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. e du/thir dc ir c uit_1997/135Filed June 19, 1997

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 96-5045

KENNETH E. NEWTON; MLPF&S CUST. BRUCE ZAKHEIM

IRA FBO BRUCE ZAKHEIM

v.

MERRILL, LYNCH, PIERCE, FENNER & SMITH, INC.;

PAINEWEBBER INC.; DEAN WITTER REYNOLDS

(D.C. No. 94-cv-05343)

JEFFREY PHILLIP KRAVITZ

v.

DEAN WITTER REYNOLDS, INC.

(D.C. No. 95-cv-00213)

MLPF&S Cust. FPO -- Bruce Zakheim IRA FBO Bruce

Zakheim, Jeffrey Phillip Kravitz, and Gloria Binder

,

Appellants

ON APPEAL FROM THE

UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF NEW JERSEY

Argued October 24, 1996

Before: STAPLETON and NYGAARD, Circuit Judges , and

MAZZONE,* Senior District Judge

.

___________________________________________________ ______________

*Honorable A. David Mazzone, United States District Court for the District of Massachusetts, sitting by designation.(Opinion filed June 19, 1997)

NORMAN S. POSER, ESQUIRE (Argued) Brooklyn Law School
250 Joralemon Street Brooklyn, NY 11201

KAREN L. MORRIS, ESQUIRE (Argued)
Morris & Morris
1105 North Market Street
Suite 1600 Wilmington, DE 19801

Attorneys for Appellants

MATTHEW D. ANHUT, ESQUIRE JONATHAN N. EISENBERG, ESQUIRE (Argued) Kirkpatrick & Lockhart 1800 Massachusetts Avenue, N.W. Washington, DC 20036-5891

Attorneys for Appellee Merrill Lynch, Pierce, Fenner & Smith, Inc.

JOSEPH A. BOYLE, ESQUIRE Kelley, Drye & Warren 5 Sylvan Way Parsippany, NJ 07054

BRUCE COOLIDGE, ESQUIRE ROBERT B. McCAW, ESQUIRE (Argued) Wilmer, Cutler & Pickering 2445 M Street, N.W. Washington, DC 20037-1420

Attorneys for Appellee PaineWebber, Inc.

2FRANK M. HOLOZUBIEC, ESQUIRE

Kirkland & Ellis
153 East 53rd Street Citicorp Center New York, NY 10022

Attorney for Appellee Dean Witter Reynolds

RICHARD H. WALKER, ESQUIRE ERIC SUMMERGRAD, ESQUIRE SUSAN F. WYDERKO, ESQUIRE JACOB H. STILLMAN, ESQUIRE Mail Stop 6-6 Securities & Exchange
Commission 450 Fifth Street, N.W. Washington, DC 20549

Attorneys for Amicus Curiae, Securities & Exchange Commission

OPINION OF THE COURT

NYGAARD, Circuit Judge

.

The issue on appeal is whether the over-the-counter customer order execution practices of several large stock
brokers constituted securities fraud. The district court concluded that these practices were not fraudulent and granted summary judgment in favor of the defendants . We
will affirm.

I.

The facts of this case are set forth thoroughly in the district court's opinion, In re Merrill Lynch Secur ities Litig.

, 911 F. Supp. 754 (D.N.J. 1995). Succinctly stated, plaintiffs are investors who purchase and sell so-called "over the counter" securities which are traded on a computeri zed price quotation system known as NASDAQ. They claim that the peculiarities of this market have given securit ies dealers

3an opportunity--upon which they have capitalized--t o

inflate their profit margins at the expense of cust omers, resulting in inferior execution prices vis-a-vis ot her dealers who have access to superior, privately quoted price s. These practices, plaintiffs allege, violated the defendan ts' duty of best execution, but were never disclosed by the dea lers, thus amounting to a securities fraud under section 10 of the Securities Exchange Act of 1934, 15 U.S.C. § 78 j(a) and Rule 10-b5 promulgated thereunder, 17 C.F.R. § 240. 10b-5.

The NASDAQ, which is now the second-largest securit ies market in the United States, is different from the New York and American Stock Exchanges, because it is a deale rcreated, rather than an auction, market. In an auct ion market, buy and sell orders actually "meet" on the exchange floor, with prices being set by the contin uous interaction of those orders, under the supervision of market "specialists." This type of market has traditionall y been used for widely traded securities.

Dealer markets, on the other hand, rely on "market makers" to set prices and maintain the liquidity of securities. This system arose out of literal, over- the-counter trading of stocks that were not as widely traded as those listed on the NYSE or AMEX. In a dealer market, eac h market maker decides the prices at which it will bu y and sell a security; the difference between the listed "ask" and "bid" prices is known as the "spread," from which t he market maker is compensated for its efforts and ris k.

Under that system, of course, as long as timely, ac curate information is available regarding each market make r's prices, orders will naturally gravitate towards the dealer with the most favorable prices, and this will estab lish a single, albeit two-price, market for each security traded. NASDAQ (which stands for National Association of Securities Dealers Automated Quotation) is the info rmation system that relays market makers' pricing informati on to buyers and sellers. NASDAQ quotes the National Best Bid and Offer--known in the industry as the "NBBO"--pri ce for every stock on the system.

Because of recently created sources of additional, nonpublic pricing information, however, the NBBO may n o

4longer always be counted upon to display the "best" price.

Systems such as SelectNet and Instinet, which are n ot available to all investors or even to all dealers, may be quoting a more favorable price than the NBBO at any given moment. Appellants allege that, not only were bette r prices displayed in many instances, but that the defendant dealers knew such prices were available, yet contin ued to book their orders at the inferior, NBBO price at th e same time that they were trading at the more favorable p rice for
their own accounts.

In addition, in many instances dealers are able to obtain more favorable prices by "crossing" the customer's order with the order of another customer. For example, as sume that a dealer quotes an "ask" price of $32 1/4 and an "bid" price of $32 for shares of XYZ Corporation. A custo mer places an order to purchase 100 shares, but, unbekn ownst to him, the dealer has an outstanding limit order f rom another customer to sell at 32 1/8. That dealer cou ld simply cross the two orders and execute the trade a t 32 1/8, saving the customer $12.50. The dealer would n ot incur any market risk on such a transaction. Appell ants allege that it is a fraud for the defendant dealers to continue to execute trades at the NBBO price, appropriating the full "spread" as a fee for their services.

The district court granted summary judgment to defendants, for two principal reasons. First, it he ld that defendants made no actionable misrepresentations, because the duty of best execution is ill-defined a nd there is no widely accepted view that execution of trades at the NBBO price fails to satisfy that duty; thus, it wou ld be improper to find that defendants omitted or conceal ed material facts. 911 F. Supp. at 771. Second, the co urt held that, even if defendants omitted information, they could not, as a matter of law, have acted with the requis ite
scienter. Id. at 772.

II.

A.

To make out a securities fraud claim under § 10 of the Securities Act of 1934 and Rule 10b-5, plaintiffs m ust

5show: (1) a misrepresentation or omission of a mate rial fact

in connection with the purchase or sale of a securi ty; (2) scienter on the part of the defendant; (3) reliance on the misrepresentation; and (4) damage resulting from th e misrepresentation. Sowell v. Butcher & Singer, Inc. , 926 F.2d 289, 296 (3d Cir. 1991). Although the district court held that there was no misrepresentation or omissio n of a material fact, we will assume, without deciding, th at the trading practices here constituted an otherwise act ionable misrepresentation, because we conclude that the dis trict court correctly decided that scienter was lacking a s a matter of law, and appellants' securities law claim s fail on
that basis alone.

The element of scienter has been defined as "a ment al state embracing intent to deceive, manipulate or de fraud."
Ernst & Ernst v. Hochfelder , 425 U.S. 185, 193 n.12, 96 S. Ct. 1375, 1381 n.12 (1976). Scienter can also be established by a showing of recklessness, which is defined as "an extreme departure from the standards of ordi nary care, . . . which presents a danger of misleading . . . that
is either known to the defendant or is so obvious t hat the actor must have been aware of it." Healey v. Cataly st Recovery, Inc. , 616 F.2d 641, 649 (3d Cir. 1980) (quoting Sundstrand v. Sun Chemical Corp. , 553 F.2d 1033, 1045 (7th Cir. 1977)). The recklessness standard compreh ends actions very close to intentional conduct; mere ind ifference to the consequences of a statement is not sufficien t. Healey , 616 F.2d at 649.

Appellants assert, nevertheless, that the record be fore the
district court contained sufficient evidence from w hich a
rational factfinder could infer scienter. The distr ict court disagreed, opining that because the duty of best ex ecution is not "established," but ambiguous, the failure to disclose that all orders were being executed at the NBBO pri ce could not, as a matter of law, have involved scienter. We agree.

Appellants attempt to refute the district court's r easoning by arguing that "the absence of a regulation prohib iting a specific practice does not mean such practice canno t be considered fraudulent." Specifically, they rely on our decision in Ettinger v. Merrill Lynch, Pierce, Fenn er & Smith,

6Inc. , 835 F.2d 1031 (3d Cir. 1987), which they assert i s

"directly on point." We are not persuaded.

It is true that Ettinger

involved a securities firm that failed to disclose excessive markups, but there the similarity to this case ends. The dealer in Ettinge r argued that its compliance with Rule 10b-10 insulated it f rom a material misrepresentation attack under Rule 10b-5, and we held simply that such compliance did not preclud e a 10b-5 action. Id. at 1036. Moreover, Ettinger involved a markup practice that both the SEC and the courts ha d already condemned--the duty in that instance, unlik e here,
was clear. See id. at 1033. And finally, scienter was not even an issue in Ettinger . It had been waived in the district
court. Id. at 1036 n.7. Ettinger is inapposite.

Appellants also cite several cases which allegedly stand for the proposition that violations of § 10(b) can occur when
a broker-dealer fails to execute customer orders at the best possible price. Two of those cases, however, involv ed execution practices that no reasonable dealer could have possibly believed proper. See Barnett v. United Sta tes , 319 F.2d 340, 345 (8th Cir. 1963) (excessive mark-ups o f between 25 and 67% not disclosed; customer order ne ver executed at advertised price, while dealer was trad ing same security for its own account at superior price); Op per v. Hancock Securities Corp. , 250 F. Supp. 668, 673 (S.D.N.Y.),
aff'd , 367 F.2d 157 (2d Cir. 1966) (dealer claimed to be searching unsuccessfully for buyer to purchase cust omer's stock, while at the same time trading in that same stock profitably for its own account). Three other cases interpose a third-party dealer in the transaction, thus incre asing the customer's expense; this practice had already been condemned by long-standing judicial and regulatory authority. See Sinclair v. SEC , 444 F.2d 399, 400 (2d Cir. 1971); In re Delaware Management Co. , 43 SEC 392, 399- 400 (1967); In re Hoit Rose & Co. , 1969 SEC LEXIS 244 (1969).1

___________________________________________________ ______________

1. Indeed, the only authority appellants are able t o cite with facts similar to the present case is an unpublished district cour t opinion in typescript, Lesko v. Merrill Lynch, Pierce, Fenner & Smith, Inc. , No. C78- 1740 (N.D. Ohio June 22, 1979), in which the court opined, with very little analysis, that a deliberate policy of sendin g all orders to the AMEX rather than "seeking the best price in the availabl e markets" stated a
claim for securities fraud. That court did not disc uss scienter, and is thus inapposite, whatever its relative persuasivene ss.

7As the district court recognized, the most instruct ive case

on the issue of scienter is Platsis v. E.F. Hutton & Co. , 946 F.2d 38 (6th Cir. 1991). There, a broker failed to disclose its production credits, spreads or markups, while at th e same time it was profiting from customer transactions ag ainst its own inventory. The district court found, after tria l, that defendants had acted with scienter, but the court o f appeals reversed because there was no established regulatory duty to disclose and intent to deceive c ould not thus be established by omission. Here, as in Platsi s , the dealers were under no established duty to execute t rades at other than the NBBO price or to disclose their exec ution practices. Indeed, it appears that the industry as a whole used the NBBO to satisfy the duty of best execution . Under the reasoning of Platsis , then, which we adopt, there was no scienter. Accord Shivangi v. Dean Witter Reynold s, Inc.

, 825 F.2d 885, 889 (5th Cir. 1987) (failure to discl ose sales compensation did not involve scienter when no court or regulator had ever held that information material a nd there
was no evidence that its disclosure was normal indu stry practice).2

On the other hand, in Chasins v. Smith, Barney & Co

. , 438 F.2d 1167 (2d Cir. 1970), a broker failed to di sclose that it was making a market in certain securities i t strongly recommended, and then sold, to plaintiff. Although scienter was not directly at issue in Chasins , the court did opine that all brokerage firms had followed the same prac tice and had never thought such disclosure was required. Mor eover, the SEC had never prosecuted any firm for this viol ation.

___________________________________________________ ______________

2. The district court and appellees maintain that t his circuit already
follows a Platsis -like rule. In Christidis v. First Pennsylvania Mor tgage
Trust , 717 F.2d 96 (3d Cir. 1983), plaintiffs sued an ac counting firm, alleging that it fraudulently failed to preparefina ncial statements in accordance with generally accepted accounting princ iples. Although scienter as such was not an issue, we affirmed the dismissal of the complaint for lack of particularity in pleading fra ud under Fed. R. Civ. P. 9(b). Id. at 100. We do not read Christidis as itself adopting the proposition that failure to disclose cannot involve scienter where there is no clear duty to do so and the practice at issue is common in the industry. It was simply a case involving the pleadi ng standard for allegations of fraud. Nevertheless, we think that P latsis is persuasively reasoned and we adopt it here.

8Indeed, as here, the practice at issue in Chasins was later

addressed by regulation. Id. at 1171 n.5.

Nevertheless, we decline to apply Chasins to this fact pattern. First, the holding there did not address s cienter. See Architectural League v. Bartos , 404 F. Supp. 304, 315 (S.D.N.Y. 1975) ("All that . . . Chasins holds . . . is that
failure to disclose market-maker status was . . . t he
omission of a material fact. The omission of a mate rial fact, without more, does not violate Rule 10b-5. All othe r elements, including scienter, must be proven[.]"). Second, in
Chasins , appellant's contention that nobody thought disclosure was required was demonstrably false, hav ing been impeached by appellant's own witness. 438 F.2d at 1171. That is not the case here. Finally, and most importantly, in Chasins the dealer was strongly recommending that the customer buy certain securiti es in which the dealer itself was making the market. The dealer thus had an undisclosed conflict of interest of maj or proportions; to the extent that the customer follow ed its "advice," the dealer made more money. See Simon v. Merrill Lynch, Pierce, Fenner & Smith, Inc. , 482 F.2d 880, 885 (5th Cir. 1973) (distinguishing Chasins on this basis); Batchelor v. Legg & Co. , 52 F.R.D. 553, 557 (D. Md. 1971) (similar).

We therefore hold that, where defendants are under no affirmative legal duty to disclose their order exec ution practices and those practices are widely followed w ithin the securities industry, as a matter of law there is no scienter when defendants fail to disclose those practices.

B.

In this case, although it appears on the surface th at appellants have adduced evidence that the nondisclo sures at issue here were not common industry practice, cl oser examination reveals that contention to be unsupport ed. Appellants first cite the deposition testimony of P aul M. Lacy, a retired securities trader, for the proposit ion that
"other broker-dealers do not execute customer order s with exclusive reference to the NBBO." His testimony sup ports nothing. Mr. Lacy retired before the beginning of the class period (November 1992), and therefore cannot offer any

9competent, firsthand testimony about industry pract ices as

they existed at the times material to this litigati on. Of even greater significance, Lacy did not even testify abo ut the practices of other securities dealers in general or even his former firm in particular, but testified only about his own practices as a trader within that firm.

Appellants also rely on proposed SEC rules on order execution as confirmation of Lacy's testimony [A 60 9]. See Order Execution Obligations, 60 Fed. Reg. 52,792 (1 995) (to be codified at 17 C.F.R. pt. 240) (proposed Oct. 10 , 1995). That document recites that traders use "a variety o f systems and procedures" to satisfy best execution. Id. at 52,794. If traders use a variety of systems, however, that
bolsters the district court's conclusion that there was no clear duty to supplement the NBBO price and that fa ilure to disclose the practice of executing all trades at the NBBO price could not have involved scienter.

Appellants likewise refer us to the opinions of a t rader
and a former SEC commissioner who believe that the duty of best execution requires affirmative efforts to s upplement the NBBO with other sources of pricing. See Nationa l Market System: Hearings Before the Subcomm. on Telecommunications & Finance of the Comm. on Energy &
Commerce , 103d Cong., Serial No. 103-67, at 355 (1993) (statement of securities dealer Bernard L. Madoff t hat he believes it is the obligation of a market maker to achieve price improvement whenever possible and does so inf ifty percent of all trades); Declaration of former SEC Commissioner Richard Y. Roberts, [A777] ("[i]t woul d be inconsistent with the duty of best execution for a brokerdealer to advantage itself by automatically executi ng customer orders at the NBBO when superior prices ar e reasonably available"). This evidence, however, is
insufficient.

To prevail on summary judgment, one need not show that every dealer executes trades at the NBBO price, but merely that enough dealers do so that the duty to supplement the NBBO price is ambiguous and scienter is negated. There is more than ample evidence of that. David S. Ruder, a former Chairman of the SEC, member of t he NASD board and law professor at Northwestern Univer sity,

10stated by affidavit that trades at the NBBO price s atisfied

the duty of best execution and that the general cus tom and practice of firms in the industry was to execute at the NBBO price [A225-27]. T. Grant Callery, General Cou nsel to NASD, also stated by affidavit that NASD views the NBBO price as satisfying the best execution duty [A 458] . Finally, Hugh Quiqley, a trader at Merrill Lynch, declared t hat he had observed the trading practices of every major f irm in the industry and observed that the standard practic e was to trade at the NBBO [A 497].

Finally, while this case was pending on appeal, the SEC finalized new regulations pertaining to order execu tion which address directly the practices at issue here. See generally Self-Regulatory Organizations; National Association of Securities Dealers; Order Granting P artial Approval and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 1 to Proposed Rule Change Relating to Implementation of the Commission 's Order Handling Rules, 62 Fed. Reg. 2415 (Jan. 16, 1 997). Under these new rules, which became effective on Ja nuary 20, 1997, market makers must display a customer's l imit order when the price of that order is superior to t he current NBBO quote. Moreover, any superior prices quoted on
electronic communications networks such as SelectNe t and Instinet must be listed as part of the NBBO price. See SEC News Release 97-3, New Trading Rules for NASD and t he Exchanges , 1997 WL 21042 (Jan. 20, 1997). By these regulatory changes, dealers will essentially be req uired to eliminate the practices that appellants complain of in this case. We believe, as did the district court, that t he fact that the Securities and Exchange Commission perceived th e need to address these order execution practices thr ough the regulatory process indicates strongly, if not concl usively, that the "duty" to cross orders and to look beyond the NBBO for pricing information was ambiguous, indeed speculative, during the class period. Regulatory ag encies would not spend the time, money and effort in promulgating regulations if the duty it sought to i mpose were already clear under established law.3

___________________________________________________ ______________

3. We do not mean to imply, however, that the duty of best execution is in any way unenforceable in a private action under § 10(b) of the 1934

11III.

In sum, the evidence in this record is legally insu fficient for a rational jury to infer that defendants failed to disclose their "NBBO-only" execution policy knowing that it was fraudulent not to do so, or that they recklessly ig nored massive evidence suggesting that it was. Accordingl y, the district court correctly found no scienter and prop erly entered summary judgment for defendants. We will af firm.

___________________________________________________ ______________

Act. Where the duty is clear, or where a practice i s obviously fraudulent and not pervasive throughout the securities industr y, the mere lack of regulations directly addressing the practice at iss ue will not constitute a
bar to such a suit.

12STAPLETON, Circuit Judge , dissenting:

During the class period, Section 10(b) and Rule 10( b)-5 (hereafter referred to collectively as "Section 10( b)") imposed upon the defendants a duty not to deliberately misl ead their clients. The plaintiffs allege that, when the defendants received the plaintiffs' orders, the defendants kne w both (1) that the plaintiffs expected them to execute these orders at a better price than the NBBO if the opportunity to do so presented itself, and (2) that the defendants thems elves had no intention of referencing anything other than the NBBO. The issue for decision is whether the plaintiffs ha ve produced sufficient evidence from which a trier of fact could reasonably infer that one or more of the defendants had this state of mind when they accepted the plaintiff s' orders for execution. I conclude that they have and that s ummary judgment for the defendants is therefore improper.

I.

The class period extends from November 4, 1992 to November 4, 1994. The district court granted summar y judgment to the defendants primarily because the SE C, during that period, had not explicitly declared tha t the duty of best execution included the duty to consult reas onably
available sources other than NBBO. Because resolvin g that issue involved considerations within the scope of t he SEC's expertise, the district court believed it would be inappropriate for the courts to recognize a legal d uty to consult other sources during the class period. Ifin d the district court's approach unacceptable because it mistakenly equates the SEC's lack of guidance with an absence of any relevant law.

Our court reaches a somewhat different conclusion. It finds that the SEC's post-class period decision eff ectively eliminating the practices of which the plaintiffs h ere complain1 "indicates strongly, if not conclusively, that the

___________________________________________________ ______________

1. The SEC proposed in 1995, and implemented in 199 7, amendments to the "Quote Rule" which now require market makers to include in the NBBO any superior price they are quoting on electro nic communications
networks like SelectNet or Instinet. See Order Execution Obligations,

13`duty' to . . . look beyond the NBBO for pricing in formation

was ambiguous, indeed speculative, during the class period." Slip Op. at 11. The court then concludes t hat there was applicable law during the class period and that it was established by the way in which a segment of the re gulated profession behaved during that period. Thus, the defendants are entitled to summary judgment, we are told, because they have shown "that enough dealers [refer enced only the NBBO during the class period] so that the duty to supplement the NBBO price [was] ambiguous and scien ter is [therefore] negated." Id. at 10 (emphasis omitted).

I believe that Congress established the principles of law applicable here when it enacted Section 10(b) and t hat these principles were not ambiguous during the clas s period. The district court's task was to apply thos e unambiguous principles to the circumstances of each transaction between a plaintiff and a defendant. Be cause there are material disputes of fact concerning thos e circumstances, I would reverse and remand for furth er proceedings.

II.

The relationship between a client and a broker is t hat of a principal and an agent. Absent special circumstan ces, it is a relationship in which it is understood by all that the client-principal seeks his own economic gain and th e broker-agent earns his commission by helping the cl ientprincipal achieve that objective. Absent instructio ns to the contrary, the broker is thus expected to maximize t he
economic benefit to the client in each transaction. Hence, the duty of best execution.

"[T]he duty of best execution requires a broker-dea ler to seek the most favorable terms reasonably available under

___________________________________________________ ______________

Exchange Act Release No. 36,310, 60 Fed. Reg. 52972 (Oct. 10, 1995) ("Proposed Rules"); Order Execution Obligations, Ex change Act Release No. 37,619A, 61 Fed. Reg. 48290 (Sept. 12, 1996) (" Final Rules"). Since the new NBBO incorporates a far wider range of pric es, the possibility of executing a trade at an inferior NBBO price when be tter prices are
available on an electronic communications network h as been eliminated.

14the circumstances for a customer's transaction." Pr oposed

Rules, 60 Fed. Reg. at 52793; U.S. Equity Market St ructure Study, Exchange Act Release No. 30,920, 57 Fed. Reg

. 32587, 32595 (July 22, 1992); see generally Restatement of Agency (2d) § 424 (1958) (stating that agent must " use reasonable care to obtain terms which best satisfy the manifested purposes of the principal"). That is, th e duty of best execution requires the defendants to execute t he plaintiffs' trades at the best reasonably available price.2 While there may be uncertainty in any particular si tuation as to what prices are reasonably available, the exi stence of a broker-dealer's duty to execute at the best of th ose prices that are reasonably available is well-established.

The set of prices that are reasonably available to a broker-dealer is constantly fluctuating. Therefore, determining what satisfies the duty of best executi on is a highly fact-and-circumstance-sensitive inquiry, wit h the scope of the duty evolving over time with changes i n technology and transformations in the structure off inancial markets. See, e.g., Final Rules, 61 Fed. Reg. at 48322-23. For example, before the creation of NASDAQ, a broke r in an over-the-counter market satisfied her duty of best execution by contacting at least three market makers prior to executing a client's order. See Proposed Rules, 60 Fed. Reg. at 52793. With the advent of NASDAQ, and the NBBO computer system providing instant access to the bes t bid and offer available nationwide, the standard for sa tisfying the duty of best execution necessarily heightened.

___________________________________________________ ______________

2. Other terms in addition to price are also releva nt to best execution. In determining how to execute a client's order, a brok er-dealer should take into account order size, trading characteristics of the security, speed of execution, clearing costs, and the cost and difficu lty of executing an order in a particular market. See, e.g., Payment for Order Flow, Exchange Act Release No. 33,026, 58 Fed. Reg. 52934 , 52937-38 (Oct. 13, 1993). When the plaintiffs state that better "p rices" were reasonably available from sources other than the NBBO, I under stand that to mean that, given an evaluation of price as well as all o f the other relevant terms, the trade would be better executed through a source of liquidity other than the NBBO (e.g. SelectNet, Instinet, in-h ouse limit orders or market orders held by the defendants, or limit orde rs placed by the public in the Small Order Execution System). Simila rly, for convenience, I use the phrase "best reasonably available price" to mean "best terms."

15The record reflects a genuine dispute of fact as to

whether prices better than those on the NBBO were reasonably available from sources other than the NB BO at the time the defendants executed the plaintiffs' tr ades at the NBBO price. There is sufficient evidence from w hich a reasonable trier of fact could find, for example, t hat prices better than the NBBO were reasonably available on t he SelectNet and Instinet at the very moment that the defendants chose to execute the plaintiffs' orders at the NBBO price. The defendants have suggested that cons ulting
other sources besides the NBBO would have added substantial expense and delay to the execution of p laintiffs' orders, more than offsetting any improvements that might have been available in terms of price. See Tr. Oral Arg. at 28-29. This, however, is clearly a factual dispute, which we are not permitted to resolve in favor of the defend ants at this juncture.

I believe the evidence is sufficient to allow a rea sonable trier of fact to conclude that, by the time of the class period, both technology and over-the-counter market s had developed to a point where it was feasible to maxim ize the economic benefit to the client by taking advantage of better prices than the NBBO.

III.

Recovery for federal securities fraud requires a sh owing of deliberate or reckless misrepresentation of a ma terial fact. The misrepresentation here, according to plai ntiffs, was an implied representation made by the defendant s when they agreed to execute the plaintiffs' orders that they would maximize the plaintiffs' economic gain in the transaction. Plaintiffs' orders did not specify the price at which they were to be executed. It is at least a re asonable inference, plaintiffs therefore insist, that they w ould not have placed these orders with the defendants withou t an understanding that the defendants would execute the m in a manner seeking to maximize plaintiffs' economic b enefit. Since the defendants knew of the plaintiffs' profit motivation, they must have understood that plaintif fs would expect them to obtain a price more advantageous to the plaintiffs than the NBBO when one was readily avail able. If,

16as plaintiffs allege, the defendants intended not t o act in a

manner consistent with this expectation when they accepted the orders and yet did not so advise plain tiffs, the defendants can be found to have made an implied representation that they knew to be false.

In addition to these inferences that can be drawn f rom an economic analysis of the plaintiffs' relationship w ith the defendants, plaintiffs rely upon evidence showing t hat respected members of the brokerage community recogn ized, even prior to the class period, that trades were re adily
available from sources other than the NBBO and that their clients expected them to take advantage of those so urces whenever it would benefit the client. See, e.g., Declaration of Paul M. Lacy [A 718]; Declaration of Junius W. P eake [A 755]; Declaration of Richard Y. Roberts [A 775]. Mo reover, the plaintiffs have shown that the SEC found clear evidence of a two-tiered market during the class period, in which NASDAQ market makers routinely traded at one price with retail clients like the plaintiffs and at a better price for themselves through quotation services like SelectNe t and
Instinet. See Final Rules, 61 Fed. Reg. at 48307-08. They have further shown that the possibility that the du ty of best execution might require resort to sources other tha n the NBBO was being actively debated during the class pe riod and that that debate ultimately resulted, after the class period, in a regulation effectively requiring as mu ch. Id.

All of this would allow a reasonable trier of fact to find that the defendants' misrepresentation--namely, tha t they would execute plaintiffs' trades in a manner maximi zing plaintiffs' economic gain--was at least reckless, i f not intentional. See Healey v. Catalyst Recovery of Pen n., Inc.

, 616 F.2d 641, 649 (3d Cir. 1980) (defining reckless ness as an extreme departure from ordinary care). Certainly , then,
scienter can be found on this record.

To be sure, as the court's opinion stresses, the
defendants have countered with affidavits of other respected members of the brokerage community statin g that their practice during the class period was the same as that of the defendants. This evidence could, of cou rse, be regarded by a trier of fact as probative of the def endants' state of mind when they accepted plaintiffs' orders . But

17these affidavits do no more than raise a material i ssue of

fact as to whether the defendants knew of the expec tation plaintiffs claim to have had; they do not settle th e matter.

At trial, the defendants would certainly be entitle d to argue to the jury that, because of industry practic e, they thought their clients would expect them to execute only at the NBBO or that they never thought about their cli ents' expectations. Moreover, any evidence, derived from knowledge of industry practice or elsewhere, that t he plaintiffs were generally aware of the defendants' exclusive reliance on the NBBO would, of course, be quite pro bative of whether the plaintiffs had the expectations they claim. But the court, in elevating the practice of a segme nt of the industry to be outcome determinative, loses sight o f the fact that the basis for the duty of best execution is th e mutual understanding that the client is engaging in the tr ade--and retaining the services of the broker as his agent-- solely for the purpose of maximizing his own economic benefit, and
that the broker receives her commission because she assists the client in reaching that goal. Based on this mutual understanding and the absence of any express limitations on the brokers' responsibility, a trier of fact could find that the defendants understood that they were expected to utilize sources other than the NBBO whe n a better price was readily available.

IV.

As I understand the court's analysis, a Section 10( b) defendant might be granted summary judgment even if her regular practice violated the duty of best executio n, and she
knew or should have known that it violated that dut y, so long as she can identify a sufficient number of oth er broker-dealers engaged in the same wrongful conduct to be able to argue in good faith that the underlying dut y was "ambiguous." I cannot accept an analysis that will produce
such a result.

Even a universal industry practice may still be fraudulent. See Chasins v. Smith, Barney & Co. , 438 F.2d 1167, 1171-72 (2d Cir. 1970) (non-disclosure of wid espread industry practice may still be non-disclosure of ma terial

18fact); Opper v. Hancock Securities Corp. , 250 F. Supp. 668,

676 (S.D.N.Y. 1966) (industry custom may be found fraudulent, especially on first occasion it is liti gated); see also Vermilye & Co. v. Adams Express Co. , 88 U.S. 138, 146 (1874). Indeed, the SEC recently completed an investigation in which it found that widespread fra ud was occurring in the NASDAQ market during a period overlapping the class period. See Report Pursuant to Section 21(a) of the Securities Exchange Act of 193 4 Regarding the NASD and the NASDAQ Market (Aug. 8, 1996).

As the court emphasizes, the practice of exclusive
reliance on the NBBO has never been held to be frau dulent by any court or regulator. But neither is there any statute, rule, regulation, or interpretation, by the SEC or by a court, that authoritatively establishes that exclusive rel iance on the NBBO, even when better prices are reasonably available, satisfies the duty of best execution. Wh ether the NBBO exhausted the category of "reasonably availabl e prices" during the class period has thus never been expressly determined. But this did not absolve the district court of the duty to resolve the plaintiffs' securi ties fraud claim once it was presented in this suit.

"In the final analysis, ultimate responsibility for
construction and enforcement of the securities laws must rest with the court." Langert v. Q-1 Corp. , Fed. Sec. L. Rep. (CCH) para. 94,445, at 95,540, 1974 WL 377 (S.D.N.Y . Mar. 15, 1974). The district court was not deprived of t his enforcement authority just because no court or regu lator had previously chosen to exercise such authority wi th respect to the practice challenged here. See, e.g., Chasins

, 438 F.2d at 1171-72 (finding that defendant's failu re to
disclose its market maker status was material omiss ion under Section 10(b), despite fact that SEC had neve r previously held that such disclosure was required).

V.

On the record before us, I believe a reasonable tri er of fact could conclude that the defendants misrepresen ted that they would execute the plaintiffs' orders so a s to

19maximize the plaintiffs' economic benefit, and that this misrepresentation was intentional or reckless becau se, at the time it was made, the defendants knew that they intended to execute the plaintiffs' orders at the N BBO price even if better prices were reasonably available. A reasonable trier of fact could find scienter with respect to a material misrepresentation, as well as the other elements es sential to a Section 10(b) fraud claim. Accordingly, I must respectfully dissent.

A True Copy:

Teste:

Clerk of the United States Court of Appeals
for the Third Circuit

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