Appendix — Orman v. Charles Schwab & Co.

APPENDIX

TABLE OF CONTENTS

Opinion of the Supreme Court of Illinois

Opinion of the Appellate Court of Illinois .

September 27, 1994 Order of the Circuit

Court of Cook County, Illinois

County Department, Chancery Division ....

June 2, 1994 Order of the Circuit

Court of Cook County, Illinois

County Department, Chancery Division ....

Constitutional Provisions, Statutes

I go kkk) ago os 0 kn eo

PAGE

. App. 1

. App. 17

App. 36

App. 1

IN THE

SUPREME COURT OF ILLINOIS

Docket No. 82697-Agenda 26-September 1997

ROBERT ORMAN et al., Appellants,

v. CHARLES SCHWAB &

COMPANY, INC., et al., Appellees.

November 20, 1997, Opinion Filed

JUSTICE HEIPLE delivered the opinion of the court:

At issue is whether Illinois breach of fiduciary duty

and breach of contract claims arising out of a broker’s

retention of order flow payments are implicitly preempt-

ed because such claims would stand as an obstacle to

the accomplishment and execution of the full purposes

and objectives of Congress in enacting the Securities

Exchange Act of 1934 (15 U.S.C. § 78a et seq. (1994)).

The plaintiffs in the three class action lawsuits consoli-

dated for review sued the broker-defendants for retain-

ing order flow payments, which they contend runs afoul

of Illinois agency law. The trial court granted defen-

dants’ motions to dismiss plaintiffs’ complaints on the

ground that their claims were preempted by the Secur-

ities Exchange Act of 1934, and the appellate court

affirmed (285 Ill. App. 3d 937). This court allowed plain-

tiffs’ petition for leave to appeal (166 II]. 2d R. 315). For

the reasons expressed below, we affirm.

ANALYSIS

The plaintiffs in these consolidated class actions assert

the rights of a putative nationwide class of customers of

App. 2

defendants, Charles Schwab & Company, Inc., Quick

and Reilly, Inc., and Olde Discount Corporation, dis-

count securities brokerage firms which plaintiffs re-

tained to execute their securities transactions. The

gravamen of plaintiffs’ complaints is that the defendants

violated Illinois agency and/or contract law when they

failed to remit to plaintiffs order flow payments received

in executing plaintiffs’ securities transactions. Order

flow payments consist of both monetary and nonmone-

tary remuneration paid to a dealer by a market maker

in exchange for the dealer’s routing a customer’s orders

through the market maker. As plaintiffs observe, brok-

ers are their customers’ agents and as such owe them

certain fiduciary duties. See Martin v. Heinold Commod-

ities, Inc., 117 Ill. 2d 67, 76-77 (1987). Under traditional

agency law, an agent who makes a profit in connection

with transactions conducted on behalf of the principal is

under a duty to remit that profit to the principal absent

an agreement to the contrary. Janes v. First Federal

Savings & Loan Ass’n, 57 Ill. 2d 398, 410 (1974), quot-

ing Restatement (Second) of Agency § 388 (1958). Plain-

tiffs’ complaints allege breach of fiduciary duty and

breach of contract premised upon defendants’ failure to

remit the order flow payments they received to the

plaintiffs.’

Defendants counter that the Securities Exchange Act

of 1934 (Exchange Act) (15 U.S.C. § 78a et seq. (1994))

' At oral argument, plaintiffs claimed for the first time that

one or more of the defendants may not have complied with

Securities and Exchange Commission Rule 10b-10. 17 C.F.R.

§ 240.10b-10(aX7Xiv) (1997). Insofar as this issue was not

raised in the lower court proceedings, or briefed before this

court, it is waived.

App. 3

implicitly preempts plaintiffs’ state-law claims. The pre-

emption doctrine is rooted in the supremacy clause of

the United States Constitution, which mandates that

“the Laws of the United States *** shall be the supreme

Law of the Land; and the Judges in every State shall be

bound thereby, any Thing in the Constitution or Laws

of any State to the Contrary notwithstanding.” U.S.

Const., art. VI, cl. 2. An act of Congress or regulatory

law promulgated thereunder may supersede the statu-

tory, regulatory or common law of any state where such

“[is] the clear and manifest purpose of Congress.” Cipol-

lone v. Liggett Group, Inc., 505 U.S. 504, 516, 120 L.

Ed. 2d 407, 422, 112 S. Ct. 2608, 2617, quoting Rice v.

Santa Fe Elevator Corp., 331 U.S. 218, 230, 91 L. Ed.

1447, 1459, 67 S. Ct. 1146, 1152 (1947). A congressional

act can either expressly or implicitly preempt a state

cause of action. Freightliner Corp. v. Myrick, 514 U.S.

280, 287, 131 L. Ed. 2d 385, 392, 115 S. Ct. 1483, 1487

(1995). Here defendants urge that plaintiffs’ state claims

relating to order flow payments are implicitly preempted

by the Exchange Act because they “stand[ ] as an obsta-

cle to the accomplishment and execution of the full pur-

poses and objectives of Congress,” as manifested in the

language, structure and underlying goals of the statute

at issue. See Hines v. Davidowitz, 312 U.S. 52, 67-68, 85

L. Ed. 581, 587, 61 S. Ct. 399, 404 (1941).

Determining whether plaintiffs’ state-law claims are

implicitly preempted by the Exchange Act requires an

understanding of the Exchange Act’s history and the

evolution of order flow payments. Congress enacted the

Exchange Act in 1934 to regulate the various aspects of

the securities industry; its implementing agency, the

Securities and Exchange Commission (SEC), is responsi-

App. 4

ble for adopting regulations which foster capital forma-

tion, facilitate competition and protect investors in the

vastly complex array of markets that constitute the

securities industry. Congress subsequently enacted

amendments to the Exchange Act in 1975 (1975 Amend-

ments) to cure “the securities industry’s languor in the

face of great changes and opportunities.” S. Rep. No. 94-

75, at 1, reprinted in 1975 U.S.C.C.A.N. 179, 180. Con-

cerned with the misallocation of capital, widespread

inefficiencies, and undesirable and potentially harmful

fragmentation of trading (S. Rep. No. 94-75, at 1, re-

printed in 1975 U.S.C.C.A.N. 179, 180), the 1975

Amendments called upon the SEC to develop a “Nation-

al Market System” which would facilitate the “economi-

cally efficient execution of securities transactions” and

“fair competition among brokers and dealers, among

exchange markets, and between exchange markets and

markets other than exchange markets.” 15 U.S.C.

§§ 78k-1(a(1 KC Xi), (aX 1 cai) (1994).

The SEC’s responsibilities included implementing

regulations to “assure the prompt, accurate, reliable,

and fair collection *** [and] distribution *** of informa-

tion with respect to *** transactions in such securities

and the fairness and usefulness of the form and content

of such information.” 15 U.S.C. § 78k-1(c)(1)(B) (1994).

In 1977, the SEC exercised its authority and adopted

Rule 10b-10, a “uniform rule applicable to all who wish

to effect transactions for or with investors” which “ad-

just(ed] regulatory requirements to eliminate those for

which compliance costs appear to be disproportionate to

the practical benefits of investor protection thereby ob-

tained.” (Securities Confirmations Proposed Rule, SEC

Exchange Act Release No. 12806, reprinted in 41 Fed.

App. 5

Reg. 41,432, 41,432 (1977)). In pertinent part, Rule 10b-

10 required that a broker-dealer disclose on a customer's

confirmation statement “whether any other remunera-

tion has been or will be received and that the source

and amount of such other remunerations will be fur-

nished upon written request.” 17 C.F.R. § 240.10b-10(a)

(7Xiv) (1997). Rule 10b-10 was in addition to section

28(a) of the 1975 Amendments, which provided in per-

tinent part:

“The rights and remedies provided by this chap-

ter shall be in addition to any and all other

rights that may exist at law or in equity oe.

Nothing in this chapter shall affect the jurisdic-

tion of the securities commission (or any agency

or officer performing like functions) of any state

over any security or any person insofar as it

does not conflict with the provisions of this chap-

ter or the rules and regulations thereunder.” 15

U.S.C. § 78bb(a) (1994).

Thus Congress and the SEC achieved the appropriate

balance between necessary regulation and free market

forces in advancing the National Market System.

Substantively, the 1975 Amendments contained a va-

riety of provisions intended to increase the number of

market participants, develop competitors to the tradi-

tional stock exchanges and utilize emerging technology

to increase competition between the exchanges and

market makers for retail customer order flow. Market

2000: An Examination of Current Equity Market De-

velopments, Market Regulation Division, Securities and

Exchange Commission 5-6 (1994). It was hoped that “Lilf

market makers in a particular market center have rea-

sonable expectations that they will receive a greater

amount of [customer] order flow if they make markets

App. 6

which are consistently better in terms of price, depth or

ease of execution *** they will be more likely to compete

aggressively thereby providing a better and more effi-

cient” National Market System. Development of a Na-

tional Market System, Exchange Act Release No. 34-

15671, Fed. Sec. L. Rep. (CCH) par. 81,572 (1979).

Toward this end, the 1975 Amendments abolished fixed

commission rates in order to increase competition within

and between securities markets. See 15 U.S.C. § 78(e)(1)

(1994).

The 1975 Amendments have been successful, prompt-

ing market makers to develop and utilize nontraditional

markets such as the over-the-counter (OTC) market and

the NASDAQ to effectuate trades, which has in turn has

increased customer options with respect to how and at

what prices they trade securities. Integral to the market

makers’ ability to attract steady streams of customer

order flow for traditional and nontraditional markets

has been the practice of paying “order flow payments.”

Generally speaking, payment for order flow is the prac-

tice of market makers or exchange specialists compen-

sating brokerage firms for directing customer orders to

them for execution. The order flow payment practice

evolved in the early 1980s and typically includes both

monetary and nonmonetary remuneration to broker-

dealers in exchange for their routing their customers’

transactions through the market makers.” When the

* Examples of order flow payments include: cash payments;

reciprocal order-routing relationships; discounts; credit; and

free services such as access to industry analysts’ reports;

accommodation and adjustments of trading errors; access to

(continued...)

|

App. 7

practice of order flow payments evolved, the National

Association of Securities Dealers took the position that

the practice was governed by Rule 10b-10, the 1977 all-

purpose provision requiring that broker-dealers disclose

on a customer’s confirmation statement whether any

other remuneration has been or will be received and

that the source and amount of such other remunerations

will be furnished upon written request. 17 C.F.R. §

240.10b-10(a)(7)iv) (1997). See, e.g., National Associa-

tion of Securities Dealers Notice to Members, NTM No.

85-32 (1985) (Rule 10b-10 applies to “payments received

by a retail firm from a market maker in return for their

directing order flow to the market maker”).

As evidenced by the instant plaintiffs’ persistent

references to order flow payments as “kickbacks,” the

practice has its detractors. See generally Note, The

Perils of Payment for Order Flow, 107 Harv. L. Rev.

1675 (May 1994). The SEC, sensitive to the various

concerns raised by the practice, has studied its impact

on both markets and consumers since as early as 1984.

See SEC Release No. 34-33026, reprinted in 58 Fed.

Reg. 52,934, 52,935 (1993). After a thorough and com-

prehensive study of order flow payments, with input

from participants industrywide, the SEC acknowledged

arguments that order flow payments produced economic

benefits to customers, including: (1) lower unit costs; (2)

increased retail brokerage firm revenue; (3) lowered

2 (...continued)

specialists proprietary order flow; reduced clearing charges;

and participation in public offerings. Inducements for Order

Flow, A Report to the Board of Governors, National Associa-

tion of Securities Dealers, Inc., 15-20 (1991).

App. 8

commissions; (4) more expeditious executions; (5) en-

hanced customer services; (6) increased competition from

automated execution systems and related practices; (7)

increased competition between wholesale dealers and

exchanges and vertically integrated firms; and (8) re-

duced execution costs in all markets, including the

exchanges. SEC Release No. 34-33026, reprinted in 58

Fed. Reg. at 52,939-40 (1993). Notwithstanding the far-

reaching benefits identified, the SEC also recognized

that order flow payments raise concerns as to whether

the customer is being treated fairly. Payment for Order

Flow, SEC Release No. 34-3026, at 24-26, reprinted in

59 Fed. Reg. 55,006 (1994).

Accordingly, in 1994 the SEC struck a deliberate bal-

ance: formulating disclosure requirements that provide

investors with relevant, important information at key

points, while at the same time avoiding impractical and

burdensome disclosure requirements that might compro-

mise the contributions of the practice to market competi-

tion. Specifically, on October 24, 1994, the SEC promul-

gated an amendment to Rule 10b-10 which, in pertinent

part, added paragraph (9)(e), which defined order flow

payments, and subparagraph (a)(7)(iii), which required

disclosure of order flow at time of confirmation. In addi-

tion, the SEC promulgated Rule 1 1Ac1-3, which required

disclosure of the practice of order flow payments at the

time an account is opened and annually thereafter. SEC

Release No. 34-34902, reprinted in 59 Fed. Reg. 55,006,

55,007-11 (1994). Finally, the SEC delayed implementa-

tion of the new rules “to provide firms with four months

to make the necessary systems and forms changes to

prepare for the implementation’: this initial four-month

“safe harbor” was extended an additional seven months

—————

App. 9

until October of 1995 in further acknowledgment of the

complex system changes that the additional disclosure

rules necessitated. See Payment for Order Flow, SEC

Release No. 35473, Fed. Sec. L. Rep. (CCH) par. 85,606,

at 86,410 (March 10, 1995).

Significantly, the SEC rejected proposals that order

flow payments be passed through to the customers. SEC

Release No. 34-34902, reprinted in 59 Fed. Reg. at

55,011 n.42 (1994). Moreover, the SEC likewise rejected

as unworkable its initial proposal that brokers disclose

the amount of remuneration received in exchange for

order flow. SEC Release No. 34-34902, reprinted in 59

Fed. Reg. at 55,010 n.39 (1994).

The order flow payments at issue in plaintiffs’ com-

plaints all took place prior to the SEC’s 1994 promulga-

tion of the Rule 10b-10 amendments and Rule 11Ac1-3.

Plaintiffs contend defendants are liable to them under

state agency law notwithstanding that defendants com-

plied with the 1977 version of Rule 10b-10 by providing

plaintiffs with confirmation slips apprising them that

remuneration may have been received from the brokers

through whom their transactions were executed and

that, upon request, the amounts would be disclosed.

Plaintiffs argue that defendants’ compliance with Rule

10b-10 cannot be invoked to preempt their state-law

claims because the practice of order flow payments was

not even in existence at the time the rule was promul-

gated. Additionally, plaintiffs observe that Rule 10b-10

was not intended as a safe harbor against state laws

which exceeded its requirements; rather, Rule 10b-10

was intended to prescribe only minimum disclosure

obligations. Ettinger v. Merrill Lynch, Pierce, Fenner &

App. 10

Smith, Inc., 835 F.2d 1031, 1034 (3d Cir. 1987), quoting

Securities Exchange Act Release No. 13,508, Fed. Sec. L.

Rep. (CCH) par. 81,143, at 87,930 n.28 (“‘[t]he rule does

not attempt to set forth all possible categories of materi-

al information to be disclosed by broker-dealers in con-

nection with a particular transaction in securities’”).

Accordingly, plaintiffs contend that additional disclosure

requirements that complement Rule 10b-10 and provide

added security to customers are entirely consistent

therewith and are not preempted. Cf. CTS Corp. uv.

Dynamics Corp. of America, 481 U.S. 69, 77, 95 L. Ed.

2d 67, 77, 107 S. Ct. 1637, 1643 (1987) (Indiana statute

containing stricter takeover requirements did not con-

flict with the Williams Act); American Airlines, Inc. v.

Wolens, 513 U.S. 219, 130 L. Ed. 2d 715, 115 S. Ct. 817

(1995) (establishing that a plaintiff may pursue a breach

of contract claim against airline despite the existence of

a comprehensive federal regulatory scheme governing

the industry).

Though plaintiffs are correct that the practice of order

flow payments had not commenced until several years

after Rule 10b-10 was adopted, it nevertheless remains

true that Rule 10b-10 is of general application and

clearly encompassed the practice when it evolved. Rule

10b-10 required brokers to include on a customer’s con-

firmation statement whether any other remuneration

has been or will be received and that the source and

amount of such other remunerations will be furnished

) upon written request. 17 C.F.R. § 240.10b-10(a)(7)iv)

| (1997). Order flow payments are “other remuneration”

and as such are governed by Rule 10b-10. Equally un-

availing is plaintiffs’ observation that Rule 10b-10 sets

forth only minimum guidelines and was not intended as

App. 11

a safe harbor for those who do not meet more rigorous

state disclosure laws. The preemption issue at bar must

be decided upon careful consideration of congressional

and SEC intent, of which Rule 10b-10 is only a partial

manifestation.

Similarly inconclusive is plaintiffs’ reliance on section

28(a) of the Exchange Act as evidence of Congress’ in-

tention to permit their state causes of action. Section

28(a) provides:

“The rights and remedies provided by this chap-

ter shall be in addition to any and all other

rights that may exist at law or in equity ***.

Nothing in this chapter shall affect the jurisdic-

tion of the securities commission (or any agency

or officer performing like functions) of any state

over any security or any person insofar as it

does not conflict with the provisions of this chap-

ter or the rules and regulations thereunder.” 15

U.S.C. § 78bb(a) (1994).

Because section 28(a) expressly acknowledges that

state and federal securities laws may coexist, and fur-

ther that no provision of the Exchange Act or the SEC’s

implementing regulations expressly prohibit application

of state agency law to broker-customer relationships,

plaintiffs contend there can be no implicit preemption.

See Leroy v. Great Western United Corp., 443 U.S. 173,

182, 61 L. Ed. 2d 464, 473, 99 S. Ct. 2710, 2716 (1979)

(section 28(a) was intended to protect, rather than limit,

state authority); Matsushita Electric Industrial Co. v.

Epstein, 516 U.S. 367, 134 L. Ed. 2d 6, 116 S. Ct. 873

(1996) (Congress contemplated the possibility of dual

litigation in state and federal courts related to securities

transactions). Section 28(a), however, is of little assist-

App. 12

ance in determining whether plaintiffs’ state causes of

action are preempted. For while it admittedly permits

“the jurisdiction of the securities commission (or any

agency or officer performing like functions) of any state

over any security or any person,” it does so only “insofar

as it does not conflict with the provisions of this chapter

or the rules and regulations thereunder.” (Emphasis

added.) 15 U.S.C. § 78bb(a) (1994). As the Supreme

Court elucidated in Freightliner Corp. v. Myrick, 514

U.S. at 288-89, 131 L. Ed. 2d at 393, 115 S. Ct. at 1488,

a statutory preemption clause which preempts state

laws that conflict with the federal law, but which also

preserves nonconflicting state laws, does not foreclose

the possibility of implied preemption. Even in such a

situation, preemption may result where the state law

“stands as an obstacle to the accomplishment and execu-

tion of the full purposes and objectives of Congress,” as

manifested in the language, structure and underlying

goals of the statute at issue. See Hines v. Davidowitz,

312 U.S. 52, 67-68, 85 L. Ed. 581, 587, 61 S. Ct. 399,

404 (1941).

Thus we consider Congress’ intent, as manifested both

by the Exchange Act and the SEC rules and regulations

promulgated thereunder. As detailed above, Congress

enacted the 1975 amendments to the Exchange Act to

counteract the languor of the then-existing securities

industry and foster a new National Market System

characterized by a more “economically efficient execution

of securities transactions” and increased competition

among all securities industry participants, including “be-

tween exchange markets and markets other than ex-

change markets.” Pub. L. No. 94-29, § 7, 89 Stat. 97,

111-12 (1975); 15 U.S.C. § 78k-1(c1)(B) (1994). This

FR et A ID TOLEDO te I AB a

App. 13

new market system was intended to address the malaise

Congress perceived was emanating from lack of competi-

tion in the securities industry-an affliction. Congress

sought to correct in advance of technological innovations

it correctly anticipated would radically alter the securi-

ties industry, both nationally and internationally.

Throughout the 1980s and 1990s, the SEC studied

order flow payments at length and determined, inter

alia, that the practice had fueled the growth of nontradi-

tional markets which had in turn led to industrywide

reductions in commission rates, faster trade executions

and enhanced services. Payment for Order Flow, SEC

Release No. 34-3026, at 24-26 (1993). Nor can the im-

pact of these nontraditional markets be overstated: from

1978 to 1992, the percentage of consolidated tape trades

in NYSE stocks executed by the NYSE declined from

85.99% to 65.17%, while the percentage executed by the

regional exchanges and NASDAQ climbed from 11.55%

to 24.22%, and 2.39% to 10.57%, respectively. Market

2000: An Examination of Current Equity Market De-

velopments, Market Regulation Division, Securities and

Exchange Commission, Ex. 18 (1994).

In 1994, after much deliberation, the SEC amended

Rule 10b-10 and promulgated Rule 11Ac1-3 to specifical-

ly address the practice of order flow payments. It there-

by required that brokers apprise customers whether

they engage in order flow payment practices at the time

the account is first established and annually thereafter.

Additionally, the confirmation slips must advise the cus-

tomer that order flow payments were received in the

course of effectuating a transaction and further advise

the customer that, upon request, the nature of the re-

App. 14

muneration will be disclosed. After careful study, the

SEC determined that these disclosure requirements

struck the appropriate balance between the need to pro-

tect consumers and the need to facilitate the increased

competition and reduced commissions brought about by

the practice of order flow payments.

Regarding the scope of the SEC’s disclosure rules vis-

a-vis the instant plaintiffs’ state-law claims, the SEC’s

refusal to require brokers to pass through to customers

or even disclose the amount of order flow remuneration

in its 1994 disclosure promulgations is significant. See

SEC Release No. 34-34902, reprinted in 59 Fed. Reg. at

55,010 n.39, 55,011 n.42 (1994). The SEC concluded that

either requirement would be unworkable because a wide

array of formulas are used in calculating order flow

payments, many of which would be near impossible to

apportion on an individual account basis; moreover,

there are a variety of nonmonetary remunerations

which, though their nature must be disclosed upon

request, are not easily valued monetarily. Requiring

such would effectively bring the practice of order flow

payments to a halt, jeopardizing all direct and indirect

benefits attributable to the practice. This the SEC re-

fused to do.

Yet this is exactly what plaintiffs urge this court to

sanction. Allowing plaintiffs to advance their breach of

fiduciary duty and contract claims would require the

defendants to identify the nature and calculate the

value of order flow payments received so that plaintiffs’

damages (the improperly retained order flow payments)

could be assessed. Though the 1994 amendments were

not in effect when the defendants retained the order

ae ee ee nee ee ee

App. 15

flow payments at issue, we believe these amendments

are nevertheless instructive as to the scope of the 1977

version of Rule 10b-10. The deleterious effects to the

National Market System that the SEC’s 1994 amend-

ments sought to avoid in allowing brokers to retain

order flow payments and limiting the order flow disclo-

sure requirements were no less a possibility prior to

1994, when the old Rule 10b-10 applied. Because the

purposes and objectives of Congress in enacting the

1975 amendments to the Exchange Act, as well as those

of the SEC in promulgating Rule 10b-10 in 1977, have

remained constant, we believe what would be deleteri-

ous today would have been deleterious throughout the

as-yet brief history of the National Market System. And,

indeed, we observe that the high courts of New York

(Guice v. Charles Schwab & Co., 89 N.Y.2d 31, 674

N.E.2d 282, 651 N.Y.S.2d 352 (1996)) and Minnesota

(Dahl v. Charles Schwab & Co., 545 N.W.2d 918 (Minn.

1996)) have so held, finding that claims substantially

similar to the ones advanced by the instant plaintiffs

are implicitly preempted because they interfere with

goals of the Exchange Act. But see Thomas v. Charles

Schwab & Co., No. 95-0307 (W.D. La. July 12, 1995);

Dumont v. Charles Schwab & Co., No. 95-0606 (E.D. La.

May 3, 1995) (ruling that similar claims are not pre-

empted).

The supremacy clause requires that state law yield

where it “stands as an obstacle to the accomplishment

and execution of the full purposes and objectives of

Congress,” as manifested in the language, structure and

underlying goals of the statute at issue. See Hines v.

Davidowitz, 312 U.S. 52, 67-68, 85 L. Ed. 581, 587, 61

S. Ct. 399, 404 (1941). Given the history and purpose of

App. 16

Congress’ 1975 amendments to the Exchange Act as well

as the SEC’s implementing regulations vis-a-vis order

flow payment disclosures, we are convinced that allow-

ing plaintiffs’ related state claims to advance would

obstruct the National Market System that Congress in-

tended to foster in enacting the 1975 Amendments. Ac-

cordingly, we affirm the judgment of the appellate court.

Appellate court judgment affirmed.

IN THE

APPELLATE COURT OF ILLINOIS

FIRST DISTRICT, SECOND DIVISION

Robert ORMAN, on Behalf of Himself

and All Similarly Situated Schwab

Customers, Plaintiff-Appellant,

Vv.

CHARLES SCHWAB & COMPANY,

INC., Defendart-Appellee.

Gordon RUBENSTEIN, °2 Behalf of Himself

| and All Similarly Situated Quick

and Reilly Customers, Plaintiff-Appellant,

Vv.

QUICK AND REILLY, INC., and United

States Clearing Corporation,

Defendant-Appellees.

Leonard M. BLAND, or Behalf of Himself

and All Similarly Situated Olde Discount

Corporation Customers, Plaintiff-Appellant,

Vv.

OLDE DISCOUNT CORPORATION,

Defendant-Appellee.

| Nos. 1-94-2277, 1-94-3423 and 1-94-3424.

Dec. 24, 1996.

JUSTICE RAKOWSKI delivered the opinion of the

: court:

App. 18

Plaintiffs, Robert Orman, Gordon Rubenstein, and

Leonard M. Bland (customers) filed complaints against

defendants, Charles Schwab & Co., Quick & Reilly, Inc.,

and Olde Discount Corporation (brokers), respectively,

alleging that brokers violated state common and statuto-

ry law when they conducted stock trades on behalf of

customers. In particular, the brokers breached their

fiduciary duties by keeping certain profits (order flow

payments) without adequate disclosure to or authoriza-

tion from the customers. Each suit was dismissed on the

brokers’ combination motions under sections 2-615 and

2-619 of the Code of Civil Procedure. 735 ILCS 5/2-615,

5/2-619 (West 1994). The trial court, in each case, found

that the customers’ claims were preempted by federal

law. Plaintiffs appeal, contending the trial courts er-

roneously held that their actions were preempted. The

cases were consolidated for appeal.

The sole issue is whether the customers’ claims based

on state common and statutory law are preempted by

the Securities Exchange Act of 1934 (the Act) (15 U.S.C.

§ 78a et seq. (1994)). We affirm.

FACTS

As stated in the facts by the parties, pursuant to

standard form contracts between the customers and

brokers, each broker was employed to buy and/or sell

stocks on the customers behalf, for which the broker

would received a commission. In such capacity, the

broker acted as the customer’s agent. When a customer

placed an order, the broker could execute it in various

markets. The broker would contact a market maker of

its choice to effectuate the required trade. The price

cssincicamiiaimeiaiiaiiiaciiaiuaiiaiaiaiiial

App. 19

obtained was negotiated between the broker and the

market maker. The market maker made a profit on

every trade. To induce brokers to deal through them,

market makers shared part of their profit with the

brokers. This practice is known as order flow payments.

It is a recognized and widespread practice_in the indus-

try and part of the competitive market.

Brokers retained the order flow payments and did not

pass them on to customers. In their complaints, plain-

tiffs allege that the brokers breached their fiduciary

duties by retaining the payments without adequate dis-

closure to them or authorization from them. Subsequent

to each transaction, the broker sent a confirmation slip

to the customer containing the disclosure required by

the Securities and Exchange Commission (the SEC);

however, the brokers did not disclose order flow pay-

ments.

Plaintiffs filed suits alleging claims for breach of fi-

duciary duty, unjust enrichment, unfair and deceptive

business practices, and breach of contract based on the

brokers’ retention of the order flow payments.

ANALYSIS

“The purpose of a motion to dismiss under section

2-619 *** is to afford litigants a means to dispose of

issues of law and easily proved issues of fact at the

outset of a case, reserving disputed questions of fact for

a jury trial.” Zedella v. Gibson, 165 Ill. 2d 181, 185

(1995). All well-pleaded facts in the complaint are ad-

mitted, but conclusions of law and fact unsupported by

specific allegations are not. Draper v. Frontier Insurance

liane

App. 20

Co., 265 Ill. App. 3d 739, 742 (1994). The trial court

| must construe the motion and supporting documents in

the light most favorable to the nonmovant. Draper, 265

Ill. App. 3d at 742. “Section 2-619(a\(9) allows dismissal

when ‘the claim asserted *** is barred by other affirma-

tive matter avoiding the legal effect of or defeating the

claim.’” Zedella, 165 Ill. 2d at 185, quoting II]. Rev. Stat.

1991, ch. 110, par. 2-619. Preemption is an affirmative

matter. Russo v. Boland, 103 Ill. App. 3d 905, 909-10

(1982). “The question on appeal is ‘whether the exist-

ence of a genuine issue of material fact should have

precluded the dismissal or, absent such an issue of fact,

whether dismissal is proper as a matter of law.’”

Zedella, 165 Ill. 2d at 185-86, quoting Kedzie & 103rd

Currency Exchange, Inc. v. Hodge, 156 Ill. 2d 112, 116-

17 (1993). We review the trial court’s decision de novo.

Kedzie, 156 Ill. 2d at 116.

Congress promulgated the Act, which created the SEC

and delegated to it the responsibility for oversight of the

securities industry. Federal oversight was designed to:

(1) protect the investing public; (2) remove impediments

to smooth operation of the national market; and (3)

impose reporting requirements that ensure a fair and

honest market. Dahl v. Charles Schwab & Co., 545

N.W.2d 918, 924 (Minn. 1996). In 1977, the SEC adopt-

ed Rule 10b-10, which outlined the necessary disclosure

brokers were required to furnish their its clients. 17

C.F.R. 240.10b-10 (1994). Rule 10b-10 mandated brokers

to furnish written notification at or before completion of

a transaction, which included:

“The source and amount of any other remunera-

tion received or to be received by him in connec-

notes Bee

App. 21

tion with the transaction: Provided, however, ***

the written notification may state whether any

other remuneration has been or will be received

and that the source and amount of such other

remuneration will be furnished upon written re-

quest of such customer.” 17 C.F.R. 240.10b-10(a)

(7)aii) (1994).

Originally, the rule made no specific reference to order

flow payments.

The rule was amended effective October 2, 1995,

which added disclosure requirements concerning order

flow payments. The rule now states that brokers must

provide customers with: “a statement whether payment

for order flow is received by the broker or dealer for

transactions in such securities and that the source and

nature of the compensation received in connection with

the particular transaction will be furnished upon writ-

ten request of the customer.” 17 C.F.R. 240.10b-10(a)

(7)iii) (1996). This disclosure must be made to the cus-

tomer at the time the customer opens his or her ac-

count. 17 C.F.R. 240.11Ac1-3(a) (1996).

All of the acts giving rise to the instant case occurred

prior to the 1995 amendment.

Plaintiffs contend the Act does not preempt state

regulation of securities. They argue this is particularly

true in light of section 28(a), which provides that “the

rights and remedies provided by this title shall be in

addition to any and all other rights and remedies that

may exist at law or in equity.” 15 U.S.C. § 78bb(a)

(1994). They further contend that the pre-1995 version

of rule 10b-10 did not encompass order flow payments

and, therefore, does not preempt state law.

App. 22

The parties submit decisions from four jurisdictions,

and independent research has disclosed no others. Three

of the jurisdictions (New York, Minnesota, and Califor-

nia) find that federal law preempts state regulation of

securities. Only the federal district courts for Louisiana

hold that state claims based on state laws are not

barred. All acts giving rise to each of these cases oc-

curred prior to the 1995 amendment of rule 10b-10, as

in the instant case.

Federal law may preempt state law either expressly or

impliedly. No express preemption exists here. See Dahil,

545 N.W.2d at 923. Thus, if state claims are preempted,

it must be by implication.

“The United States Supreme Court has iden-

tified a two-pronged analysis for determining

whether Congress made such an implication

(implied preemption)]. State law is preempted if

Congress has entirely displaced the possibility of

state regulation or if state regulation conflicts

with federal law. [Citation.] The Court has in-

dicated that four main considerations are rele-

vant to an inquiry into whether Congress has

impliedly displaced possible state regulation: 1)

the scheme of federal regulation may be so per-

vasive as to leave no room for supplemental

state action; 2) the federal interest may be so

dominant that state regulation will be presump-

tively precluded; 3) the objective of the federal

regulation may reveal a preemptive purpose; or

4) the state policy may produce a result inconsis-

tent with that federal objective. [Citation.] State

law will conflict with federal law when ‘compli-

ance with both federal and state regulations is a

physical impossibility’ or where state law ‘stands

App. 23

as an obstacle to the accomplishment and execu-

tion of the full purposes and objectives of Con-

gress.’” Dahl, 545 N.W.2d at 924, quoting Pacific

Gas & Electric v. State Energy Resources

Comm’n, 461 U.S. 190, 204, 75 L. Ed. 2d 752,

765, 103 S. Ct. 1713, 1722 (1983).

In Guice v. Charles Schwab & Co., No. 200 (N.Y.

October 17, 1996), the New York Court of Appeals held

that plaintiffs’ state claims were preempted. Plaintiffs

argued defendants breached their fiduciary duties by

retaining order flow payments without adequate disclo-

sure. The court rejected this argument, finding the state

claims preempted by the 1975 amendments to the Act as

implemented by SEC regulations. The Guice court de-

termined that the 1975 amendments granted the SEC

authority to shape a new national market system, gave

it power to regulate, and authorized it to police the new

system. One of the goals of the 1975 amendments was

to develop a “national market system for security trad-

ing” (Guice, slip op. at 17) which was to be policed by a

“coherent and rational regulatory structure.” Guice, slip.

op. at 17. The SEC was directed to administer this

structure, which it did through regulations. In further-

ance of these goals, in 1977, the SEC adopted rule 10b-

10, a uniform rule for all transactions in the national

market. According to Guice, the SEC had monitored and

studied the securities industry for years and consistently

applied rule 10b-10 to order flow payments. The Guice

court noted that the SEC amended rule 10b-10 after

recognizing that order flow payments furthered purposes

of Congress “by enhancing more efficient and less costly

execution of customers’ orders and by promoting compe-

tition.” Guice, slip op. at 18. Although the amendment

App. 24

occurred after the facts giving rise to the claims in

Guice, the court implied that this amendment demon-

strated the SEC’s continued regulation of order flow

payments.

Guice rejected plaintiffs’ argument that section 28(a)

foreclosed preemption of areas other than those explicit-

ly listed in that section.

In finding preemption, the court reasoned that state

claims would serve as an obstacle to federal goals and,

thus, could not endure. It based its rationale on the

legislative history of the 1975 amendments and the

SEC’s history of regulating order flow payments. First,

the court was:

“(Clonvinced that permitting the courts of each

State to enforce [their] common-law agency

standards of disclosure on the practice of order

flow payments *** would unavoidably result in

serious interference with the ‘accomplishment

and execution of the full purposes and objectives

of Congress’ [citation], in enacting the 1975

amendments, and would directly conflict with

SEC regulations limiting the disclosure require-

ments regarding receipt of order flow payments

*** ” Guice, slip op. at 16-17.

Likewise:

“Permitting the courts of each State to impose

civil liability on national securities brokerage

firms, ***, for failure to meet more stringent

common-law agency standards of disclosure of

receipt of order flow payments (rather than the

federally-mandated uniform specific disclosure

***) would inevitably defeat the congressional

purpose of enabling the SEC to develop and

—— eee eee

SS aa ae.

App. 25

police that ‘coherent regulatory structure’ for a

national market system.” (Emphasis in original.)

Guice, slip op. at 18.

If each state were allowed to specify the nature of

disclosure, brokerage firms would be required to tailor

their disclosure statements to each state’s law and the

“carefully-crafted SEC disclosure requirements would

have little, if any, influence.” Guice, slip op. at 19. Be-

cause the state law would adversely affect the SEC’s

ability to regulate uniformly, the state law was pre-

empted.

The Guice court also determined the objectives of

Congress would be thwarted in a second way: order flow

payments would be eliminated. “At worst, onerous

stricter disclosure costs plus the threat of lawsuits all

around the country, based on breach of common-law

agency relationships, would likely result in many brok-

erage firms abandoning acceptance of order flow pay-

ments altogether, an even more drastic undermining of

congressional objectives.” Guice, slip op. at 20. The SEC

clearly authorizes the use of order flow payments and

recognizes its benefit to the industry. Any activity that

defeats this goal is an obstacle to federal law.

In sum, the court stated:

“The stricter standards of order flow payment

disclosure which may be required under State

common-law agency principles inevitably will

supplant the disclosure rules of the SEC on the

same subject and come to dominate the rela-

tionship between broker and customer *** [thus]

upset(ting] the policy-based delicate balance

Congress directed the SEC to achieve in the

regulatory regime envisaged under the 1975

App. 26

amendments to the Securities Exchange Act.”

Guice, slip op. at 21-22.

In Dahl, 545 N.W.2d 918, the Minnesota Supreme

Court ruled that the SEC rules preempted plaintiffs’

state common and statutory law actions. Before stating

its rationale for finding preemption, the court rejected

several of the parties’ arguments, which correspond to

arguments raised in the instant case. First, it rejected

plaintiffs’ argument that only those areas specifically

identified in section 28(a), and no others, were preempt-

ed, stating that the savings clause provision in section

28 did “not prevent implied preemption of areas of

securities law not specified in the clause.” Dahl, 545

N.W.2d at 923. Second, it rejected defendants’ argument

that the pre-1995 version of rule 10b-10 expressly

preempted state law. The Dahl court stated that the

“SEC *** had no rule in place expressly mentioning

order flow payments.” Dahl, 545 N.W.2d at 923. Third,

it concluded that rule 10b-10 as amended in 1995 did

not apply since it was not in effect at the time the

trades giving rise to the claims in Dahl were conducted.

The Dahl court found implied preemption, based on

state laws being an obstacle to federal goals. Because

the securities industry is not only national, but also

international, the Dahl court asserted that a decision by

any particular state court would reach beyond the

state’s border. Thus, although it would be possible for

brokers to comply with both state and federal disclosure

regulations, individual disclosure requirements would

y frustrate the federal objectives. In Dahl, as in the case

before us, plaintiffs sought to impose a duty upon

brokers to either obtain the consent of the customer to

retain order flow payments prior to a transaction, or to

Te

sane warm Deal

App. 27

remit the payments to customers. Defendants contended,

as do they in the instant case, that such a requirement

would in effect lead to the extinction of order flow

payments. The court agreed with defendants.

“For Schwab to fully comply with these state

agency law requirements, it would need to be

able to ascertain the exact amounts of these

profits [order flow payments] in order to seek its

clients’ consent, or to remit them to its custom-

ers if consent were withheld. Since it cannot

parse out order flow payments to such a degree,

compliance with the potential consent require-

ments of Minnesota law might put an end to the

practice of order flow payments, which is allowed

under federal law. Thus, the remedy [customers]

seek could frustrate the objectives of the SEC

and Congress.” Dahl, 545 N.W.2d at 925.

Finally, in McKey v. Charles Schwab & Co., No.

BC139314 (Cal. Super. Ct. September 10, 1996), and

Miller v. Charles Schwab & Co., No. BC137133 (Cal.

Super. Ct. September 10, 1996), the superior court of

California for Los Angeles County found plaintiffs’ state

claims preempted. It too noted that the pre-1995 version

of rule 10b-10 is part of an overall regulatory scheme

which would be frustrated by allowing individual state

adjudication of disclosure requirements. According to

this court, “[i]t strikes the Court as poor public policy to

create confusion, by allowing a proliferation of common

law disclosure standards, from California and presum-

ably 49 other states, in the interest of protecting an

intangible principle of ‘better disclosure’ where there is

no tangible damage.” McKey, slip op. at 1. In sum, the

“additional standards proposed by *** plaintiff[s] would

App. 28

stand as an obstacle to the federal regulatory scheme.”

McKey, slip op. 1.

Conversely, the federal districts courts for both the

Eastern and Western District of Louisiana have held

that state claims are not preempted. Thomas v. Charles

Schwab & Co., No. 95-0307 (W.D. La. July 12, 1995);

Dumont v. Charles Schwab & Co., No. 95-0606 (E.D. La.

May 4, 1995).

In Thomas, the court stated “Congress has not ex-

pressly preempted state law and, after a review of the

record, this court finds that congressional intent to

preempt state law cannot be inferred.” Thomas, slip op.

at 3. Thomas concluded:

“[A]ldditional disclosure regarding ‘amount of

renumeration [sic]’ and that ‘the renumeration

[sic] was paid by a party whose interests are

adverse to those of the customer’ will not conflict

with this SEC regulation nor act as an obstacle

to the protection of a fair competitive market

and investor interests. ,

In addition, defendant has not persuaded this

court that it was Congress’ intent to provide

comprehensive regulation dealing with the dis-

closure of order flow payments to the exclusion

of all state laws regarding agency and fiduciary

duties.” Thomas, slip op. at 4.

In Dumont, the court determined that section 28(a)

neither expressly preempted state law nor demonstrated

a pervasive federal regulatory scheme. Based on this

finding, the court stated:

“Where as here, Congress has not explicitly or

implicitly displaced all state regulation in a

specified field, preemption arises only if compli-

App. 29

ance with both federal and state law is an im-

possibility or when the state law is an obstacle

to the accomplishment of the purposes of the

federal scheme. Although applying the Louisiana

standard of fiduciaries to a national brokerage

company such as Schwab may require a stricter

standard of care to its customers, the application

of Louisiana law does not conflict with the SEC’s

authority and power to regulate the securities

industry, and compliance with both federal regu-

lations and the stricter Louisiana standard of

care is not impossible. Moreover, since greater

disclosure could benefit the investor, the appli-

cable of Louisiana law may indeed serve the

basic purpose of federal laws and regulations.

Dumont, slip op. at 4.

We find the decisions from New York, Minnesota, and

California persuasive. Each extensively discussed the

history and scheme of the securities market and federal

participation in it. As all of them commented, the

securities industry is a national market which must be

regulated uniformly. To allow plaintiffs’ causes of action

to survive in the Illinois state courts, the federal unifor-

mity goal will be frustrated, if not destroyed. If different

state disclosure requirements must be met by brokerage

firms across the nation, uniformity will not exist. If

uniformity is not to prevail, neither rule 10b-10 nor the

SEC would serve any function or purpose in regulating

disclosure. Accordingly, the goals of the federal govern-

ment would be frustrated. While stricter disclosure re-

quirements may be advantageous, as rule 10b-10 now

requires, the SEC’s amendment of the rule demonstrates

its intent to regulate the area and to set forth the nec-

essary disclosure requirements.

App. 30

While we agree with Thomas and Dumont that state

disclosure regulations may not directly conflict with

federal law, we do not agree with their conclusions that

state law is no obstacle to the federal goals. Although

stricter disclosure may serve the federal goal of protect-

ing investors, the Dumont court ignores the fact that the

law of Louisiana may be different than the laws of the

49 other states. It gives no rationale regarding the lack

of uniformity among the states nor the affect different

laws would have on the securities industry. The Thomas

court looked only to and was concerned with the law of

Louisiana. Additionally, the Thomas court cites no auth-

ority in support of its decision and fails to discuss or

even address rule 10b-10 except in passing. The court in

Dumont relied on section 28(a), with only a brief discus-

sion of rule 10b-10, and provided little, if any, basis for

its decision. Thus, we find Thomas and Dumont uncon-

vincing.

For these reasons and those additional reasons out-

lined in Guice and Dahl, we conclude plaintiffs’ claims

were barred by federal preemption, thus, defeating

them. Consequently, the trial court properly dismissed

plaintiffs’ complaints as a matter of law.

For the foregoing reasons, the decision of the circuit

court of Cook County is affirmed.

Affirmed.

McNAMARA, J., concurs.

ZWICK, P.J., dissents.

App. 31

Justice ZWICK, dissenting:

The majority concludes that common law agency prin-

ciples are implicitly pre-empted by the implementation

by the Securities and Exchange Commission Rule 10b-

10. They reach this conclusion by adopting the sweeping

and erroneous premise that “the securities industry is a

national market which must be regulated uniformly.”

Slip op. at 15. In my view, the majority has gotten it

exactly backwards. The disclosure by an agent to his

principle that he is earning additional renumeration

[sic] or a “kickback” does nothing to interfere with uni-

form regulation of the securities industry.

In passing the securities laws, Congress deliberately

created a dual system of regulation in which both fed-

eral and state laws govern industry participants, so long

as state regulation is not inconsistent with federal law.

Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Ware,

414 U.S. 117, 137, 94 S. Ct. 383, 38 L. Ed. 2d 348

(1973). Section 28(a) of the Exchange Act could not be

clearer: “(t]he rights and remedies provided by this title

shall be in addition to any and all other rights and

remedies that may exist at law or in equity.” 15 U.S.C.

78bb(a) (Emphasis added). To this end, Rule 10b-10 was

promulgated by the SEC in 1977 to set forth the mini-

mum disclosure requirements, not displace those dis-

closures required by the common law.

Rule 10b-10 is entitled “Confirmation of Transactions”

and sets forth various disclosures that a broker or

dealer must make to customers in writing at or before

the completion of certain transactions. In the release

announcing the adoption of the Rule, the SEC stated in

pertinent part:

App. 32

“The rule does not attempt to set forth all possi-

ble categories of material information to be

disclosed by broker-dealers in connection with a

particular transaction in securities. Rule 10b-10

only mandates the disclosure of information

which can generally be expected to be material.

Of course, in particular circumstances, addition-

al information may be material and disclosure

may be required.”

Securities Exchange Act Release No 13,508 [1977-1978

Decisions] Fed. Sec. L. Rep. (CCH) Par. 81,143, at

87,930 n. 28 (May 5, 1977). Thus, Rule 10b-10 was

never intended to serve as a “safe harbor.”

Throughout the process of adopting, and then amend-

ing, Rule 10b-10, the Securities and Exchange Commis-

sion has maintained the position that additional disclo-

sure beyond the SEC rules may be required. See e.g.,

Ettinger v. Merrill Lynch, Pierce, Fenner & Smith, 835

F.2d 1031, 1035 (3rd Cir. 1987). Although the SEC

ultimately adopted a safe harbor for brokers and dealers

in Rule 11Ac1-3 (17 C.F.R. § 240.11Ac1-3), which pro-

vides a mechanism pursuant to which brokers and deal-

ers can effectively disclose payment for order flow con-

cerns to customers prior to the establishment of a agent/

principal relationship, it is important to keep in mind

that this new Rule was not in effect at the time the

transactions now at issue took place. Rule 11Ac1-3,

therefore, is simply not relevant to the plaintiffs’ claims

or to our preemption analysis.

If the allegations of plaintiffs’ complaint are taken as

true, as they must be at this stage of the proceedings, it

is clear that the plaintiffs have alleged a valid cause of

action. This case is indistinguishable from Janes v. First

App. 33

Federal Savings and Loan Ass’n, 57 Ill. 2d 398, 312

N.E.2d 605 (1974), in which a lender that obtained title

insurance for its customers and then received rebates

from the title company for sending it the business was

held to have a fiduciary duty to pass the rebate money

on to the customers. The supreme court noted that,

“unless otherwise agreed, an agent who makes a profit

in connection with transactions conducted by him on

behalf of the principal is under a duty to give such profit

to the principal.” Janes, 57 Ill. 2d at 410, 312 N.E.2d

605, quoting Restatement (Second) of Agency, § 388.

There are any number of similar opinions, from Illinois

as well as from other jurisdictions, stating this same

long-standing and fundamental agency principle.

The prior disclosures required by the common law for

an agent to keep the type of “kickbacks” that order flow

payments represent in no way represents an obstacle to

the federal goal of establishing an efficient and equita-

ble national market. If brokers and dealers wish to earn

a profit in executing their clients orders in addition to

their bargained-for commissions, all that the common

law requires is for brokers and dealers to disclose this

additional renumeration [sic] prior to entering into the

agency relationship with their clients, as Rule 11Ac1-3

now contemplates. In that they hold otherwise, the cases

relied upon by the majority are wrongly decided.

The Guice court reasoned that since the 1975 amend-

ments to the Securities Exchange Act were designed, in

part, to create a “yniform” national market, the SEC

must have intended to promote a “uniform” rule for

order flow payments when it promulgated Rule 10b-10

in 1977. Yet my research indicates that payment for

App. 34

order flow is a fairly recent practice which grew up after

the SEC’s promulgation of Rule 10b-10 in 1977. Order

flow payments appear to have first come to the attention

of the news media and the National Association of

Securities Dealers only in 1985. See Note, The Perils of

Payment for Order Flow, 107 Harv. L.Rev. 1675, 1676,

fn. 8 (1994); Jane Sasseen, Dirty Little Secret, Forbes,

June 17, 1985, at 203. It follows that payment for order

flow by brokers could not have been contemplated or

specifically regulated in 1977 by Rule 10b-10 when the

SEC promulgated the rule. It is not surprising, there-

fore, that the 1976 SEC release asking for public

comment on then proposed Rule 10b-10 does not men-

tion payment for order flow. Instead, the release ex-

plains that the proposed rule is designed to deal with a

quite different problem, namely, “with agency crosses in

the over-the-counter market where the broker acts as

agent for both the buyer and the seller.” SEC Proposed

Rulemaking, Exchange Act Release No. 12806 (Sept. 16,

1976) (Emphasis added.) Similarly, the 1977 SEC re-

lease which accompanied the final rule discusses how

the rule would be applied when a brokerage firm rep-

resents the buyer and seller in the same transaction.

Exchange Act Release No. 13508 (May 5, 1977).

The Minnesota Supreme Court’s recent opinion in

Dahl is no more compelling. The Dahl court concludes

that, “For [defendant] Schwab to fully comply with these

state agency law requirements, it would need to be able

to ascertain the exact amounts of these profits in order

to seek its clients’ consent, or to remit them to its

customers if consent were withheld.” Dahl, 545 N.W.2d

at 925. This conclusion is unsupported by agency law,

logic or the record in our case.

|

App. 35

An agency is a consensual relationship. State Security

Insurance Co. v. Frank B. Hall & Co., 258 Ill. App. 3d

588, 595, 196 Ill. Dec. 775, 630 N.E.2d 940 (1994). As

such, the relationship can be modified by mutual agree-

ment as the parties see fit. All the defendants need have

done to comply with the common law is to have in-

formed their clients that, as a condition of accepting

client business, the defendants would insist on retaining

any order flow payments received in connection with the

execution of client orders. Defendants elected not to do

so. If the defendants now believe they have an onerous

obligation under the common law to refund order flow

payments, I can only conclude that they have brought |

this obligation upon themselves by not fully informing

their clients of the true nature of their renumeration

[sic].

For the above reasons, I respectfully dissent.

App. 36

IN THE CIRCUIT COURT OF

COOK COUNTY, ILLINOIS

COUNTY DEPARTMENT, CHANCERY DIVISION

GORDON RUBENSTEIN,

Plaintiff,

versus No. 94 CH 1446

QUICK & REILLY, INC. and

)

)

)

)

)

)

U.S. CLEARING CORP., )

)

)

Defendants.

ORDER

This Cause, coming on to be heard upon the MOTION

TO DISMISS of the defendants, QUICK & REILLY,

INC. and U.S. CLEARING CORP., due notice having

been given and the court being fully advised in the

premises;

IT IS HEREBY ORDERED:

That Defendants’ Motion to Dismiss is hereby granted;

Further this court finds no just cause for delay of en-

forcement or appeal.

/s/ Judge Arthur L. Dunne

Circuit Court Judge

Dated: September 27, 1994

App. 37

IN THE CIRCUIT COURT OF

COOK COUNTY, ILLINOIS

COUNTY DEPARTMENT, CHANCERY DIVISION

ROBERT ORMAN,

Plaintiff,

versus No. 93 CH 7365

CHARLES SCHWAB & CO., INC.,

Defendant.

ORDER

This cause coming on to be heard on motion of de-

fendant to dismiss the complaint, due notice having

been given, the parties having appeared and argued the

motion, it is hereby ordered:

That defendant’s motion to dismiss be and is GRANT-

ED. This court having determined that plaintiff's claims

are preempted by federal law and having adopted the

opinion of the District Court of Hennepin County,

Minnesota in that complaint styled DAHL v. CHARLES

SCHWAB & COMPANY.

Further that this court finds no just cause for delay of

enforcement or appeal of this order.

/s/ Judge Edward C. Hofert

Circuit Court Judge

Dated: June 2, 1994

App. 38

CONSTITUTIONAL PROVISIONS,

STATUTES AND REGULATIONS

1. FEDERAL CONSTITUTIONAL PROVISION.

The Supremacy Clause, U.S. Constitution, Article VI,

clause 2, provides:

This Constitution, and the Laws of the United

States .. . shall be the supreme Law of the

Land; and the Judges of every State shall be

bound thereby, any Thing in the Constitution or

Laws of any State to the Contrary notwithstand-

ing.

2. FEDERAL SECURITIES LAWS.

Section 28 of the Securities Exchange Act of 1934, 15

U.S.C. § 78bb, reads, in relevant part:

78bb. Effect on existing law

Addition of rights and remedies; recovery of

actual damages; State securities commissions

(a) The rights and remedies provided by this

chapter shall be in addition to any and all other

rights and remedies that may exist at law or in

equity.

3. RULES OF THE SECURITIES AND EXCHANGE

COMMISSION.

17 C.F.R. § 240.10b-10 (promulgated 1977), Rule 10b-

10, Confirmation of Transactions:

App. 39

(a) It shall be unlawful for any broker or

dealer to effect for or with an account of a

customer any transaction in, or to induce the

purchase or sale by such customer of, any securi-

ty (other than U.S. Savings Bonds or municipal

securities) unless such broker or dealer, at or

before completion of such transaction gives or

sends to such customer written notification

disclosing—

* * *

(2)i) If the broker or dealer is acting as an

agent for such customer, for some other person,

or for both such customer and some other per-

son,

* * *

(7iv) The source and amount of any other

remuneration . . . received by him in connection

with the transaction: Provided, however, that if,

in the case of a purchase, the broker was not

participating in a distribution, or in the case of

a sale, was not participating in a tender offer,

written notification may state whether any other

remuneration has been or will be received and

that the source and amount of such other remu-

neration will be furnished upon written request

of such customer.

§ 240.10b-10 (amended 1994) — Confirmation of trans-

actions.

(a)* * *

(7)* * *

App. 40

(iii) For a transaction in any subject security as

defined in § 240.11Ac1-2 or a security authorized

for quotation on an automated interdealer quo-

tation system that has the characteristics set

forth in Section 17B of the Act (15 U.S.C. 78q-2),

a statement whether payment for order flow is

received by the broker or dealer for transactions

in such securities and that the source and na-

ture of the compensation received in connection

with the particular transaction will be furnished

upon written request of the customer; and

17 C.F.R. 240.11Ac1-3 (adopted 1994)

Rule 11Ac1-3. Customer Account Statements.

(a) No broker or dealer acting as an agent for

a customer may effect any transaction in, induce

or attempt to induce the purchase or sale of, or

direct orders for purchase or sale of, any subject

security as defined in §240.11Ac1-2 or a security

authorized for quotation on an automated inter-

dealer quotation system that has the character-

istics set forth in section 17B of the Act (15

U.S.C. 78q-2), unless such broker or dealer in-

forms such customer, in writing, upon opening a

new account and on an annual basis thereafter,

of the following:

(1) The broker’s or dealer’s policies regarding

receipt of payment for order flow as defined in

§ 240.10b-10(e)(9), from any broker or dealer,

national securities exchange, registered securi-

ties association, or exchange member to which it

routes customers’ orders for execution, including

a statement as to whether any payment for

App. 41

order flow is received for routing customer

orders and a detailed description of the nature of

the compensation received; and

(2) The broker’s or dealer’s policies for deter-

mining where to route customer orders that are

the subject of payment for order flow as defined

in § 240.10b-10(e)(9) absent specific instructions

from customers, including a description of the

extent to which orders can be executed prices

superior to the best bid or best offer as defined

in § 240.11Ac1-2.