1997 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

6-19-1997

Newton v. Merrill Lynch

Precedential or Non-Precedential:

Docket 96-5045

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Recommended Citation

"Newton v. Merrill Lynch" (1997). 1997 Decisions. Paper 135.

http://digitalcommons.law.villanova.edu/thirdcircuit_1997/135
Filed 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. 

 2 
FRANK 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 Securities 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 computerized 

price quotation system known as NASDAQ. They claim that 

the peculiarities of this market have given securities dealers 

 3 
an opportunity--upon which they have capitalized--to 

inflate their profit margins at the expense of customers, 

resulting in inferior execution prices vis-a-vis other dealers 

who have access to superior, privately quoted prices. These 

practices, plaintiffs allege, violated the defendants' duty of 

best execution, but were never disclosed by the dealers, 

thus amounting to a securities fraud under section 10 of 

the Securities Exchange Act of 1934, 15 U.S.C. § 78j(a) and 

Rule 10-b5 promulgated thereunder, 17 C.F.R. § 240.10b-5. 

The NASDAQ, which is now the second-largest securities 

market in the United States, is different from the New York 

and American Stock Exchanges, because it is a dealercreated, rather than an auction, market. In an auction 

market, buy and sell orders actually "meet" on the 

exchange floor, with prices being set by the continuous 

interaction of those orders, under the supervision of market 

"specialists." This type of market has traditionally 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, each 

market maker decides the prices at which it will buy and 

sell a security; the difference between the listed "ask" and 

"bid" prices is known as the "spread," from which the 

market maker is compensated for its efforts and risk. 

Under that system, of course, as long as timely, accurate 

information is available regarding each market maker's 

prices, orders will naturally gravitate towards the dealer 

with the most favorable prices, and this will establish a 

single, albeit two-price, market for each security traded. 

NASDAQ (which stands for National Association of 

Securities Dealers Automated Quotation) is the information 

system that relays market makers' pricing information to 

buyers and sellers. NASDAQ quotes the National Best Bid 

and Offer--known in the industry as the "NBBO"--price for 

every stock on the system. 

Because of recently created sources of additional, nonpublic pricing information, however, the NBBO may no 

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

Systems such as SelectNet and Instinet, which are not 

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 better prices 

displayed in many instances, but that the defendant

dealers knew such prices were available, yet continued to 

book their orders at the inferior, NBBO price at the same 

time that they were trading at the more favorable price 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, assume 

that a dealer quotes an "ask" price of $32 1/4 and an "bid" 

price of $32 for shares of XYZ Corporation. A customer 

places an order to purchase 100 shares, but, unbeknownst 

to him, the dealer has an outstanding limit order from 

another customer to sell at 32 1/8. That dealer could 

simply cross the two orders and execute the trade at 32 

1/8, saving the customer $12.50. The dealer would not 

incur any market risk on such a transaction. Appellants 

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 held that 

defendants made no actionable misrepresentations, 

because the duty of best execution is ill-defined and there 

is no widely accepted view that execution of trades at the 

NBBO price fails to satisfy that duty; thus, it would be 

improper to find that defendants omitted or concealed 

material facts. 911 F. Supp. at 771. Second, the court held 

that, even if defendants omitted information, they could 

not, as a matter of law, have acted with the requisite 

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 must 

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

in connection with the purchase or sale of a security; (2) 

scienter on the part of the defendant; (3) reliance on the 

misrepresentation; and (4) damage resulting from the 

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 omission of a 

material fact, we will assume, without deciding, that the 

trading practices here constituted an otherwise actionable 

misrepresentation, because we conclude that the district 

court correctly decided that scienter was lacking as a 

matter of law, and appellants' securities law claims fail on 

that basis alone. 

The element of scienter has been defined as "a mental 

state embracing intent to deceive, manipulate or defraud." 

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 ordinary 

care, . . . which presents a danger of misleading . . . that 

is either known to the defendant or is so obvious that the 

actor must have been aware of it." Healey v. Catalyst

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 comprehends 

actions very close to intentional conduct; mere indifference 

to the consequences of a statement is not sufficient. 

Healey, 616 F.2d at 649. 

Appellants assert, nevertheless, that the record before the 

district court contained sufficient evidence from which a 

rational factfinder could infer scienter. The district court 

disagreed, opining that because the duty of best execution 

is not "established," but ambiguous, the failure to disclose 

that all orders were being executed at the NBBO price could 

not, as a matter of law, have involved scienter. We agree. 

Appellants attempt to refute the district court's reasoning 

by arguing that "the absence of a regulation prohibiting a 

specific practice does not mean such practice cannot be 

considered fraudulent." Specifically, they rely on our 

decision in Ettinger v. Merrill Lynch, Pierce, Fenner & Smith,

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

"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 Ettinger argued 

that its compliance with Rule 10b-10 insulated it from a 

material misrepresentation attack under Rule 10b-5, and 

we held simply that such compliance did not preclude a 

10b-5 action. Id. at 1036. Moreover, Ettinger involved a 

markup practice that both the SEC and the courts had 

already condemned--the duty in that instance, unlike 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, involved 

execution practices that no reasonable dealer could have 

possibly believed proper. See Barnett v. United States, 319 

F.2d 340, 345 (8th Cir. 1963) (excessive mark-ups of 

between 25 and 67% not disclosed; customer order never 

executed at advertised price, while dealer was trading same 

security for its own account at superior price); Opper 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 customer'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 increasing 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 to cite with facts similar 

to the present case is an unpublished district court 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 sending all orders to the AMEX 

rather than "seeking the best price in the available markets" stated a 

claim for securities fraud. That court did not discuss scienter, and is 

thus inapposite, whatever its relative persuasiveness. 

 7 
As the district court recognized, the most instructive 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 the same 

time it was profiting from customer transactions against its 

own inventory. The district court found, after trial, that 

defendants had acted with scienter, but the court of 

appeals reversed because there was no established 

regulatory duty to disclose and intent to deceive could not 

thus be established by omission. Here, as in Platsis, the 

dealers were under no established duty to execute trades at 

other than the NBBO price or to disclose their execution 

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 Reynolds, Inc., 

825 F.2d 885, 889 (5th Cir. 1987) (failure to disclose sales 

compensation did not involve scienter when no court or 

regulator had ever held that information material and there 

was no evidence that its disclosure was normal industry 

practice).2 

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

438 F.2d 1167 (2d Cir. 1970), a broker failed to disclose 

that it was making a market in certain securities it 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 practice and 

had never thought such disclosure was required. Moreover, 

the SEC had never prosecuted any firm for this violation. 

_________________________________________________________________ 

2. The district court and appellees maintain that this circuit already 

follows a Platsis-like rule. In Christidis v. First Pennsylvania Mortgage

Trust, 717 F.2d 96 (3d Cir. 1983), plaintiffs sued an accounting firm, 

alleging that it fraudulently failed to preparefinancial statements in 

accordance with generally accepted accounting principles. Although 

scienter as such was not an issue, we affirmed the dismissal of the 

complaint for lack of particularity in pleading fraud 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 pleading standard for 

allegations of fraud. Nevertheless, we think that Platsis is persuasively 

reasoned and we adopt it here. 

 8 
Indeed, 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 scienter. 

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 . . . the 

omission of a material fact. The omission of a material fact, 

without more, does not violate Rule 10b-5. All other 

elements, including scienter, must be proven[.]"). Second, in 

Chasins, appellant's contention that nobody thought 

disclosure was required was demonstrably false, having 

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 securities in 

which the dealer itself was making the market. The dealer 

thus had an undisclosed conflict of interest of major 

proportions; to the extent that the customer followed 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 execution 

practices and those practices are widely followed within 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 that 

appellants have adduced evidence that the nondisclosures 

at issue here were not common industry practice, closer 

examination reveals that contention to be unsupported. 

Appellants first cite the deposition testimony of Paul M. 

Lacy, a retired securities trader, for the proposition that 

"other broker-dealers do not execute customer orders with 

exclusive reference to the NBBO." His testimony supports 

nothing. Mr. Lacy retired before the beginning of the class 

period (November 1992), and therefore cannot offer any 

 9 
competent, firsthand testimony about industry practices as 

they existed at the times material to this litigation. Of even 

greater significance, Lacy did not even testify about 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 609]. See

Order Execution Obligations, 60 Fed. Reg. 52,792 (1995) (to 

be codified at 17 C.F.R. pt. 240) (proposed Oct. 10, 1995). 

That document recites that traders use "a variety of 

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 failure 

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 trader 

and a former SEC commissioner who believe that the duty 

of best execution requires affirmative efforts to supplement 

the NBBO with other sources of pricing. See National

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 that he 

believes it is the obligation of a market maker to achieve 

price improvement whenever possible and does so infifty 

percent of all trades); Declaration of former SEC 

Commissioner Richard Y. Roberts, [A777] ("[i]t would be 

inconsistent with the duty of best execution for a brokerdealer to advantage itself by automatically executing 

customer orders at the NBBO when superior prices are 

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 the 

NASD board and law professor at Northwestern University, 

 10 
stated by affidavit that trades at the NBBO price satisfied 

the duty of best execution and that the general custom and 

practice of firms in the industry was to execute at the 

NBBO price [A225-27]. T. Grant Callery, General Counsel 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 that he 

had observed the trading practices of every major firm in 

the industry and observed that the standard practice was 

to trade at the NBBO [A 497]. 

Finally, while this case was pending on appeal, the SEC 

finalized new regulations pertaining to order execution 

which address directly the practices at issue here. See

generally Self-Regulatory Organizations; National 

Association of Securities Dealers; Order Granting Partial 

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, 1997). 

Under these new rules, which became effective on January 

20, 1997, market makers must display a customer's limit 

order when the price of that order is superior to the current 

NBBO quote. Moreover, any superior prices quoted on

electronic communications networks such as SelectNet and 

Instinet must be listed as part of the NBBO price. See SEC 

News Release 97-3, New Trading Rules for NASD and the

Exchanges, 1997 WL 21042 (Jan. 20, 1997). By these 

regulatory changes, dealers will essentially be required to 

eliminate the practices that appellants complain of in this 

case. We believe, as did the district court, that the fact that 

the Securities and Exchange Commission perceived the 

need to address these order execution practices through the 

regulatory process indicates strongly, if not conclusively, 

that the "duty" to cross orders and to look beyond the 

NBBO for pricing information was ambiguous, indeed 

speculative, during the class period. Regulatory agencies 

would not spend the time, money and effort in 

promulgating regulations if the duty it sought to impose 

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 

 11 
III. 

In sum, the evidence in this record is legally insufficient 

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 ignored 

massive evidence suggesting that it was. Accordingly, the 

district court correctly found no scienter and properly 

entered summary judgment for defendants. We will affirm. 

_________________________________________________________________ 

Act. Where the duty is clear, or where a practice is obviously fraudulent 

and not pervasive throughout the securities industry, the mere lack of 

regulations directly addressing the practice at issue will not constitute a 

bar to such a suit. 

 12 
STAPLETON, 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 mislead 

their clients. The plaintiffs allege that, when the defendants 

received the plaintiffs' orders, the defendants knew 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 themselves had 

no intention of referencing anything other than the NBBO. 

The issue for decision is whether the plaintiffs have 

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 plaintiffs' orders 

for execution. I conclude that they have and that summary 

judgment for the defendants is therefore improper. 

I. 

The class period extends from November 4, 1992 to 

November 4, 1994. The district court granted summary 

judgment to the defendants primarily because the SEC, 

during that period, had not explicitly declared that the duty 

of best execution included the duty to consult reasonably 

available sources other than NBBO. Because resolving that 

issue involved considerations within the scope of the SEC's 

expertise, the district court believed it would be 

inappropriate for the courts to recognize a legal duty to 

consult other sources during the class period. Ifind 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 effectively 

eliminating the practices of which the plaintiffs here 

complain1 "indicates strongly, if not conclusively, that the 

_________________________________________________________________ 

1. The SEC proposed in 1995, and implemented in 1997, amendments to 

the "Quote Rule" which now require market makers to include in the 

NBBO any superior price they are quoting on electronic communications 

networks like SelectNet or Instinet. See Order Execution Obligations, 

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

was ambiguous, indeed speculative, during the class

period." Slip Op. at 11. The court then concludes that there 

was applicable law during the class period and that it was 

established by the way in which a segment of the regulated 

profession behaved during that period. Thus, the 

defendants are entitled to summary judgment, we are told, 

because they have shown "that enough dealers [referenced 

only the NBBO during the class period] so that the duty to 

supplement the NBBO price [was] ambiguous and scienter 

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 that 

these principles were not ambiguous during the class 

period. The district court's task was to apply those 

unambiguous principles to the circumstances of each

transaction between a plaintiff and a defendant. Because 

there are material disputes of fact concerning those 

circumstances, I would reverse and remand for further 

proceedings. 

II. 

The relationship between a client and a broker is that of 

a principal and an agent. Absent special circumstances, it 

is a relationship in which it is understood by all that the 

client-principal seeks his own economic gain and the 

broker-agent earns his commission by helping the clientprincipal achieve that objective. Absent instructions to the 

contrary, the broker is thus expected to maximize the 

economic benefit to the client in each transaction. Hence, 

the duty of best execution. 

"[T]he duty of best execution requires a broker-dealer 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, Exchange Act Release 

No. 37,619A, 61 Fed. Reg. 48290 (Sept. 12, 1996) ("Final Rules"). Since 

the new NBBO incorporates a far wider range of prices, the possibility of 

executing a trade at an inferior NBBO price when better prices are 

available on an electronic communications network has been eliminated. 

 14 
the circumstances for a customer's transaction." Proposed 

Rules, 60 Fed. Reg. at 52793; U.S. Equity Market Structure 

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, the duty of 

best execution requires the defendants to execute the 

plaintiffs' trades at the best reasonably available price.2 

While there may be uncertainty in any particular situation 

as to what prices are reasonably available, the existence of 

a broker-dealer's duty to execute at the best of those 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 execution is a 

highly fact-and-circumstance-sensitive inquiry, with the 

scope of the duty evolving over time with changes in 

technology and transformations in the structure offinancial 

markets. See, e.g., Final Rules, 61 Fed. Reg. at 48322-23. 

For example, before the creation of NASDAQ, a broker 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 best bid 

and offer available nationwide, the standard for satisfying 

the duty of best execution necessarily heightened. 

_________________________________________________________________ 

2. Other terms in addition to price are also relevant to best execution. In 

determining how to execute a client's order, a broker-dealer should take 

into account order size, trading characteristics of the security, speed of 

execution, clearing costs, and the cost and difficulty 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 "prices" were reasonably 

available from sources other than the NBBO, I understand that to mean 

that, given an evaluation of price as well as all of the other relevant 

terms, the trade would be better executed through a source of liquidity 

other than the NBBO (e.g. SelectNet, Instinet, in-house limit orders or 

market orders held by the defendants, or limit orders placed by the 

public in the Small Order Execution System). Similarly, for convenience, 

I use the phrase "best reasonably available price" to mean "best terms." 

 15 
The 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 NBBO at 

the time the defendants executed the plaintiffs' trades at 

the NBBO price. There is sufficient evidence from which a 

reasonable trier of fact could find, for example, that prices 

better than the NBBO were reasonably available on the 

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 consulting 

other sources besides the NBBO would have added 

substantial expense and delay to the execution of plaintiffs' 

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 defendants at 

this juncture. 

I believe the evidence is sufficient to allow a reasonable 

trier of fact to conclude that, by the time of the class 

period, both technology and over-the-counter markets had 

developed to a point where it was feasible to maximize the 

economic benefit to the client by taking advantage of better 

prices than the NBBO. 

III. 

Recovery for federal securities fraud requires a showing 

of deliberate or reckless misrepresentation of a material 

fact. The misrepresentation here, according to plaintiffs, 

was an implied representation made by the defendants 

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 reasonable 

inference, plaintiffs therefore insist, that they would not 

have placed these orders with the defendants without an 

understanding that the defendants would execute them in 

a manner seeking to maximize plaintiffs' economic benefit. 

Since the defendants knew of the plaintiffs' profit

motivation, they must have understood that plaintiffs would 

expect them to obtain a price more advantageous to the 

plaintiffs than the NBBO when one was readily available. If, 

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

manner consistent with this expectation when they 

accepted the orders and yet did not so advise plaintiffs, 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 from an 

economic analysis of the plaintiffs' relationship with the 

defendants, plaintiffs rely upon evidence showing that 

respected members of the brokerage community recognized, 

even prior to the class period, that trades were readily 

available from sources other than the NBBO and that their 

clients expected them to take advantage of those sources 

whenever it would benefit the client. See, e.g., Declaration 

of Paul M. Lacy [A 718]; Declaration of Junius W. Peake [A 

755]; Declaration of Richard Y. Roberts [A 775]. Moreover, 

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 SelectNet and 

Instinet. See Final Rules, 61 Fed. Reg. at 48307-08. They 

have further shown that the possibility that the duty of best 

execution might require resort to sources other than the 

NBBO was being actively debated during the class period 

and that that debate ultimately resulted, after the class 

period, in a regulation effectively requiring as much. Id.

All of this would allow a reasonable trier of fact to find 

that the defendants' misrepresentation--namely, that they 

would execute plaintiffs' trades in a manner maximizing 

plaintiffs' economic gain--was at least reckless, if not 

intentional. See Healey v. Catalyst Recovery of Penn., Inc., 

616 F.2d 641, 649 (3d Cir. 1980) (defining recklessness 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 stating 

that their practice during the class period was the same as 

that of the defendants. This evidence could, of course, be 

regarded by a trier of fact as probative of the defendants' 

state of mind when they accepted plaintiffs' orders. But 

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these affidavits do no more than raise a material issue of 

fact as to whether the defendants knew of the expectation 

plaintiffs claim to have had; they do not settle the matter. 

At trial, the defendants would certainly be entitled to 

argue to the jury that, because of industry practice, they 

thought their clients would expect them to execute only at 

the NBBO or that they never thought about their clients' 

expectations. Moreover, any evidence, derived from 

knowledge of industry practice or elsewhere, that the 

plaintiffs were generally aware of the defendants' exclusive 

reliance on the NBBO would, of course, be quite probative 

of whether the plaintiffs had the expectations they claim. 

But the court, in elevating the practice of a segment of the 

industry to be outcome determinative, loses sight of the fact 

that the basis for the duty of best execution is the mutual 

understanding that the client is engaging in the trade--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 when 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 execution, and she 

knew or should have known that it violated that duty, so 

long as she can identify a sufficient number of other 

broker-dealers engaged in the same wrongful conduct to be 

able to argue in good faith that the underlying duty 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 widespread 

industry practice may still be non-disclosure of material 

 18 
fact); 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 litigated); 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 fraud 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 1934 

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 fraudulent 

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 reliance on 

the NBBO, even when better prices are reasonably 

available, satisfies the duty of best execution. Whether the 

NBBO exhausted the category of "reasonably available 

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' securities 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 this 

enforcement authority just because no court or regulator 

had previously chosen to exercise such authority with 

respect to the practice challenged here. See, e.g., Chasins, 

438 F.2d at 1171-72 (finding that defendant's failure to 

disclose its market maker status was material omission 

under Section 10(b), despite fact that SEC had never 

previously held that such disclosure was required).

V. 

On the record before us, I believe a reasonable trier of 

fact could conclude that the defendants misrepresented 

that they would execute the plaintiffs' orders so as to 

 19 
maximize the plaintiffs' economic benefit, and that this 

misrepresentation was intentional or reckless because, at 

the time it was made, the defendants knew that they

intended to execute the plaintiffs' orders at the NBBO 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 essential 

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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