1998 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

1-30-1998

Newton v. Merrill Lynch

Precedential or Non-Precedential:

Docket 96-5045

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Recommended Citation

"Newton v. Merrill Lynch" (1998). 1998 Decisions. Paper 22.

http://digitalcommons.law.villanova.edu/thirdcircuit_1998/22
Filed January 30, 1998 

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 Binde r, 

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,* District Judge 

Reargued En Banc October 29, 1997 

_________________________________________________________________ 

*Hon. A. David Mazzone, United States District Judge for the District of 

Massachusetts, sitting by designation. 
BEFORE: SLOVITER, Chief Judge, BECKER, STAPLETON, 

MANSMANN, GREENBERG, SCIRICA, NYGAARD, ALITO, 

ROTH and LEWIS, Circuit Judges 

(Opinion Filed January 30, 1998) 

 Norman S. Poser 

 Brooklyn Law School 

 250 Joralemon Street 

 Brooklyn, NY 11210 

 Karen L. Morris (Argued) 

 Morris & Morris 

 1105 North Market Street 

 Suite 1600 

 Wilmington, DE 19801 

 Attorneys for Appellants 

 Matthew D. Anhut 

 Jonathan N. Eisenberg 

 Kirkpatrick & Lockhart 

 1800 Massachusetts Avenue, N.W. 

 Washington, D.C. 20036-5891 

 Attorneys for Appellee 

 Merrill, Lynch, Pierce, 

 Fenner & Smith, Inc. 

 Joseph A. Boyle 

 Kelley, Drye & Warren 

 5 Sylvan Way 

 Parsippany, NJ 07054 

 Bruce Coolidge 

 Robert B. McCaw (Argued) 

 Wilmer, Cutler & Pickering 

 2445 M Street, N.W. 

 Washington, D.C. 20037-1420 

 Attorneys for Appellee 

 PaineWebber, Inc. 

 2 
 Frank M. Holozubiec 

 Kirkland & Ellis 

 153 East 53rd Street 

 Citicorp Center 

 New York, NY 10022 

 Attorney for Appellee 

 Dean Witter Reynolds 

 Richard H. Walker 

 Eric Summergrad 

 Susan F. Wyderko 

 Jacob H. Stillman 

 Mail Stop 6-6 

 Securities & Exchange Commission 

 450 Fifth Street, N.W. 

 Washington, D.C. 20549 

 Attorneys for Amicus Curiae 

 Securities & Exchange 

 Commission 

OPINION OF THE COURT 

STAPLETON, Circuit Judge: 

I. 

Plaintiff-Appellants are investors who purchased and sold 

securities on the NASDAQ market, the major electronic 

market for "over-the-counter" securities, during the two 

year period from November 4, 1992 to November 4, 1994 

("the class period"). The defendants are NASDAQ market 

makers. NASDAQ is a self-regulating market owned by the 

National Association of Securities Dealers ("NASD"), subject 

to oversight by the Securities and Exchange Commission 

("SEC"). 

An "over-the-counter" market like NASDAQ differs in

important respects from the more familiar auction markets, 

like the New York and American Stock Exchanges. The

NYSE and AMEX markets are distinguished by a physical 

exchange floor where buy and sell orders actually"meet," 

with prices set by the interaction of those orders under the 

 3 
supervision of a market "specialist." In a dealer market like 

NASDAQ, the market exists electronically, in the form of a 

communications system which constantly receives and

reports the prices at which geographically dispersed market 

makers are willing to buy and sell different securities. 

These market makers compete with one another to buy and 

sell the same securities using the electronic system; 

NASDAQ is, then, an electronic inter-dealer quotation 

system. 

In a dealer market, market makers create liquidity by 

being continuously willing to buy and sell the security in 

which they are making a market. In this way, an individual 

who wishes to buy or sell a security does not have to wait 

until someone is found who wishes to take the opposite 

side in the desired transaction. To account for the effort 

and risk required to maintain liquidity, market makers are 

allowed to set the prices at which they are prepared to buy 

and sell a particular security; the difference between the 

listed "ask" and "bid" prices is the"spread" that market 

makers capture as compensation. 

The electronic quotation system ties together the 

numerous market makers for all over-the-counter securities 

available on NASDAQ. All NASDAQ market makers are 

required to input their bid and offer prices to the NASD 

computer, which collects the information and transmits, for 

each security, the highest bid price and lowest ask price 

currently available. These prices are called the"National 

Best Bid and Offer," or NBBO. The NASD computer, 

publicly available to all NASDAQ market makers, brokers 

and dealers, displays and continuously updates the NBBO 

for each offered security. 

Plaintiffs allege that technological advances made it 

feasible during the class period for the defendant market 

makers to execute orders at prices quoted on private online services like SelectNet and Instinet and that those 

prices were frequently more favorable to their investor 

clients than the NBBO price. According to plaintiffs, the 

defendants regularly used these services and knew that 

prices better than NBBO were often available through them. 

Even though they knew that their investor clients expected 

them to secure the best reasonably available price,

 4 
plaintiffs say, the defendants executed plaintiffs' orders at 

the NBBO price when they knew that price was inferior and 

when they, at the same time, were trading at the more 

favorable price for their own accounts. In this way, they 

were able to inflate their profit margins at the expense of 

their investor clients. This practice is alleged to violate 

section 10 of the Securities Act of 1934, 15 U.S.C.S 78j, 

and Rule 10b-5 promulgated thereunder, 17 C.F.R. 

S 240.10b-5. 

The plaintiffs also charge defendants with two other 

violations of section 10 and Rule 10b-5. Market makers 

who simultaneously hold a market order for both sides of a 

transaction may obtain more favorable prices than the 

NBBO by "crossing" these in-house orders. Transactions 

handled in this way are executed within the spread, giving 

both the purchaser and seller a better price. Similarly, a 

customer order can be matched by a market maker with an 

in-house limit order on the other side of the transaction. 

Since a limit order specifies a particular price at which to 

execute a transaction, matching another customer order at 

that price may beat the currently displayed NBBO quote for 

that security. Plaintiffs allege that the failure of the 

defendants to execute orders of their clients in these ways 

when feasible constitutes a fraudulent practice because, by 

executing at the NBBO rather than matching customer

orders, the defendants capture the full market "spread" as 

a fee for their services without incurring any actual risk in 

the transaction. 

II. 

The defendants filed a motion to dismiss for failure to 

state a claim upon which relief could be granted. At the 

direction of the district court, this motion was converted 

into a motion for summary judgment, which was ultimately 

granted. See In re Merrill Lynch Securities Litigation, 911 F. 

Supp. 754 (D.N.J. 1995). The district court rested its 

decision on two principal grounds. First, the court

determined that the defendants made no misrepresentation. 

Though recognizing that the defendants, by accepting 

plaintiffs' orders, impliedly represented that they intended 

to execute those orders in conformity with the "duty of best 

 5 
execution," the court considered the scope of this duty 

sufficiently ill-defined that execution at the NBBO could 

not, as a matter of law, be found inconsistent with the 

duty. The court concluded that in the face of uncertainty 

about the scope of defendants' duty of best execution, 

holding them liable would be "highly imprudent." 911 F. 

Supp. at 771. Second, the court held that, even if 

defendants made a material misrepresentation, they could 

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

scienter. 

To state a claim for securities fraud under S 10 of the 

Securities Act of 1934 and Rule 10b-5, plaintiffs must 

demonstrate: (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. See Sowell v. Butcher & Singer, 

Inc., 926 F.2d 289, 296 (3d Cir. 1991). Because plaintiffs 

have demonstrated that a genuine issue of material fact 

exists as to the elements of their securities fraud claim, we 

will reverse the district court. 

III. 

The parties agree that a broker-dealer owes to the client 

a duty of best execution. They further agree that a brokerdealer, by accepting an order without price instructions, 

impliedly represents that the order will be executed in a 

manner consistent with the duty of best execution and that 

a broker-dealer who accepts such an order while intending 

to breach that duty makes a misrepresentation that is 

material to the purchase or sale. The parties differ, 

however, on whether a trier of fact could conclude from this 

record that the implied representation made by the 

defendants included a representation that they would not 

execute at the NBBO price when prices more favorable to 

the client were available from sources like SelectNet and 

Instinet. 

As we explain hereafter, this difference can be resolved 

only by determining whether, during the class period or 

some portion thereof, it was feasible for the defendants to 

 6 
execute trades through SelectNet and Instinet when prices 

more favorable than the NBBO were being quoted there. 

This is a matter concerning which the record reflects a 

material dispute of fact. If such prices were reasonably 

available and the defendants, at the time of accepting 

plaintiffs' orders, intended to execute them solely by 

reference to the NBBO, they made a material 

misrepresentation in connection with the purchase or sale 

of the securities involved. If a finder of fact could infer, in 

addition, that the defendants' implied representation was 

knowingly false or made with reckless indifference, it would 

follow that summary judgment for the defendants was

inappropriate. 

The duty of best execution, which predates the federal 

securities laws, has its roots in the common law agency 

obligations of undivided loyalty and reasonable care that an 

agent owes to his principal.1 Since it is understood by all 

that the client-principal seeks his own economic gain and 

the purpose of the agency is to help the client-principal 

achieve that objective, the broker-dealer, absent 

instructions to the contrary, is expected to use reasonable 

efforts to maximize the economic benefit to the client in 

each transaction. 

The duty of best execution thus requires that a brokerdealer seek to obtain for its customer orders the most 

_________________________________________________________________ 

1. See, e.g., Hall v. Paine, 112 N.E. 153, 158 (Mass. 1916) ("broker's 

obligation to his principal requires him to secure the highest price 

obtainable"); Restatement of Agency (Second)S 424 (1958) (agent must 

"use reasonable care to obtain terms which best satisfy the manifested 

purposes of the principal"). See also Opper v. Hancock Securities Corp., 

250 F.Supp. 668, 676 (S.D.N.Y.) ("[T]he duties of a securities broker are, 

if anything, more stringent than those imposed by general agency law."), 

aff 'd, 367 F.2d 157 (2d Cir. 1966). Moreover, as the district court 

correctly recognized, the best execution duty "does not dissolve when the 

broker/dealer acts in its capacity as a principal." 911 F.Supp. at 760. 

Accord E.F. Hutton & Co., Exchange Act Rel. No. 25887, 49 S.E.C. 829, 

832 (1988) ("A broker-dealer's determination to execute an order as 

principal or agent cannot be `a means by which the broker may elect 

whether or not the law will impose fiduciary standards upon him in the 

actual circumstances of any given relationship or transaction.' ") 

(citation 

omitted). 

 7 
favorable terms reasonably available under the 

circumstances. See, e.g., Sinclair v. SEC, 444 F.2d 399, 400 

(2d Cir. 1971) (fiduciary duty requires broker-dealer "to 

obtain the best available price" for customers' orders); 

Arleen W. Hughes, 27 S.E.C. 629, 636 (1948) ("A corollary 

of the fiduciary's duty of loyalty to his principal is his duty 

to obtain . . . the best price discoverable in the exercise of 

reasonable diligence."), aff 'd sub nom. Hughes v. SEC, 174 

F.2d 969 (D.C. Cir. 1949). Accord Order Execution 

Obligations, Exchange Act Release No. 37,619A, 61 Fed. 

Reg. 48290, 48322 (Sept. 12, 1996) ("Final Rules"). That is, 

the duty of best execution requires the defendants to 

execute the plaintiffs' trades at the best reasonably 

available price.2 While ascertaining what prices are 

reasonably available in any particular situation may require 

a factual inquiry into all of the surrounding circumstances, 

the existence of a broker-dealer's duty to execute at the 

best of those prices that are reasonably available is wellestablished and is not so vague as to be without 

ascertainable content in the context of a particular trade or 

trades. 

As the SEC has recognized on a number of occasions, the 

scope of the duty of best execution has evolved over time 

with changes in technology and transformation of the 

structure of financial markets.3 For example, before the 

_________________________________________________________________ 

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 must 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, we 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, we use the phrases "best reasonably available price" and 

"best terms" interchangeably. 

3. See, e.g., Final Rules, 61 Fed. Reg. at 48322-23 ("The scope of this 

duty of best execution must evolve as changes occur in the market that 

 8 
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 Order Execution Obligations, Exchange Act 

Release No. 36,310, 60 Fed. Reg. 52792, 52793 (Oct. 10, 

1995) ("Proposed Rules"). 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. 

After the class period, the SEC issued rules that altered the 

definition of the NBBO to include consideration of many of 

the alternative sources of liquidity that plaintiffs claim 

should have been consulted during the class period, such 

as SelectNet and Instinet. See Final Rules, 61 Fed. Reg. at 

48306-16. Prospectively, at least, this heightened the 

standard still further. 

Because the scope of the duty of best execution is 

constantly evolving and because the "reasonably available" 

component of the duty is fact dependent, broker-dealers 

have long been required to conform customer order 

practices with changes in technology and markets. For 

example, the NASD's Rules of Fair Practice, adopted in 

1968, required brokers in the over-the-counter market to 

"use reasonable diligence to ascertain the best inter-dealer 

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 the prevailing market 

conditions." NASD Manual (CCH), art. III S 1, P 2151.03 

(1995) (Interpretation A). Included in the factors used to 

satisfy the requirement of "reasonable diligence" are both 

"the number of primary markets checked," and the 

"location and accessibility to the customer's broker-dealer 

of primary markets and quotations sources." Id. 

Almost a year before the end of the class period, the SEC 

staff issued a report entitled "Market 2000: An Examination 

_________________________________________________________________ 

give rise to improved executions for customer orders, including 

opportunities to trade at more advantageous prices. As these changes 

occur, broker-dealers' procedures for seeking to obtain best execution for 

customer orders also must be modified to consider price opportunities 

that become `reasonably available.' "). 

 9 
of Current Equity Market Developments." This report notes 

that the SEC has consistently taken the position that the 

evolving nature of the markets requires a broker-dealer to 

"periodically assess the quality of competing markets to 

ensure that its order flow is directed to markets providing 

the most advantageous terms for the customer's order." 

Market 2000 Report, 1994 SEC LEXIS 136, *11-12. As the 

term "periodically assess" suggests and as the SEC 

confirms in its amicus briefing before us, this segment of 

the report was not speaking to the issue of whether, during 

the class period, the duty of best execution included a 

requirement that broker-dealers engage in an order-byorder analysis of competing markets. It does, however, 

expressly recognize a duty on the part of broker-dealers to 

periodically examine their practices in light of market and 

technology changes and to modify those practices if

necessary to enable their clients to obtain the best 

reasonably available prices. 

The plaintiffs' orders did not specify the price at which 

they should be executed. It is a reasonable inference that 

plaintiffs, in placing their orders, sought their own 

economic advantage and that they would not have placed 

them without an understanding that the defendants would 

execute them in a manner that would maximize plaintiffs' 

economic benefit from the trade. Given the objective of the 

agency and the regulatory background we have reviewed, 

we conclude that a trier of fact could infer that the 

defendants' acceptance of the orders was reasonably

understood as a representation that they would not be 

executed at the NBBO price when better prices were 

reasonably available elsewhere. Accordingly, we must 

examine the record evidence relevant to whether prices 

quoted on private on-line services like SelectNet and 

Instinet were reasonably available during the class period 

and whether those prices were more favorable than the 

NBBO when plaintiffs' orders were executed. 

The evidence pointed to by plaintiffs indicates that (1) 

SelectNet and Instinet were in existence throughout the 

class period; (2) the quotations reported by these services 

reflected buyers and sellers ready to trade at the quoted 

prices; (3) the defendants themselves actively traded on 

 10 
SelectNet and Instinet during the class period; and (4) other 

respected members of the brokerage community, since

before the class period, have regarded these services as 

providing reasonably available prices and have executed 

orders through them when the prices reported were more 

favorable to the client than the NBBO price. In addition, the 

plaintiffs have tendered expert testimony confirming the 

reasonable availability of execution sources other than the 

NBBO during the class period. 

With respect to whether SelectNet and Instinet prices 

were more favorable at the time their orders were executed, 

plaintiffs point to an SEC study of prices during the three 

month period from April through June 1994. The SEC 

found that "approximately 85% of the bids and offers 

displayed by market makers in Instinet and 90% of the bids 

and offers displayed on SelectNet were at better prices than 

those posted publicly on NASDAQ." Final Rules, 61 Fed. 

Reg. at 48308. Plaintiffs have also tendered evidence of a 

few trades executed for them by defendants at the NBBO 

where evidence of contemporaneous offers on Instinet and 

SelectNet indicate that lower prices were available. Plaintiffs 

have filed a Rule 56(f) affidavit indicating that they need 

discovery in order to provide similar evidence with respect 

to the remainder of their trades.4 

To be sure, the defendants, with record support, insist 

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. 5 This, 

_________________________________________________________________ 

4. Defendants suggest that the lack of evidence of injury in all 

plaintiffs' 

transactions supports an affirmance on the basis of lack of standing. We 

believe the evidence we have reviewed in text supports plaintiffs' claim 

to 

standing. Plaintiffs submitted evidence that would warrant a finding that 

several trades were made on their behalf when better prices were 

contemporaneously available from other sources. The SEC study of 1994 

prices suggests that, more likely than not, there were other trades in 

this 

category. In any event, the plaintiffs have filed a Rule 56(f) affidavit 

that 

would preclude a summary judgment for defendants on this issue at this 

time. 

5. In particular, the defendants rely upon the existence during the class 

period of the Small Order Execution System ("SOES"). SOES is an 

 11 
however, does nothing more than create a material dispute 

of fact which we are not permitted to resolve in favor of the 

defendants at this juncture. 

We 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. Summary judgment for defendants 

on this element of plaintiffs' claim was therefore not 

appropriate. 

IV. 

As we have noted, recovery on a federal securities fraud 

claim requires a showing of scienter: a deliberate or 

reckless misrepresentation of a material fact. See Ernst & 

Ernst v. Hochfelder, 425 U.S. 185, 193 (1976); Eisenberg v. 

Gagnon, 766 F.2d 770, 776 (3d Cir. 1985). The alleged 

misrepresentation here is an implied representation made 

by the defendants when they agreed to execute the 

plaintiffs' orders that they intended to maximize the 

_________________________________________________________________ 

electronic routing system that was created in 1984 to allow orders from 

small investors to be automatically executed at the NBBO. Defendants 

claim that since the NBBO was the exclusive source for trades executed 

through SOES, the duty of best execution was presumptively met for 

these trades. The evidence to which the defendants point supports their 

position that execution at the NBBO was a common practice in handling 

orders from small investors. It does not alone, however, require a finding 

that trades at better prices through SelectNet or Instinet were not 

reasonably available even for small orders or that a broker-dealer's duty 

of best execution was automatically discharged by executions through 

SOES. While size is undoubtedly a relevant factor in determining the 

scope of the duty of best execution, for summary judgment purposes we 

find the state of the record with respect to small orders no different 

than 

the record with respect to other orders. The affidavit of Richard Y. 

Roberts, who served as the chairman of the SEC throughout the class 

period, notes that, to his knowledge, the SEC did not take the position 

that execution through SOES automatically satisfied the duty of best 

execution, and indicates that, in his opinion, such a position would be 

contrary to several SEC releases. At any rate, not all of plaintiffs' 

orders 

were executed through SOES. 

 12 
plaintiffs' economic gain in the transaction. Since the 

defendants knew of the plaintiffs' profit motivation, they 

must have understood, according to the plaintiffs, that 

plaintiffs would expect them to obtain a price more

advantageous to the plaintiffs than the NBBO when one 

was readily available. If 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, 

plaintiffs insist that the defendants can be found to have 

made an implied representation that they knew to be false. 

We believe that a reasonable trier of fact couldfind this 

chain of inferences persuasive based on a straight forward 

economic analysis of the plaintiffs' relationship with the 

defendants. In addition, however, 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 an SEC study found clear evidence of a twotiered 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, shortly 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). 

 13 
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 

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 defendants, in elevating the practice of a segment 

of the industry to be outcome determinative, lose 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 compensation 

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, although intending to 

execute with sole reference to the NBBO, understood that 

they were expected to utilize sources other than the NBBO 

when a better price was readily available.6 

_________________________________________________________________ 

6. The foregoing analysis is generally applicable to plaintiffs' claim 

that 

it was reasonably feasible for defendants to "cross" customer orders on 

opposing sides of a transaction and match customer orders with inhouse limit orders. Plaintiffs' record support, including affidavits from 

respected members of the investment community, raises a disputed 

issue of material fact as to whether these practices were reasonably 

feasible during the class period. If the defendants intended to execute 

plaintiffs' orders at the NBBO despite the reasonable availability of 

these 

alternative pricing sources, and if the defendants acted knowingly or 

with reckless indifference to the falsity of their material 

representations, 

then plaintiffs have a securities fraud claim for these practices as well. 

 14 
V. 

In concluding as we do, we are not unmindful of the fact, 

deemed determinative by the district court, that execution 

of customer orders at the NBBO was a practice "widely, if 

not almost universally followed" in the securities industry 

during the class period. 911 F. Supp. at 772. Under the 

district court's logic, a Section 10(b) defendant would be 

entitled to summary judgment even if it were her regular 

practice to knowingly violate the duty of best execution, so 

long as she could 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." We cannot accept an analysis that would 

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 

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

676 (S.D.N.Y.) (industry custom may be found fraudulent, 

especially on first occasion it is litigated) aff 'd, 367 F.2d 

157 (2d Cir. 1966); 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 

certain practices by NASDAQ market makers, not at issue 

here, were fraudulent even though they were widely 

followed within the industry. See Report of Investigation 

Pursuant to Section 21(a) of the Securities Exchange Act of 

1934 Regarding the NASD and the NASDAQ Market, 1996

SEC LEXIS 2146 (Aug. 8, 1996). 

As defendants emphasize, the practice of exclusive 

reliance on the NBBO has never been held to be fraudulent 

by any court or regulator. On the other hand, there is no 

statute, rule, regulation, or interpretation, by the SEC or by 

a court, that authoritatively establishes that, for all trades, 

the NBBO exhausted the category of "reasonably available 

prices" during the class period. This absence of precedent 

did not, however, absolve the district court of the duty to 

resolve the plaintiffs' securities fraud claim once it was 

presented in this suit. 

 15 
"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) P 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).

VI. 

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

fact could conclude that the defendants misrepresented 

that they would execute the plaintiffs' orders so as to 

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 thus find scienter with respect to a 

material misrepresentation, as well as the other elements 

essential to a Section 10(b) fraud claim. Accordingly, we will 

reverse the summary judgment entered by the district court 

and remand for further proceedings. 

A True Copy: 

Teste: 

 Clerk of the United States Court of Appeals 

 for the Third Circuit 

 16