufficient to establish that Idzik acted with scienter.
Moreover, considering the SAC holistically, the scienter allegations against Roessner are plainly insufficient. There are no particularized allegations against Roessner other than that he was the General Counsel and an Executive Vice President of E*TRADE from 2009 until he became the CEO of E*TRADE Financial in September 2016. The plaintiff cannot allege scienter by merely pointing to
Finally, the plaintiff claims that he can establish scienter against the corporate defendants based on the scienter of unidentified individuals within the corporate defendants. In doing so, the plaintiff eschews any theory that such individuals actеd recklessly, instead arguing that the individuals had a motive to misrepresent best execution adherence, namely, the pursuit of millions in PFOF on behalf of the corporate defendants. While a plaintiff is not required to identify specifically the individuals at a company who acted with scienter in order to plead scienter with respect to a company, see Solow v. Citigroup, Inc.,
The plaintiff has therefore failed to allege plausibly that any agent of the corporate defendants had a culpable motive that could be imputed to the corporate defendants. In sum, Count One must also be dismissed without prejudice for failure to plead scienter.
The plaintiff alleges that the individual defendants are liable under Section 20(a) of the Exchange Act because they controlled the corporate defendants, which in turn violated Section 10(b) and Rule 10b-5. Section 20(a) provides:
Every person who, directly, or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable .., unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
15 U.S.C. § 78t(a). “To establish a prima facie case of control person liability, a plaintiff must show (1) a primary violation by the controlled person, (2) control of the primary violator by the defendant, and (3) that the defendant was, in some meaningful sense, a culpable participant in the controlled person’s fraud.” ATSI,
In addition, the plaintiff has failed to allege.culpable participation on the part of the individual defendants. Although “[t]he Second Circuit has not defined what is meant by the requirement that a controlling entity be a ‘culpable participant,’ ” Pension Comm. of the Univ. of Montreal Pension Plan v. Banc of Am. Secs., LLC,
Accordingly, Count Two must also be dismissed without prejudice.
V.
The plaintiff has asked for leave to re-plead in the event the SAC is found deficient. Rule 15(a) provides that leave to file an amended complaint should be granted “freely ... when justice so requires.” Fed. R. Civ. P. 15(a)(2); see also Foman v. Davis,
Conclusion
The Court has considered all of the remaining arguments of the parties. To the extent not specifically addressed above, they are either moot or withоut merit. For the foregoing reasons, the defendants’ mo
The Clerk is directed to close all pending motions.
SO ORDERED.
Notes
. The SAC alleges that "E*TRADE Financial is liable for all statements made by E*TRADE because E*TRADE[’s] statements at all relevant times were attributable to, controlled by, and authored by E*TRADE Financial,” SAC ¶ 59, which the defendants do not dispute.
. All filings with the SEC cited' in this Opin- - ion and Order refer to filings by E*TRADE Financial unless otherwise no.ted., ..
. FINRA Rule 5310 superseded NASD Rule 2320 on May 31, 2012, and incorporates NASD Rule 2320’s provisions concerning a broker-dealer’s duty of best execution. See SAC ¶¶ 44, 90.
. G1X was named “E*TRADE Capital Market, LLC” before February 2013. See 2012 Form 10-K at 1; see also SAC ¶ 64. For convenience, the entity is referred to only as G1X in this Opinion and Order.
. FINRA's announcement is available at httр://www.finra.org/newsroom/2016/finra-fines-etrade-900k-bestexecution-and-protection-customer-order-information.
. In light of the disposition of this opinion, it is unnecessary to reach the. defendants’ alternative arguments for dismissal related to the timeliness of the claims and the falsity of the alleged misrepresentations.
. The'plaintiff does not attempt to plead the fraud-on-the-market presumption identified in Basic Inc. v. Levinson,
. While the plaintiff relies on the finding of scienter against the CEO in Zola,
. Zola,