Opposition Brief — Estate of Braunstein v. Merrill Lynch, Pierce, Fenner & Smith Inc.
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No. 97-1491] :
In The
Supreme Court of the United States
—-
October Term, 1997
THE ESTATE OF DAVID J. BRAUNSTEIN and ROSEMARIE
BRAUNSTEIN, et al.,
Petitioners.
MERRILL LYNG. Freee. FoeeNnee & SMITH
INCORPORATED, et al.,
Respondents.
On Petition for Writ of Certiorari to the
Court of Appeals of the State of New York
RESPONDENTS’ BRIEF IN OPPOSITION
TIMOTHY S. BISHOP A. ROBERT PIETRZAK
MAYER, BROWN & PLATT Counsel of Record
190 South LaSalle Street CATHLEEN M. TIERNAN
Chicago, Illinois 60603 DANIEL A. McLAUGHLIN
(312) 782-0600 BROWN & WOOD LLP
One World Trade Center
New York, New York 10048
(212) 839-5300
Attorneys for Respondents
145806 a . : = utz
raat (800) 274-3321 + (800) 359-6859 i poeliate
A DIVISION OF COUNSEL PRESS Services
r
inc
QUESTION PRESENTED
Whether the federal regulatory scheme permitting securities
broker-dealers to use customer free credit balances in their
business for specified purposes would be compromised by state
common law requirements that broker-dealers pay any economic
benefits from such use directly to their customers, where
Congress and the SEC have recognized the existence and utility
of retention by broker-dealers of benefits from such use.
il
RULE 29.6 STATEMENT
The following are the parent companies or nonwholly
owned subsidiaries of respondents:
The parent of respondent Merrill Lynch, Pierce, Fenner &
Smith, Inc. is Merrill Lynch & Co., Inc. The only non-wholly
owned subsidiary of Merrill Lynch, Pierce, Fenner & Smith,
Inc. is Merrill Lynch Professional Clearing Corp.
Neither respondent Prudential Securities, Inc. nor its ultimate
parent, The Prudential Insurance Company of America, a mutual
insurance company, nor any subsidiary or affiliate has issued
shares to the public.
Respondent Smith Barney Shearson, Inc. is now Smith
Barney, Inc. The direct parent of Smith Barney, Inc. is Salomon
Smith Barney Holdings Inc., and the ultimate parent of Smith
Barney Inc. is Travelers Group Inc. Smith Barney, Inc. does
not have any non-wholly-owned subsidiaries.
Respondents Kemper Securities Group, Inc. and Kemper
Securities, Inc. are now EVEREN Securities, Inc. The parent
of EVEREN Securities, Inc. is EVEREN Capital Corporation.
EVEREN Securities, Inc. does not have any non-wholly-owned
subsidiaries.
The ultimate parent of respondent Dean Witter Reynolds,
Inc. is Morgan Stanley Dean Witter & Co. The only non-wholly
owned subsidiary of Dean Witter Reynolds, Inc. is SPS
Transaction Services, Inc.
Respondent Alex, Brown & Sons, Inc. is now BT Alex.
Brown Incorporated. The parents of BT Alex. Brown
Incorporated are Bankers Trust New York Corporation and BT
iil
Alex. Brown Holdings Incorporated. The only non-wholly
owned subsidiary of BT Alex. Brown Incorporated is Alex.
Brown Investment Management Incorporated.
The ultimate parent of respondent Bear, Stearns Securities
Corp. is The Bear Stearns Companies. Bear, Stearns Securities
Corp. does not have any non-wholly-owned subsidiaries.
The ultimate parent of respondent Charles Schwab & Co.,
Inc. is The Charles Schwab Corporation. Charles Schwab &
Co., Inc. does mot have any non-wholly-owned subsidiaries.
Respondent Kidder Peabody & Co., Incorporated is now a
wholly-owned subsidiary of Paine Webber Group, Inc.
The only parent, subsidiary, or affiliate of respondent
Paine Webber, Ime. that is publicly held is Paine Webber Group,
Inc.
Respondent Lehman Brothers, Inc. (“Lehman”) has the
following parent: Lehman Brothers Holdings, Inc. (“Holdings’’).
Holdings is a public company. No other Lehman affiliates have
offered shares or other obligations to the public.
iv
TABLE OF CONTENTS
Page
CE FOO on os iw kn i soen 600 Hae ieee eeee i
FD ee TIN 6 io .c b8 od eK Sih 0 Va en ak ii
Se ee NS 5 he Wes aaa er eek weeeuees iv
pig ke | re ey hr mee ae ety ieee) er vi
So PPE TCP RET CCE CLT Pere ee eT l
eg ko res emer ren rey ee nye l
A. The Proceedings In The New York Courts .... 3
Reasous Tor Tecyine Cee Writ: cc chevetewess 5
I. The New York Courts Properly Applied This
Court's Preemption Decisions To The Interaction
Between The Federal Regulatory Scheme
Governing Free Credit Balances And Petitioners’
State Common Law Claims. ..........c008, 6
A. Federal Regulation of Free Credit Balances
Ue Die ean VA EA x sae ER See eT aN 6
1. “Free Credit Gatances” .. 266 .es sss 6
2. Broker-Dealers’ Treatment of Free Credit
Balances Is Pervasively Regulated ... 6
7
Vy
Contents
Page
S... RE: ce2ks cera ees 7
DP ss eae oa eee oka dees 7
B. The New York Courts Properly Applied This
Court’s Preemption Standards .......... 1]
1. This Court Has Consistently Held That
State Laws That Conflict With The
Purposes and Objectives of Federal
Regulation Are Preempted ......... 1]
2. Petitioners’ State Common Law Claims
Conflict With The Purposes and
Objectives of The Federal Regulatory
| PEPE TE Neer ere rey 13
II. There Is No Conflict Between The Legislative
Purpose Of Section 28(a) Of The Exchange Act
And The Lower Courts’ Finding That Petitioners’
CIANS ALG PYORINDUOG, «iss oo ie y es danwa keds 17
Ill. The Facts Of This Litigation Are Unique And
STNEY FO SONONs ac ae Ne SVs aan hae ee 22
ha RN Si ONae ae aA tL Tua Apne pO eka at MRE LATOR 25
vi
Contents
Page
TABLE OF CITATIONS
Cases Cited:
Barnett Bank v. Nelson, 517 U.S. 25 1996) ......... 12, 14
Capital Cities Cabie Inc. v. Crisp, 467 U.S. 691
CUE. haa he kod Sebkd weean bene ee meb ks 11, 12, 14
Carr v. CIGNA Secs., 95 F.3d 544 (7th Cir. 1996) ... 24
Carstensen vy. Brunswick Corp., 49 F.3d 430 (8th Cir.),
cert. denied, 516 U.S. 866 (1995) .............. 16
CSX Transportation, Inc. v. Easterwood, 507 U.S. 658
CEDRAD Saw CReN RACERS ES cea Oa TT Oaks 12
Dahl v. Charles Schwab & Co., 545 N.W. 2d 918
(Minn.), cert. denied, 117 S. Ct. 176 (1996) ...... 22
Dumont v. Charles Schwab & Co., Nos. 96-C-2685 &
97-CA-1225 (La. Ct. App. 4th Cir. Apr. 8, 1998) .. 22
Edgar v. MITE Corp., 457 U.S. 624 (1982) ........ 15, 18
Eirman v. Olde Discount Corp., 697 So. 2d 865 (Fla.
Dist. Ct. App.), certification denied, (Fla. Aug. 28,
PUREE canvas dhadode bank s cebae awhadatek eek was 22
Fekety v. Gruntal & Co., 191 A.D. 2d 370, 595 N.Y.S.
ae SPS CE UAE TE ES Tc ke nwene sie 23-24
fa
vil
Contents
Page
Fidelity Fed. Sav. & Loan Ass'n v. de la Cuesta, 458
SL: OE REE: aid Dak Shaw ee ree eh ee eat aaee's 12
Freightliner Corp. v. Myrick, 514 U.S. 280 (1995) ... 15, 16
Guice v. Charles Schwab & Co., 89 N.Y. 2d 31, 674
N.E. 2d 282, 651 N.Y.S. 2d 352 (1996), cert. denied,
Eat Gi Qe Dee CaOeTT hs cab ec ese 4, 5, 18, 19, 20, 21, 22
Hillsborough Co., Florida v. Automated Med. Labs, Inc.,
ES Ain, Oe LEPEE. cand Cie keno n ea wrnca net 12
In Re Prudential Secs., Inc. Sweep Litigation, No.
122747/95 (N.Y. Sup. Ct. N.Y. Cty. Jun. 24, 1997)
Sap eRe eg ae BD oe ly ee Mee tO) NENT A aay aa
International Paper Co. v. Ouellete, 479 U.S. 481
PRED eal wir iba Nea D Kia Sirk CRRA ET LOR ORS 12, 18
Matter of Atkeison, 446 F. Supp. 844 (M.D. Tenn. 1977)
Sew ah on CPSP RRs 6 ESN wack wee evo whieh eee 7
Medtronic v. Lohr, 518 U.S. 470, 116 S. Ct. 2240
CREE. (dus bie sce eh wb ee ER BOS Ae A Oc bie wa ee 16
Michigan Canners & Freezers Ass'n v. Agricultural
Marketing and Bargaining Bd., 467 U.S. 461
LENGE Sein CURE CCLAS EES OR ER REELS RET RE RREAE LAS 18
Orman v. Charles Schwab & Co., 688 N.E. 2d 620 (Ill.
1997), petition for cert. filed (Feb. 18, 1998) (No. 97-
PET hohe wake be hee bade e oan he Ca bea ke 22
vull
Contents
Paccar, Inc. v. NHTSA, 573 F.2d 632 (9th Cir.), cert.
Same, Se Tak ee CHIE) vc kc asenskatdcsetes
Perl v. Smith Barney Inc., 230 A.D.2d 664, 646 N.Y.S.2d
678 (N.Y.A.D. Ist Dep’t), appeal denied, 89 N.Y.2d
803, 675 N.E.2d 1234, 653 N.Y.S.2d 281 (N.Y.
EPGE cad ce Opa ee eae Osek CEES R TES Ohlateerenss
Pokorny v. Ford Motor Co., 902 F.2d 1116 (3d Cir.),
cert. denied, 498 U.S. 853 (1990) ..............
Press v. Chemical Inv. Servs., No. 96 Civ. 8331, 1997
WL 795100 (S.D.N.Y. Dec. 22, 1997) ...........
Ray v. Atlantic Richfield Co., 435 U.S. 151 (1987) ...
Schneidewind v. ANR Pipeline Co., 485 U.S. 293
EET ASME EP PRb KCK OSL GOES LUE Vehawe ibeR:
Securities Indus. Ass'n v. Connolly, 883 F.2d 1114 (Ist
Cir. 1989), cert. denied, 495 U.S. 956 (1990) .....
Shulick v. Paine Webber, Inc., 700 A.2d 534 (Pa. Super.
i OG CERT Se PE PCR PE Ter el bec rie
Surrey Strathmore Corp. v. Dollar Sav. Bank, 36 N.Y.
2d 173, 325 N.E. 2d 527, 366 N.Y.S. 2d 107 (1975)
0-6.) 8 Be 2'2. 2-6 O2D.O-2' 62 02.6. 8. 2.86 4.4.6 8-86 249 2 2 ee OO 8S 6.8 2S
Page
23
16
16
1]
22
24
ix
Contents
Page
Statutes Cited:
SP Seed Oe UD COPOUE AOOED Na kbc a ba sacseys bes 7
15 U.S.C.A. § 780(c)(3) (West Supp. 1996) ........ ay an
15 U.S.C.A. § 78bb(a) (West 1981) ....... 5, 17, 18, 19, 24
United States Constitution Cited:
ies Se Was GEG Svs ccaeaaidess Gacketweas 1]
Other Authorities Cited:
Pe een RON 5 sags Kaho mde cee s wae 7, ae, Om
Pe Sides FP PO EOIND. Shed ee taau ashes LS 46-95. We Tae O2
Ee Spe A REND a Fk awe ened vie bean ar 2,6
iF Sis: PMD Pe hae coe Nd ee ee dee heen 7, 8
eee ME RE Ae adsiee bed UES has oan eek he us 4
rae Se SPREE, CN a NaC as ue ON ASRS Ang eee 4
Adoption of Rule 15c3-2, Exchange Act Release No. 34-
7325, [1961-1964 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¥ 77,000 at 81,668 (May 27, 1964) ....... 8, 9, 15
Contents
Proposed Rule 15c3-2, Exchange Act Release No. 34-
7266, [1961-1964 Transfer Binder] Fed. Sec. L. Rep.
(CCH) J 76,978 at 81,622 (Mar. 12, 1964) .......
H. Rep. No. 91-1613, 91st Cong., 2d Sess. (1970),
reprinted in 1970 U.S.C.C.A.N. 5254, 5255-56 ...
In re Newman (Ann), SEC No-Action Letter, [1970-71
Transfer Binder] Fed. Sec. L. Rep. (CCH) ¥ 78,177 at
gk st ee eee ae 10,
Notice to Broker-Dealers Concerning Interest-Bearing
Free Credit Balances, Exchange Act Release No. 34-
18262, 4 Fed. Sec. L. Rep. (CCH) J 25,134B at
Page
13,
24
Paes COME: ay BOOED 45 ks cecadnasstaseuss 9-10, 13
Proposal to Adopt Rules 15c3-3 and 15c3-4 and to
Amend Rules 8c-] and ]5c2-1, Exchange Act Release
No. 34-9388, 1971 WL 16389, at *6 (Nov. 8, 1971)
a bak MRR wola ces Ae ee ee eG ee eS
Adoption of Rule 15c3-3, Exchange Act Release No. 34-
9856, [1972-1973 Transfer Binder] Fed. Sec. L. Rep.
(CCH) J 79,083 at 82,346 (Nov. 13, 1972) .......
Proposal to Adopt Rule 15c3-3, No. 34-9622, [1972
Transfer Binder] Fed. Sec. L. Rep. (CCH) ¥ 78,801 at
ee Be” BS os | SRR ere
SEC, Report of Special Study of Securities Markets, :H.
Doc. No. 95, 88th Cong., Ist Sess., Pt. 1, at 391-401,
Ee REE Ni hb Sao Sen debra xd ance cee cess 10, 11, 13, 21
9,
15
i ani
xt
Contents
Page
New York Stock Exchange, Inc. Rule 436, NYSE Guide
Seen: eae CD os hs kd hee oo cs neous earas 10
Weinstein-Korn-Miller, New York Civil Practice: CPLR,
¥ 5601.09, at 56-46 (Matthew Bender 1996) ...... 5
Hon. Frank Horton, SEC No-Action Letter, 1983 SEC
No-Act. LEXIS 2027 (Mar. 12, 1983) ........... 10
APPENDIX
Appendix A — Motion And Memorandum Opinion Of
The Supreme Court Of The State Of New York, New
York County Filed October 2, 1996 ............. la
Appendix B — Motion And Memorandum
Decision Of The Supreme Court Of The State Of New
York, New York County In Sandra Ballan vy.
Prudential Securities, Inc. Filed June 24, 1997 .... 20a
hi PMA
I
Respondents, eleven leading securities broker-dealers,
respectfully request that this Court deny the petition for a writ
of certiorari.
OPINIONS BELOW
The opinions of the Supreme Court of the State of New
York, County of New York (the “trial court”) dismissing
petitioners’ initial complaint for lack of particularity and denying
respondents’ motion to dismiss the amended complaint are
published, respectively, at N.Y.L.J., Jun. 22, 1995, at 29, col.
4, and N.Y.L.J., May 16, 1996, at 27, col. 4. (Petitioners’
Appendix (“Pet. App.”) A38, A154). The opinion of the trial
court denying class certification is published at N.Y.L.J., Oct.
2, 1996, at 22, col. 5. (Respondent’s Appendix (“Resp. App.’)
la). The opinion of the Supreme Court of the State of New
York, Appellate Division, First Department (“Appellate
Division”) is reported at 238 A.D. 2d 242, 657 N.Y.S. 2d 12.
(Pet. App. A34). The Decision and Order of the New York
Court of Appeals (“New York Court of Appeals”) dismissing
the appeal as of right is reported at 90 N.Y. 2d 934, 686 N.E.
2d 1366, 664 N.Y.S. 2d 271. (Pet. App. A26). The Decision
aad Order of the New York Court of Appeals denying the motion
for leave to appeal is reported at 91 N.Y. 2d 803. (Pet. App.
A31).
STATEMENT OF THE CASE
At issue in this action is which law, federal or state, regulates
the obligations of securities broker-dealers to their customers in
handling cash — referred to as “free credit balances” — arising
in customers’ brokerage accounts.' The federal regulatory
1. Free credit balances are defined in Rule 15c3-3 of the
Securities Exchange Act of 1934 (“Exchange Act”) as “liabilities of
a broker or dealer to customers which are subject to immediate cash
(Cont'd)
2
scheme expressly permits broker-dealers to use customers’ free
credit balances in the operation of specific areas of their
businesses, subject to certain disclosure requirements. Both the
Securities and Exchange Commission (“SEC”) and Congress
have recognized that securities industry practice generally is
not to make payments to customers for the use of such balances,
and that customers benefit from such use. The SEC also has
rejected specific proposals that free credit balances be treated as
trust funds, and has instead declared that the payment of interest
to customers on free credit balances is a matter of contract, not
a matter of right, between the individual customer and the broker-
dealer as creditor and debtor. Petitioners challenge the conclusion
of the Appellate Division that this carefully designed federal
scheme would be “severely compromised” by, and therefore
preempts, application of state law to require payments to
customers for the use of free credit balances. (Pet. App. A37).
Petitioners are or were brokerage customers of respondents,
eleven leading registered securities broker-dealers.’ Petitioners
purport to bring this action on behalf of a massive,
unmanageable class.’ Petitioners claim, without setting forth
(Cont'd)
payment to customers on demand, whether resulting from sales of
securities, dividends, interest, deposits or otherwise ... .” Exchange
Act Rule 15c3-3(a)(8), 17 C.F.R. § 240.15c3-3(a)(8) (1996).
2. Not all petitioners are customers of all respondents.
3. The class was defined as:
All persons or entities in the United States who have, or
have had accounts with one or more of the respondents
in which they have had free credit balances which
existed overnight or longer from which the respondents
(Cont'd)
3
any particulars, that respondents “create” and then “use their
customers’ free credit balances, generate an economic benefit
from this use and retain such economic benefit as their own.”
(Pet. App. A52 at J 3). Petitioners also allege that respondents
have “delayed the transfer of the Plaintiffs’ and Class members’
free credit balances, enabling them to further retain and use
these free credit balances for their own profit.” (/d.). Based on
these generalized allegations, the amended complaint asserts state
common law claims for breach of fiduciary duty and unjust
enrichment. (Pet. App. A78-81 at JJ 29-41). Petitioners seek
an accounting and restitution for any gain or economic benefit
derived from respondents’ use of the free credit balances existing
overnight or longer in petitioners’ accounts and allegedly
retained by respondents. (Pet. App. ASI at J 1). In addition,
petitioners seek a temporary and permanent injunction enjoining
respondents from continuing the practices complained of, as
well as a declaratory judgment that respondents’ acts are illegal.
(Pet. App. A81-82).
A. The Proceedings in the New York Courts
Respondents moved to dismiss the initial complaint in this
aciion on the grounds that, inter alia, petitioners’ claims were
(Cont'd)
have received economic benefit for which the
respondents have not properly accounted to the
petitioners.
(Pet. App. A60 at ¥ 11.). The trial court refused to certify the class
because, inter alia, it found that petitioners “have failed to show
that a common ‘method and procedure’ was adopted by defendants
whereby free credit balances were unnecessarily created, delayed,
or retained” and “have not made it at all clear who they seek to
represent.” Resp. App. 13a, 18a (emphasis in original).
4
preempted by federal law.* The trial court denied respondents’
federal law grounds for dismissal but dismissed the complaint
with leave to replead on the grounds that petitioners failed
adequately to plead causes of action for breach of fiduciary
duty and unjust enrichment, pursuant to Section 3013 and Rule
3016(b)° of the New York Civil Practice Law and Rules
(“CPLR”). (Pet. App. A154). Petitioners then filed an amended
complaint. (Pet. App. A150). Respondents again moved to
dismiss; the trial court denied the motion. (Pet. App. A38).
Defendants appealed both orders. While the appeal was pending,
the trial court denied class certification. (Resp. App. 1a).
The Appellate Division reversed the trial court and
dismissed the action as preempted by federal law.® The court
relied primarily on a recent decision of the New York Court of
Appeals, a decision with respect to which this Court denied
certiorari. Guice v. Charles Schwab & Co., 89 N.Y. 2d 31, 674
N.E. 2d 282, 651 N.Y.S. 2d 352 (1996), cert. denied, 117 S.
Ct. 1250 (1997). Following the Appellate Division’s dismissal,
4. Prior to the filing of this action, petitioners filed a
predecessor action in Arizona Superior Court. The case was stayed
on forum non conveniens grounds; that stay is still in effect.
5. CPLR Rule 3016(b) requires that breaches of trust be pleaded
with particularity.
6. The petition characterizes the Appellate Division’s opinion
as “incorrectly focusing on the permissive use of free credit balances
(an issue that was never contested by petitioners) rather than the
fruits of such usage.” Pet. 2-3. In fact, that court described
petitioners’ claims as “seek[ing] an accounting and restitution of
any benefit received by defendants from use of free credit balances
belonging to the class members.” (Pet. App. A36) (emphasis added).
Thus, the Appellate Division plainly recognized petitioners’
purported distinction between “use” and “benefits from use” and
found it unpersuasive.
5
petitioners sought review by appeal as of right to the New York
Court of Appeals. That court dismissed the appeal.’ (Pet. App.
A26). Petitioners then moved for leave to appeal to the New
York Court of Appeals, citing the “national importance” of the
issues presented. See Motion Of Plaintiffs-Appellants For Leave
To Appeal To The Court Of Appeals, at 8, in the New York
Court of Appeals, Index No. 111667/94. That motion was
denied. (Pet. App. A31). Petitioners then filed the instant
petition.
REASONS FOR DENYING THE WRIT
This Court should deny the writ because: (i) the court below
correctly applied this Court’s preemption jurisprudence to the
federal regulatory scheme governing free credit balances;
(ii) there is substantial uniformity in the lower courts that Section
28(a) of the Securities and Exchange Act of 1934 (“Exchange
Act”) does not foreclose preemption of state common law claims
that conflict with the Exchange Act and SEC regulations; and
(iii) the facts of this litigation are unique and unlikely to recur.
7. Petitioners represent that “the New York Court of Appeals
dismissed the petitioners [sic] appeal as of right on constitutional
grounds because — in that court’s view — there was no
constitutional issue.” Pet. 3 (emphasis in original). This is a
misstatement of the New York Court of Appeals’ finding, which was
that “no substantial constitutional question is directly involved.”
Pet. App. A29 (emphasis added). In light of the New York Court of
Appeals’ decision less than a year earlier in Guice and the similarity
of the issues presented in this case, that court properly found that
petitioners’ grounds for objection to the Appellate Division’s finding
of preemption were not substantial. See Weinstein-Korn-Miller, New
York Civil Practice: CPLR, { 5601.09, at 56-46 (Matthew Bender
1996) (“Regardless of what the magnitude of a constitutional
question might otherwise be, the question is not substantial once
the Court [of Appeals] has authoritatively resolved it in a recent
decision.”’).
6
I.
THE NEW YORK COURTS PROPERLY APPLIED
THIS COURT’S PREEMPTION DECISIONS TO THE
INTERACTION BETWEEN THE FEDERAL
REGULATORY SCHEME GOVERNING FREE CREDIT
BALANCES AND PETITIONERS’ STATE COMMON
LAW CLAIMS.
The petition primarily raises the question of the proper
application of this Court’s preemption decisions to the interaction
of petitioners’ state common law claims with the particular
federal regulatory scheme at issue. Examination of the regulatory
background demonstrates that, under well-settled law,
petitioners’ claims are preempted.
A. Federal Regulation of Free Credit Balances
1. “Free Credit Balances”
Free credit balances are cash balances in customer brokerage
accounts that are payable to customers on demand and that result
from securities transactions, deposits of cash including sales of
securities, or receipt of dividends or interest. See Exchange Act
Rule 15c3-3(a)(8), 17 C.F.R. § 240.15c3-3(a)(8) (1996).
Because securities accounts are transaction accounts, free credit
balances held by a broker-dealer at any given time will represent
a fluctuating and complex mass of large and small receipts and
disbursements relating to securities transactions and positions.
2. Broker-Dealers’ Treatment of Free Credit Balances
Is Pervasively Regulated
The handling of customers’ free credit balances by securities
broker-dealers has been subject to intensive and longstanding
oversight and supervision by Congress and the SEC.
eT SIS NTE NN nen
aes ke od
Re ge
a. Congress
Congress has determined that the “national public interest”
requires a “national market system” and a “national system for
clearance and settlement of securities transactions.” Exchange
Act, Section 2, 15 U.S.C.A § 78(b) (West 1981) (emphasis
supplied). As an integral part of the national regulation of the
securities markets, Congress has expressly mandated that the
SEC “shall prescribe” rules and regulations regarding “the
carrying and use of customers’ deposits or credit balances.”
Exchange Act, Section 15(c)(3), 15 U.S.C.A. § 780(c)(3) (West
Supp. 1996) (emphasis supplied). Indeed, Congress has long
been aware that free credit balances, which are funds protected
by the Securities Investor Protection Act, “may be and are used
by broker-dealers to maintain positions in securities, to finance
margin purchases of other customers, and to operate their
businesses generally” and has recognized that “[o]Jnly rarely, is
interest on [free credit balances] paid by the broker to the
customer.” H. Rep. No. 91-1613, 91st Cong., 2d Sess. (1970),
reprinted in 1970 U.S.C.C.A.N. 5254, 5255-56. See also Matter
of Atkeison, 446 F. Supp. 844, 849 (M.D. Tenn. 1977) (quoting
House Report and other Congressional statements).
b. SEC
The SEC has complied with the mandate of Congress to
regulate broker-dealers’ use of customer free credit balances in
brokerage accounts by adopting Rules 15c3-2 and 15c3-3 under
the Exchange Act. See 17 C.F.R. §§ 240.15c3-2 and 240.15c3-
3(e) (1996). Rule 15c3-2, adopted in 1964, permits a broker-
dealer to use free credit balances in connection with the
operation of its business, as long as the broker-dealer informs
customers at least quarterly regarding the amount of free credit
balances carried for each customer’s account, that such funds
are not segregated and may be used in the operation of the
8
business of the broker-dealer, and that such funds are payable
on demand. See Exchange Act Rule 15c3-2, 17 C.F.R.
§ 240.15c3-2 (1996). The SEC rejected a version of this Rule
that would have required broker-dealers to disclose whether or
not interest would be paid on free credit balances. Adoption of
Rule 15c3-2, Exchange Act Release No. 34-7325, [1961-1964
Transfer Binder] Fed. Sec. L. Rep. (CCH) 9 77,000 at 81,668
(May 27, 1964) (“Adoption of Rule 15c3-2”).
Rule 15c3-3, adopted in 1972, pursuant to Congress's
explicit mandate, expressly authorizes broker-dealers to use free
credit balances to finance customer-related activities such as the
clearance and settlement of margin transactions, short sales, and
failed deliveries. See Exchange Act Rule 15c3-3(e), 17 C.F.R.
240.15c3-3(e) (1996) and Exhibit A thereto. In proposing this
Rule, the SEC explained that it had engaged in a careful
balancing of competing concerns:
The purpose behind the proposed rules is to afford
as complete protection as possible to customers .. .
without depriving the industry of necessary and
legitimate means to carry on customer oriented
business.
Proposal to Adopt Rules 15c3-3 and 15c3-4 and to Amend
Rules 8c-1 and ]5c2-1, Exchange Act Release No. 34-9388,
1971 WL 16389, at *6 (Nov. 8, 1971) (“First Proposal of
Rule 15c3-3") (emphasis supplied). The SEC intended Rule
15c3-3 to be “comprehensive” and uniform in its application.
See Adoption of Rule 15c3-3, Exchange Act Release No. 34-
9856, [1972-1973 Transfer Binder] Fed. Sec. L. Rep. (CCH)
{ 79,083 at 82,346 (Nov. 13, 1972).
Notwithstanding the fiduciary aura with which petitioners .
Seek to imbue their account relationships with their broker-
Ra i i
4
j
9
dealers, the SEC has explicitly rejected the notion that a broker-
dealer acts as a trustee for customer free credit balances.* Rather,
the SEC has stated that the relationship of broker-dealers to
customers with respect to free credit balances is that of debtor-
creditor. See Adoption of Rule 15c3-2, J 77,000 at 81,668;
Proposed Rule 15c3-2, Exchange Act Release No. 34-7266, [1961-
1964 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¥ 76,978 at 81,622
(Mar. 12, 1964) (“Proposal of Rule 15c3-2”) (the relationship
between a broker-dealer and its customer with respect to free credit
balances “is that of creditor-debtor’). The SEC has rejected the
characterization of free credit balances as “trust funds,” explaining
that it “sought to avoid freezing the liquid resources of the securities
industry or depriving it of business opportunities in areas, such as
margin lending, where it has traditionally played a significant and
constructive role.” Proposal to Adopt Rule ]15c3-3, No. 34-9622,
[1972 Transfer Binder] Fed. Sec. L. Rep. (CCH) J 78,801 at
81,729-30 (May 31, 1972) (“Second Proposal of Rule ]5c3-3").
The SEC has expressly stated that the payment of interest
on customers’ free credit balances is a matter of contract to be
agreed upon between a broker-dealer and its customer, rather
than a matter of right. Indeed, it is illegal for broker-dealers to
pay interest on free credit balances created for the purpose of
earning interest. See Notice to Broker-Dealers Concerning
Interest-Bearing Free Credit Balances, Exchange Act Release
No. 34-18262, 4 Fed. Sec. L. Rep. (CCH) 9 25,134B at
8. As originally proposed, Rule 15c3-3 would have required
the segregation of all customer funds in “a ‘Special Account for the
Exclusive Benefit of Customers’ (‘the Special Account’) in the
nature of a trust fund,” as well as requiring a reserve account. See
First Proposal of Rule 15c3-3, 1971 WL 16389, at *2-3 (emphasis
added). As adopted, the Rule dropped the Special Account
requirement and complete segregation in favor of a reserve account
requirement.
10
18,327-3 (Nov. 17, 1981) (“Notice Concerning Interest’); Hon.
Frank Horton, SEC No-Action Letter, 1983 SEC No-Act.
LEXIS 2027 (Mar. 12, 1983); Jn re Newman (Ann), SEC No-
Action Letter, [1970-71 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¥ 78,177 at 80,545 (May 6, 1971) (declining to require
payment of interest on free credit balances inasmuch as such
matters are “governed by contract between the parties”)
(““Newman’’); New York Stock Exchange, Inc. (“NYSE”) Rule
436, NYSE Guide (CCH) § 2436 (1990).
Long before the SEC’s adoption of Rule 15c3-3, the role
of free credit balances in enabling broker-dealers to provide
services to customers had already been recognized by the SEC
in its Special Study of 1963. SEC, Report of Special Study of
Securities Markets, H. Doc. No. 95, 88th Cong., Ist Sess.,
Pt. 1, at 393-94 (1963) (“Special Study”).’ In the Special Study,
the SEC noted that “[f]ree credit balances come into being in
the normal course of the broker-dealers’ business” and that
“[f]rom the point of view of the broker-dealer, free credit
balances represent a desirable source of funds since generally
they can be used interest-free [footnote omitted].” /d. at 393,
394-95 (emphasis suppliec). The SEC concluded that “rigidly
denying broker-dealers the use of such balances would cause
serious dislocation to a significant part of the securities industry”
and that any such denial “would have to be considered in the
9. The Special Study analyzed the effectiveness of the federal
securities laws and regulations and suggested specific
recommendations to strengthen public confidence in the securities
markets. See Special Study at 415. Petitioners take out of context
passages from the Special Study, which “recognized the importance
of the rules and regulations of various state and federal regulatory
agencies ... in providing rights and protection for customers ...”
Pet. 10, n.5 (emphasis in original); Special Study, Ch. III.D.1.d. at
391. This part of the study, however, pertained solely to margin
agreements — not to free credit balances. /d.
pec iS lc
Satta net uae
1]
light of its effect upon the services now provided by the industry.”
Id. at 401 (emphasis supplied). Such services, which may vary
from one firm to another, can include financing and settling
customer margin trades and short sales, settling sales where
customers fail to deliver the securities sold, maintaining custody
of customers’ securities, receiving and crediting dividends and
interest paid on such securities, and others too numerous to
name.
Thus, the SEC, which is charged by Congress with the
protection of investors, has extensively regulated the use of
free credit balances by broker-dealers. The resulting federal
scheme is a carefully balanced one that should not be upset.
B. The New York Courts Properly Applied This Court’s
Preemption Standards
1. This Court Has Consistently Held That State Laws That
Conflict With The Purposes and Objectives of Federal
Regulation Are Preempted
The Supremacy Clause preempts petitioners’ state law
causes of action because they would frustrate the federal
regulation of broker-dealer activities in connection with
customer free credit balances. See U.S. Const., art. VI, cl. 2.
Federal preemption of state law can occur in three circumstances:
where Congress explicitly preempts state law (“express
preemption”), where preemption is implied because Congress
has occupied the entire field of law (“field preemption”), and
where preemption arises from a conflict between federal and
state law (“conflict preemption’). See Capital Cities Cable Inc.
v. Crisp, 467 U.S. 691, 699 (1984). For there to be conflict
preemption, there need not be directly opposing duties between
federa! and state law that would render compliance with both a
literal impossibility. See Schneidewind v. ANR Pipeline Co.,
12
485 U.S. 293, 310 (1988) (preemption may be found even
where “collision between the state and federal regulation may
not be an inevitable consequence.”) (citation omitted); Securities
Indus. Ass'n v. Connolly, 883 F.2d 1114, 1118 (1st Cir. 1989)
(“a direct, facial contradiction between state and federal law is
not necessary to catalyze an ‘actual[ ] conflict’, ...”) (citation
omitted), cert. denied, 495 U.S. 956 (1990). Instead, an
irreconcilable conflict sufficient to give rise to conflict
preemption will exist if state law undermines the federal
regulatory scheme or when state law “stan[ds] 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 federal statute at issue. See Barnett
Bank v. Nelson, 517 U.S. 25, 31 (1996) (citation omitted).
Preemption under such circumstances is well-established. See
International Paper Co. v. Ouellete, 479 U.S. 481, 491-92
(1987); Hillsborough Co., Florida v. Automated Med. Labs,
Inc., 471 U.S. 707, 713 (1985)."°
The doctrine of conflict preemption relates not only to acts
of Congress but also to regulations promulgated by federal
agencies such as the SEC. See, e.g., Capital Cities, 467 U.S. at
699 (Federal Communications Commission). Moreover, state
common law, as well as statutes, may be preempted. See CSX
Transportation, Inc. v. Easterwood, 507 U.S. 658, 675 (1993)
(Secretary of Transportation’s regulations preempted plaintiff’s
common law negligence action); Fidelity Fed. Sav. & Loan
Ass'n v. de la Cuesta, 458 U.S. 141, 154-55, 159 (1982)
(Federal Home Loan Bank Board’s due-on-sale regulation
10. While petitioners make much of caselaw referring to a
presumption against preemption of matters of state exercise of local
police powers, such as with respect to health and safety, the same
concerns are not implicated in state regulation of the national
operations of securities firms and their place in the national system
for clearance and settlement of securities transactions.
ee tate A la %
13
preempted California common law doctrine limiting due-on-
sale provisions).
2. Petitioners’ State Common Law Claims Conflict With
The Purposes and Objectives of The Federal Regulatory
Scheme
The SEC, in regulating broker-dealers’ use of customer free
credit balances, has sanctioned the use of free credit balances
by broker-dealers, recognizing that such use does not usually
involve payment of interest to the customer but nevertheless
has substantial overall benefits for customers and the securities
markets. See Special Study, at 393-95, 401; Notice Concerning
Interest, J 25,1348 at 18,327-3; First Proposal of Rule 15c3-3,
1971 WL 16389, at *6; Newman, J 78,177, at 80,545. The
detailed regulation of free credit balances in Rules 15c3-2 and
15c3-3 contains no provision for compensation to customers
of any imputed income to broker-dealers from the use of free
credit balances; nor does it require segregation of customer
funds, as one would expect in a fiduciary relationship. Rather,
the regulatory approach relies on specific disclosure
requirements, including disclosures that the free credit balances
will not be segregated, unlike fiduciary funds, and that the
customer’s broker-dealer can use these balances in its business.
Petitioners do not allege that respondents violated these
disclosure requirements.
Instead, petitioners complain that respondents fail to disclose
that they “will obtain and retain economic benefits” from the
use of customer free credit balances; do not advise customers
“of the nature and extent of the economic benefit actually
derived” and do not “describe, report or identify what free credit
balances are nor the amount of the Plaintiffs’ or Class members’
free credit balances on hand at any time.” (Pet. App. A65-66 at
Yi 25-26) (emphasis supplied). Petitioners thus seek additional
14
disclosure beyond the SEC-mandated disclosure of Rule
15c3-2 — a Rule from which the SEC deliberately deleted any
requirement that payment or non-payment of interest be
disclosed. The disclosure plaintiffs seek is, therefore, inconsistent
with, and thus preempted by, federal law.
This Court found in Barnett Bank that state law may not
forbid what federal law purposefully permits. In that case, this
Court ruled that a federal statute permitting national banks to
sell insurance preempts state law to the contrary, stating:
In this case we must ask whether or not the Federal
and State Statutes are in “irreconcilable conflict.”
The two statutes do not impose directly conflicting
duties on national banks — as they would, for
example, if the federal law said, “you must sell
insurance,” while the state law said, “you may not.”
Nonetheless, the Federal Statute authorizes national
banks to engage in activities that the State Statute
expressly forbids. Thus, the State’s prohibition of
those activities would seem to “stand as an obstacle
to the accomplishment” of one of the Federal
Statute’s purposes....
Id. at 31 (emphasis supplied). Accord Capital Cities, 467 U.S.
at 699 (striking state law forbidding cable companies from
broadcasting federally-permitted liquor advertisements). This
Court’s reasoning in Barnett Bank is applicable to this action.
Since being given authority by Congress to regulate the
treatment of customer free credit balances more than two decades
ago, the SEC has not only permitted the present treatment by
broker-dealers of free credit balances, it has specified, in Rule
15c3-2, the disclosure that must be made to the customer with
respect to these balances. As discussed above, the SEC has chosen
not to require that all or part of any benefit obtained from broker-
15
dealers’ use of customer free credit balances inure to those
customers. Indeed, the SEC deliberately rejected the treatment
of free credit balances as trust funds. See Second Proposal of
Rule 15c3-3, | 78,801 at 81,729-30; Adoption of Rule 15c3-2,
{ 77,006 at 81,668 (May 27, 1964); Proposal of Rule 15c3-2,
{ 76,978 at 81,622. This regulatory choice may not be
overridden by state common law. See Edgar v. MITE Corp.,
457 U.S. 624, 635 (1982) (plurality found conflict preemption
where federal requirements like those of state law had been
considered but rejected).
Further, application of state law to the treatment of free
credit balances by broker-dealers would unduly encroach upon
the balance of interests struck by Congress and the SEC in
regulating that practice. See Edgar, 457 U.S. at 634, 639
(plurality found that state anti-takeover statute upset
congressional balancing of management’s and shareholders’
interests by favoring the former). The SEC has attempted to
provide, so much as possible, “virtually complete customer
protection” while not “depriving the industry of necessary and
legitimate means to carry on customer oriented business.” First
Proposal of Rule 15c3-3, 1971 WL 16389, at *6.
Petitioners cite Freightliner Corp. v. Myrick, 514 U.S. 280,
282 (1995), for the proposition that “the absence of a federal
standard cannot implicitly extinguish state common law.” Pet.
13. In Freightliner, the defendants claimed that certain
regulations of the National Highway Traffic Safety
Administration (“NHTSA”) concerning air brakes preempted
the petitioners’ state law negligent design claims. The Ninth
Circuit, however, had previously enjoined NHTSA from
enforcing those regulations, citing the agency’s failure to show
sufficient evidence to justify its regulations. See Paccar, Inc. v.
NHTSA, 573 F.2d 632, 640-43 (9th Cir.), cert. denied, 439
U.S. 862 (1978). Accordingly, this Court found that the lack
16
of federal regulation did not result from any affirmative decision
by the agency not to regulate, but from a federal court order.
Id. at 286-87. Unlike the NHTSA in Freightliner, however, the
SEC has extensively studied and specifically rejected the
requirement that broker-dealers treat free credit balances as trust
funds. Accordingly, the SEC’s decision is a carefully considered
federal standard that extinguishes all inconsistent state common
law causes of action.
Even if characterized solely as a decision not to regulate, a
decision by a federal agency to take a “hands-off” approach
does not serve as a signal to a State that it may regulate. See Ray
v. Atlantic Richfield Co., 435 U.S. 151, 178 (1987) (“ ‘where
failure of . . . federal officials affirmatively to exercise their full
authority takes on the character of a ruling that no such
regulation is appropriate or approved pursuant to the policy of
the statute,’ [s]tates are not permitted to use their police power
to enact such a regulation.”) (quotation and citation omitted);
Carstensen v. Brunswick Corp., 49 F.3d 430, 431 (8th Cir.)
(“The decision not to regulate has the same preemptive force as
a decision to regulate.”), cert. denied, 516 U.S. 866 (1995);
Pokorny v. Ford Motor Co., 902 F.2d 1116, 1123 (3d Cir.)
(finding preemption of state defective design claim where less
restrictive federal automobile safety regulation was intended to
preserve industry flexibility and customer choice), cert. denied,
498 U.S. 853 (1990)."
11. Petitioners also cite this Court’s recent decision in
Medtronic v. Lohr, 518 U.S. 470, 116 S. Ct. 2240 (1996), for the
proposition that “substantially identical state and federal standards
of behavior or performance [do not] preempt state causes of action.”
Pet. 13. Petitioners concede, however, that the obligations they seek
to impose are not “substantially identical” to the federal scheme. /d.
Moreover, the decision in Medtronic turned upon the meaning of a
Statutory term — “requirements” — that is not at issue here. See
Medtronic, 518 U.S. at __, 116 S. Ct. at 2255-59.
NR DRe RS a abe Ed WIR Ld Od Be
17
In sum, by asking that respondents’ treatment of free credit
balances be subjected to greater obligations under state law than
under federal regulation, petitioners would have state courts
eviscerate the SEC’s carefully drawn regulatory scheme. The
New York courts properly found that the Supremacy Clause
does not permit this.”
Il.
THERE IS NO CONFLICT BETWEEN THE
LEGISLATIVE PURPOSE OF SECTION 28(a) OF THE
EXCHANGE ACT AND THE LOWER COURTS’
FINDING THAT PETITIONERS’ CLAIMS ARE
PREEMPTED.
Petitioners rely upon the “Savings Clause” of the Exchange
Act, Section 28(a), to posit a “conflict” that needs to be resolved
by this Court. They argue that the lower courts in this action
“failed to consider” that Section 28(a) provides that “the
Exchange Act’s rights and remedies are ‘in addition to any and
all other rights and remedies that may exist a law or in equity.’ ”
Pet. 11. In fact, the Section 28(a) argument was presented to
the Appellate Division in extensive briefing and at oral
argument, and rejected.'’ The New York Court of Appeals then
12. For purposes of opposing the petition for a writ of
certiorari, respondents will not fully address the alternative grounds
raised below for dismissal. As argued below, however, the complaint
should also be dismissed under the Commerce Clause of the
Constitution and pursuant to the principles of primary jurisdiction.
Moreover, as discussed, infra, Point III, there is no merit to
petitioners’ state law claim.
13. See Brief For Defendants-Appellants, at 25-26, n.15, Brief
For Plaintiffs-Respondents, at 14-16; and Reply Brief For
Defendants-Appellants, at 14-16, all in the Appellate Division, Index
No. 111667/94.
18
refused to grant leave to appeal that decision. (Pet. App. A31).
Moreover, as petitioners fail to mention, numerous courts have
addressed this issue in recent years, primarily in the context of
challenges to the practice known as “payment for order flow.”
In every such action in which the merits have been addressed,
the courts have ultimately found in favor of preemption.
In any event, petitioners’ argument is without merit. Conflict
preemption has been found by this Court despite the existence
of savings clauses in federal statutes. For example, this Court
held that Vermont’s common law cause of action for nuisance
against a water pollution source in New York was preempted
by the Clean Water Act, despite the Act’s savings clause, which
provided that “nothing. .. shall restrict any right which any
person ... may have under any ... common law ... to seek
any other relief.” Jnternational Paper Co. v. Ouellette, 479 U.S.
481 (1987). This Court found that permitting the law of a state
in which the pollution source was not located to impose a
“separate discharge standard . . . would be a serious interference
with the achievement of the ‘full purposes and objectives of
Congress.’ ” Ouellette, 479 U.S. at 493. This Court concluded
that “[i]t is unlikely — to say the least — that Congress intended
to establish such a chaotic regulatory structure.” /d. at 497. See
also Michigan Canners & Freezers Ass'n v. Agricultural
Marketing and Bargaining Bd., 467 U.S. 461 (1984) (Michigan
statute preempted by Agricultural Fair Practices Act because of
conflict between the Michigan statute and that Act, despite a
savings Clause similar to Section 28(a)).
Similarly, a plurality of this Court has determined that
Section 28(a) did not foreclose conflict preemption but “left
the determination [of preemption] ... to the courts.” Edgar,
457 U.S. at 631. Thus, as the New York Court of Appeals
found in Guice, Section 28(a) negates a finding of “field”
preemption, but it does not alter the conflict preemption analysis.
19
Guice, 89 N.Y. 2d at 49-50, 674 N.E. 2d at 291-92, 652 N.Y.S.
2d at 361-62. The Appellate Division properly recognized that
such reasoning applies with equal force to petitioners’ argument
that Section 28(a) expressly preserves their claims. After
considering this argument and the New York Court of Appeals’
unanimous holding in Guice, the Appellate Division decided
that this action was controlled by Guice. (Pet. App. A37).
Petitioners do not challenge the holding of Guice. Rather,
petitioners dispute that Guice is similar to this action, Pet. 16-
17 & n. 6, an argument expressly rejected by the Appellate
Division and implicitly rejected by the New York Court of
Appeals when it determined that no substantial constitutional
issue was directly presented in petitioners’ unsuccessful effort
to appeal to that court. (Pet. App. A26). Guice involved state
common law claims relating to “payments for order flow”, i.e.,
allegedly undisclosed benefits obtained by broker-dealers in
connection with execution of orders for customer accounts.
Payments for order flow are the subject of SEC rules that require
disclosure of payment for order flow practices on customer
confirmations and account statements, as well as upon opening
new accounts. See Guice, 89 N.Y. 2d at 39-43, 674 N.E. 2d at
286-88, 651 N.Y.S. 2d at 356-58. Although these regulations
specify how and when information about brokers’ receipt of
payments for order flow is to be disclosed to customers, the
SEC has refused either to ban the practice or to require brokers
to pass the benefits of payments for order flow along to their
customers. In light of this regulatory history, the New York
Court of Appeals held that state law causes of action against
two defendant broker-dealers for, inter alia, breach of fiduciary
duty were preempted by the Supremacy Clause because they
conflicted with federal law. The court reasoned:
Permitting the courts of each State to impose civil
liability on national securities brokerage firms .. .
LE
20
for failure to meet more stringent common-law
agency standards of disclosure of receipt of order
flow payments ... would inevitably defeat that
congressional purpose of enabling the SEC to
develop and police that “coherent regulatory
structure” for a national market system. Securities
broker-dealers, confronted with the risk of nation-
wide class action civil damage liability, including
restitution of commissions and punitive damages... .
would be impelled to tailor their disclosures to each
State’s common law agency jurisprudence, and the
carefully-crafted SEC disclosure requirements would
have little, if any, influence. Surely “[i]t is unlikely
— to say the least — that Congress intended to
establish such a chaotic regulatory structure...”
* * *
When, thus, a State’s regulation, through the
imposition of common-law tort liability or otherwise,
adversely affects the ability of a Federal
administrative agency to regulate comprehensively
and with uniformity in accordance with the
objectives of Congress, “then the state law may be
pre-empted even though ‘collision between the state
and federal regulation may not be an inevitable
consequence...’ ”
Guice, 89 N.Y. 2d at 46-47, 674 N.E. 2d at 290, 651 N.Y.S.
2d at 360 (citations and footnote omitted). This Court declined
to review the New York Court of Appeals’ decision. 117 S. Ct.
1250 (1997)."*
14. Petitioners claim that the order flow decisions do not
control the result here because the order flow payments involved in
(Cont'd)
iiienieaaeaimiiiiiiiiihiiaaaaiasiiiiill
21
The issues raised in this case are, in all material respects,
virtually identical to those addressed in Guice. Here, as in Guice,
the plaintiffs assert that defendant broker-dealers obtained
unaccounted-for benefits from plaintiff’s’ securities accounts,
which they did not pass along to their customers, allegedly in
violation of state common law duties. Here, as in Guice, the
claims purportedly extend to a nationwide class of plaintiffs
and would effectively require all broker-dealers to conform their
nationwide operations to state law standards. Here, as in Guice,
the complaints seek monetary relief for the asserted breaches of
fiduciary duty. Here, as in Guice, the complaint asserts claims
based upon nondisclosure of matters of which the SEC does
not mandate disclosure. Compare Guice, 89 N.Y. 2d at 38-39,
674 N.E. 2d at 285, 651 N.Y.S. 2d at 355 with Pet. App. A65-
66 at J 25-26. Here, as in Guice, the SEC has not prohibited
the challenged practice but has sought to balance conflicting
policy concerns by regulations through disclosure and other
requirements. See First Proposal of Rule 15c3-3, 1971 WL
16389, at *6. Here, as in Guice, conformance to one or more
State law standards would moot the SEC regulations by
suppressing a practice explicitly found by the SEC to have
important benefits to customers. See Special Study, at 393-401.
Finally, here, as in Guice, the SEC has extensively studied and
consistently adhered to its regulatory approach. Its regulation
has, from the start, been premised on its finding that the
(Cont'd)
those cases, unlike free credit balances, have been the subject of
extensive study by the SEC. Pet. 16. This contention is rebutted by
the legislative and regulatory history discussed earlier in this brief,
establishing that both the SEC and Congress carefully studied,
recognized the benefits of, and approved the use of free credit
balances by broker-dealers without payments to customers.
Moreover, under section 15(c)(3) of the Exchange Act, the SEC
possesses pervasive authority to monitor the use of free credit
balances by broker-dealers.
22
relationship of broker to customer in the handling of customer
free credit balances is one of debtor-creditor, and thus the
payment of interest on such balances is a matter of contract, not
a matter of right. See supra, Point I.
Moreover, Guice stands as part of a consistent line of cases
finding that the federal securities laws preempt certain state
common law claims against broker-dealers where those claims
are based on state law that is more restrictive than the carefully
considered federal regulatory scheme. See, e.g., Dumont v.
Charles Schwab & Co., Nos. 96-C-2685 & 97-CA-1225 (La.
Ct. App. 4th Cir. Apr. 8, 1998); Orman v. Charles Schwab &
Co., 688 N.E. 2d 620, 621, 625-26 (Ill. 1997), petition for
cert. filed (Feb. 18, 1998) (No. 97-1367); Shulick v. Paine
Webber, Inc., 700 A.2d 534, 536, 538 (Pa. Super. Ct. 1997);
Eirman v. Olde Discount Corp., 697 So. 2d 865, 866 (Fla.
Dist. Ct. App.), certification denied, (Fla. Aug. 28, 1997); Dahl
v. Charles Schwab & Co., 545 N.W. 2d 918 (Minn.), cert.
denied, 117 S. Ct. 176 (1996).
Ill.
THE FACTS OF THIS LITIGATION ARE UNIQUE
AND UNLIKELY TO RECUR.
Petitioners’ claim that this case is of such great importance
as to warrant this Court’s review ignores the limited scope of
the conflict in issue. The SEC’s regulation of free credit balances
preempts only a narrow subset of state law claims. The
unimportance of these claims is borne out by the fact that only
one other state court case has presented a conflict between the
purported state law obligations of broker-dealers in handling
free credit balances and the federal regulatory scheme and that
case has been dismissed without appeal. See Jn Re Prudential
Secs., Inc. Sweep Litigation, No. 122747/95 (N.Y. Sup. Ct.
ET OR Sati
23
N.Y. Cty. Jun. 24, 1997). (Resp. App. 20a).'° And, petitioners’
claims are in any event without merit.'® Moreover, as noted
15. Thus, certiorari should also be denied because the
particular conflict between state and federal law presented by this
case is unlikely to recur. It is entirely possible that, once this
litigation is concluded, this issue will not be presented to any court
any time soon. The progress of this litigation demonstrates why.
Petitioners brought suit against eleven of the largest firms in the
securities industry. As noted above, the class they sought to represent
was inherently unwieldy and tremendously diverse in interests, and
the particular practices at issue varied greatly by time, individual
defendant, and type of transaction and account. The trial court's
October 2, 1996 opinion denying the motion for class certification
left grave doubis as to whether, under these circumstances, such a
class could ever be certified. (Resp. App. la). Petitioners’ claims
would require the factfinder to unravel, at a minimum, virtually every
securities transaction in petitioners’ accounts throughout the
applicable limitations period. Furthermore, as discussed below, there
is no state law duty to pay interest or any other compensation for
use of free credit balances; the relationship between a brokerage
firm and its customers, when they choose to leave funds idle in their
accounts, is that of debtor-creditor.
16. Petitioners’ theory that a fiduciary relationship is created
whenever a broker-dealer handles customer funds directly conflicts
with controlling authority in New York regarding the limited
circumstances in which broker-dealers owe fiduciary duties to their
customers. Because almost every aspect of the ordinary customer-
broker business involves the handling of customer assets, if
petitioners’ position were correct, a broker-dealer necessarily would
owe a fiduciary duty to its customer virtually at all times. This is not
the law; the New York courts have held that “a broker does not, in
the ordinary course of business, owe a fiduciary duty” to a customer.
See, e.g., Perl v. Smith Barney Inc., 230 A.D.2d 664, 666, 646 N.Y.S.2d
678, 680 (N.Y.A.D. Ist Dep't), appeal denied, 89 N.Y.2d 803, 675
N.E.2d 1234, 653 N.Y.S.2d 281 (N.Y. 1996); Fekety v. Gruntal & Co.,
(Cont'd)
24
above, the broader issue — the impact of Section 28(a) on state
law claims that conflict with the Exchange Act — has been
resolved with substantial uniformity by the lower courts, See
supra Point II. Finally, the practices of which petitioners
complain are of decreasing practical importance. Competition
in the brokerage industry has increasingly led respondents and
other broker-dealers to offer “sweep” accounts in which free
credit balances are automatically invested in money market
funds. Thus, the free market has provided a response, bearing
out the wisdom of the SEC’s insistence that payment of interest
on free credit balances is “governed by contract between the
parties.” Newman, J 78,177, at 80,545.
(Cont'd)
191 A.D. 2d 370, 371, 595 N.Y.S.2d 190, 190-91 (N.Y.A.D. Ist Dep't
1993). See also Press v. Chemical Inv. Servs., No. 96 Civ. 8331, 1997
WL 795100, *8-10 (S.D.N.Y. Dec. 22, 1997), and cases cited therein.
This is consonant with “[t}he general [common law] rule ... that a
broker is not the fiduciary of his customer unless the customer
entrusts him with discretion to select the customer’s investments”
Carr v. CIGNA Secs., 95 F.3d 544, 547 (7th Cir. 1996) (Posner, C.J.).
Similarly, petitioners’ unjust enrichment theory is fatally flawed. The
right to use funds (which petitioners do not challenge, see Pet. 2-3)
implies the right to retain the earnings thereon, unless otherwise
agreed. See, e.g., Surrey Strathmore Corp. v. Dollar Sav. Bank, 36
N.Y.2d 173, 177, 325 N.E.2d 527, 529-30, 366 N.Y.S.2d 107, 110-11
(1975) (permitting bank to retain benefits earned from using
customer funds inasmuch as bank was authorized to use funds).
Moreover, petitioners have not pleaded, nor can they, that any
enrichment of respondents was at the “expense” of petitioners, i.e.,
that any plaintiff has demanded access to his or her free credit
balance and that the demand was rejected.
25
CONCLUSION
For the foregoing reasons, respondents respectfully request
that this Court deny the petition for certiorari.
Respectfully submitted,
A. ROBERT PIETRZAK
Counsel of Record
CATHLEEN M. TIERNAN
DANIEL A. McLAUGHLIN
BROWN & WOOD LLP
One World Trade Center
New York, New York 10048
(212) 839-5300
TIMOTHY S. BISHOP
MAYER, BROWN & PLATT
190 South LaSalle Street
Chicago, Illinois 60603
(312) 782-0600
Attorneys for Respondents
April 10, 1998
la
APPENDIX A — MOTION AND MEMORANDUM OPINION
OF THE SUPREME COURT OF THE STATE OF NEW YORK,
NEW YORK COUNTY FILED OCTOBER 2, 1996
SUPREME COURT OF THE STATE OF NEW YORK —
NEW YORK COUNTY
PRESENT: Hon. Charles E. Ramos Part 53
Justice
INDEX NO. 111667/94
MOTION DATE 7/30/96
MOTION SEQ. NO. 006
MOTION CAL. NO. 01
ESTATE OF DAVID J. BRAUNSTEIN, et al.
es
MERRILL LYNCH, PIERE, FENNER & SMITH, Inc., et al.
“ae See
Cross-Motion: 0 Yes Mi No
Upon the foregoing papers, it is ordered that this motion
for class certification is decided in accordance with the annexed
memorandum.
Dated: 9/26/96 s/ Charles E. Ramos
; J.S.C.
2a
Appendix A
SUPREME COURT OF THE STATE OF NEW YORK
COUNTY OF NEW YORK: COMMERCIAL DIVISION
THE ESTATE OF DAVID J. BRAUNSTEIN and ROSEMARIE
BRAUNSTEIN, et al.,
Plaintiffs,
- against -
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED et al.,
Defendants.
CHARLES E. RAMOS, J:
This is an action by the customers of several major securities
brokerage firms, challenging the control and use of “free credit
balances” on their customers’ investment accounts. Plaintiffs
move, pursuant to CPLR §§ 901 and 902, for an order to certify
the class action on their claims for common law breach of
fiduciary duty and unjust enrichment.
THE FACTS
Plaintiffs are twelve Arizona residents' and customers of
the defendants which do business or are headquartered in New
York. Plaintiffs seek to represent a class consisting of:
1. Several of the named plaintiffs originally filed this litigation
in Arizona Superior Court on July 12, 1993. The case was then stayed
on forum non convenience grounds by order dated November I,
1993, in which the court held that New York was a more appropriate
(Cont'd)
3a
Appendix A
All persons or entities who have, or have had
accounts with one or more of the defendants in
which they have had free credit balances which
existed overnight or longer from which the
defendants have received economic benefits for
which the defendants have not properly accounted
to the plaintiffs. Excluded from the class are the
defendants, all employees of the defendants and the
members of their immediate families, the subsidiaries
and affiliates of the defendants, any trusts of any
entities which they control or of which they are the
beneficiaries and the heirs, successors or assigns of
any of the defendants.
(First Amended Complaint at p. 9). Free credit balances are
cash balances in a customer’s account which are otherwise
unencumbered, and are subject to immediate cash payment to a
customer on demand. Generally, they result from sales of
securities, dividends, interest, or transfers of account balances
from one broker to another, and may exist overnight or longer
depending upon the type of transaction involved. Defendants
use these balances to make loans to other customers at allegedly
relatively high interest rates. At issue is whether defendants can
profit from such use without paying to their customers any
portion of the profits earned on the use of the customer’s funds.
On June 7, 1995, Justice Walter Schackman of this court
dismissed the complaint without prejudice for failure to plead a
(Cont'd)
forum for the litigation. Further holding that “(should the New York
court impose any substantial impediment to or limitation upon that
litigation which this court would not impose,” the court would
consider vacating the stay and denying the defendants’ motion to
dismiss. (Plaintiffs’ Notice of Motion, Second Ex. A, p.8).
4a
Appendix A
breach of fiduciary duty and unjust enrichment with the requisite
particularity under CPLR § 3016(b). In his ruling, he found
that broker-dealers are permitted to use free credit balances for
their own purposes, under Securities Exchange Rule 15c3-2
and 15c3-3, and that “to the extent that the balances are thus
used, they are not being misused; there has been no breach of
trust.” (J. Schackman’s Order, 6/7/95 at p. 3).
Plaintiffs then served the amended complaint which alleges
that the defendants have adopted methods and procedures to
use free credit balances which have been unnecessarily created
or left in customers’ accounts for longer periods than necessary.
It further alleges that defendants have failed to adequately
disclose, or account to plaintiffs for profits earned from the use
of their balances. Plaintiffs seek restitution of any profit earned
by defendants, an accounting, and injunctive relief.
The amended complaint was upheld by Justice Schackman
in his order dated May 7, 1996. Therein, he states that: “the
relationship between a stockbroker and its customer . . . is that
of principal and agent and, thus, is fiduciary in nature.” In
quoting Greenwald v. Shearson Lehman Brothers, Inc., (NYLJ,
Nov 4, 1993, at 22, col.3 [Sup Ct, NY County]), he also states
that:
Whenever the broker is acting as the agent of the
customer, for example, in executing a customer’s
order or handling customer funds, the customer has
the right to assume and to rely on the fact that the
broker is acting for his or her benefit at all times
during the relationship. (Cite omitted).
(Decision, at p. 3; citing Evangelist v. Fidelity Brokerage
Services, Inc., _. AD2d __, 637 NYS2d 392 [Ist Dept 1996]
Sa
Appendix A
[reversing dismissal of class action complaint against securities
broker alleging breach of fiduciary duty resulting from failure
to disclose practice of receiving order flow payments from
market makers as inducement for placing orders with them];
Feinberg v. Dean Witter Reynolds, Sup Ct, NY County, August
14, 1992, Arber, J., Index No. 11868/92 [fiduciary duty may
exist regarding undisclosed $50 service charge on brokerage
accounts]}).
CPLR ARTICLE 9
Under CPLR § 901(a), one or more members of a class
may sue or be sued as representative parties on behalf of all if:
1) the class is so numerous that joinder of all
members, whether otherwise required or
permitted, is impracticable;
2) there are questions of law or fact common to
the class which predominate over any
question affecting only individual members;
3) the claims or defenses of the representative
pasties are typical of the claims or defenses
of the class;
4) the representative parties will fairly and
adequately protect the interest of the class;
and
5) a class action is superior to other available
methods for the fair and efficient adjudication
of the controversy.
6a
Appendix A
The goal of the class action device is to “achieve economics
of time, effort, and expense, and promote uniformity of decision
as to persons similarly situated”. (Sanders v. Robinson
Humphrey/American Express, Inc., 634 F Supp 1048, 1054;
Friar v. Vanguard Holding Corp., 78 AD2d 83, 91 [2nd Dept.
1980]). The movant bears the burden of proving that all of the
prerequisites of CPLR § 90 (a) have been met, which must be
shown by offering more than mere conclusory allegations. (Katz
v. NVF, 100 AD2d 470, [ist Dept. 1984]; Brandon v. Chefetz,
121 Misc.2d 54, 56 [1st Dept 1983]). It is not until all of the
prerequisites of § 901 (a) have been met that the court can
consider CPLR § 902 which sets forth five illustrative guidelines
for the court to determine the viability of a class action. Whether,
or not, to certify a class is within the court’s discretion. However,
the statute should be liberally construed, since the state’s policy
is in favor of maintenance of class actions. (Brandon v. Chefetz,
106 AD2d 162 [Ist Dept. 1985]). Because Article 9 of the CPLR
is modeled on Rule 23 of the Federal Rules of Civil Procedure,
New York courts have looked to interpretations of Rule 23 for
guidance. (Stern v. Carter, 82 AD2d 321 [2nd Dept 1978];
2 Weinstein-Korn-Miller, NY Civ Prac 9 901.02).
FINDINGS
In applying the criteria of CPLR § 901(a), the court finds
that while the class is sufficiently numerous, class action is not
currently warranted. Because plaintiffs have not shown a
common course of conduct in the mishandling of accounts,
class certification must be denied as to this aspect of the
complaint. Breach of a duty to disclose and the claim for unjust
enrichment are commonly based upon similar facts. However,
under the remaining criteria, plaintiffs have failed to demonstrate
that there are common issues of law, a typicality of claims and
7a
Appendix A
practices of the various defendants that allegedly give rise to
those claims, and that the plaintiffs can adequately represent
the class. On this record, the court also cannot find that a class
action is a superior method, and therefore, the motion for class
certification is denied without prejudice to renew.
DISCUSSION
The number of potential class members in this proposed
nation-wide class action lies somewhere in the millions. Plaintiffs
need not specify an exact number of class members, but must
show only that joinder is impracticable through “some evidence
or reasonable estimate of the number of purported class
members.” (Zeidman v. J. Ray McDermott & Co., 651 F2d
1030, 1038 [Sth Cir. 1981]). Defendants have indicated that
they maintained a total of approximately 23,600,000 accounts,
in 1993, on which approximately 1,170,000 transfers occurred.
None of them contend that the plaintiffs have not met the
numerosity requirement, and thus, this court finds that the first
prerequisite of CPLR § 901(a) has been satisfied.
Defendants essentially oppose class certification on the
grounds that common questions do not predominate. They
allege that a trial will require examination of: each of the
defendants’ various types of customer accounts; the policies
and procedures of each defendant for handling their accounts;
the various type of transactions creating free credit balances;
the identity of those portions actually used; the timing of the
availability of each free credit balance; and the amount by which
each defendant has benefitted. (Def. Memo. p. 24-32).
Defendants also contend that common issues do not
predominate because individual issues will be raised since class
8a
Appendix A
members reside throughout the United States and in some
foreign jurisdictions, and thus, the court will have to apply the
laws of all fifty states. Some customers have signed account
customer agreements which contain choice of law provisons.
Defendants allege that the court will have to apply the laws of
at least three states, and perform a conflict of laws analysis for
those class members who have not signed an agreement. Thus,
they conclude that a case of this magnitude is unmanageable,
and therefore, class certification should be denied.
Commonality is established, under CPLR § 901 (a) (2),
when the activity complained of involves one set of operative
facts from which plaintiffs’ claims arise. (Green v. Wolf, 406
F2d 291, 299-300 [2d Cir. 1968], cert denied, 395 US 977
[1969]; Friar v.. Vanguard Holding Corp., supra 78 AD2d at
99). “It is unnecessary that every question be common to each
member of the class; all that is required is that common questions
predominate over individual ones.” (Gilman v. Merrill Lynch,
Pierce, Fenner & Smith, Inc., 93 Misc.2d 941, 947 [Sup. Ct.
NY County 1978]). Generally, the courts focus on the liability
issue in deciding whether the predominance requirement has
been met, and if the liability issue is common to the class,
common questions are held to predominate over individual
questions. (Dura-Bilt Corp. v. Chase Manhattan Corp., 89 FRD
87, 93 [SD NY 1981] citing, Sargent v. Genesco Inc., 75 FRD
79 [M.D. Fla. 1977]; Brady v. Lac Inc., 72 FRD 22 [SD NY
1976}).
Some courts have held that commonality is satisfied when
the plaintiffs’ complaint centers on the defendants having
engaged in a common course of conduct, or a common core of
facts which clearly links the class members to the resolution of
the litigation even though the individuals are not identically
9a
Appendix A
situated. (Weinstein-Korn-Miller, NY Civ Prac J 901.11). On
this basis, commonality can be inferred until it is proven at trial
that the plaintiffs and all class member are similarly situated.
(See, Brandon v. Chefetz, supra 106 AD2d at 167 [granting
class certification where defendant participated in a common
scheme by using long term compensation agreements to
misappropriate portions of the shareholders’ profits]; Stellema
v. Vantage Press, Inc, 121 Misc.2d 1058 [Sup Ct NY County
1983], aff’d in part, mfd in part, 109 AD2d 423 [lst Dept
1985] [finding the representations were uniform and generally
transmitted in two documents]; Green v. Wolf Corporation, supra
406 F2d 291 [granting class certification where the defendants’
misrepresentations in three prospectuses comprised a common
course of conduct]; Jn re Lilco Securities Litigation, 111 FRD
663 [ED NY 1986] [finding a common course of conduct after
defendants failed to disclose material information in written
documents “addressed to the class as a whole[.]”; Vulcan Society
of Westchester County v. Fire Dept. Of City of White Plains, 82
FRD 379 [SD NY 1979] [finding four defendant municipalities
had engaged in a common course of conduct by using the same
written examination purportedly to further their discriminatory
hiring practices]; Roberts v. Heim, 670 F Supp 1466 [ND Cal
1987], aff’d in part mdfd in part, 857 F2d 646 [finding a
course of conduct based upon an alleged conspiracy]).
Some courts, however, have declined to find a common
course of conduct. (See, Sanders v. Robinson Humphrey/
American Express, Inc., supra, 634 F.Supp T0487 ND Ga T9868]
{finding that there was no proof of a uniform “sale pitch” by
the defendants to all the members of the proposed classes]; Jn
re Scientific Control Corp. Securities Lit., 80 FRD 237 [SD
NY 1978] [rejecting, as against certain defendants, allegations
of a common course of conduct where there was no proof that
10a
Appendix A
they used misleading written financial statements]; Evans v. City
of Johnstown, 97 AD2d 1 [3d Dept 1983] [denying class action
for personal injury claims arising from operation of sewage plant
because individual issues of causation and damages are particular
to each plaintiff]; See, also Castano v. American Tobacco
Company, 84 F3d 734 [Sth Cir 1996] and Jn re American
Medical Systems, Inc., 75 F3d 1069 [6th Cir 1996] [no common
course of conduct in mass products liability or negligence cases
because proof will vary from plaintiff to plaintiff on the issue
of causation. ]})
Two distinct breaches of fiduciary duty have been alleged
in the complaint: 1) a failure to disclose, and 2) a mishandling
of customers’ accounts. (Amended Complaint, p. 12 at J 20).
A common course of conduct in breach of a duty to disclose
will, if proven at trial, support all of the class members’ claims.
However, no common core set of facts have been shown which
would support the allegation that all accounts have been
similarly mishandled.
Regardless of the type of account, no lesser duty is owed
to a stockbroker’s customer than the duty to disclose any material
information regarding the account (See, Richardson v. Shaw
209 US 365 [1908]). Once a transaction is made and until its
completion, or where there has been a reposing of trust, the
same duty is owed to all account holders. (See, Le Marchant v.
Moore, 150 NY 209 [1896]; Hopkins v. Clarke, 158 NY 299
[1899}). Plaintiffs have alleged that each defendant unilaterally
controls a customer’s free credit balances, and therefore, all
customers have reposed a similar type of trust. On this issue,
defendants have not shown that individual questions
predominate, because, arguably, a duty may attach to any
customer’s account where a free credit balance exists. For
lla
Appendix A
example, if free credit balances are found to occur prior to the
end of a transaction, or are within a broker’s exclusive control,
it may be found a duty is owed until the transaction is complete,
and until the balance is no longer “free”. Therefore, proof of a
duty to disclose need not depend on individual facts particular
to each class members’ account.
Similar to the cases cited above, common questions will
predominate on this issue because each member may have claims
against the defendants for omitting this information from their
customers’ written account statements. In breach of their duty,
plaintiffs have alleged that each defendant sends to all customers
an account statement which fails to disclose the dollar amount
of existing free credit balances, and that their customers will
not receive any of the benefits earned. (Amended Complaint,
p. 14 at J 24). Although defendants admit that a customer has a
right to withdraw their free credit balances on demand, it has
been asserted that “a client [can] not tell specifically [from the
account statements] whether his balance is a free credit balance
or not’. (Dolan Deposition, at p. 38 [2]-41[13]). Thus, the
wrong complained of may be identical for each of the class
members. Similarly, the several defenses that have been raised
are available against all class members.
This court is unpersuaded by defendants’ contention that
plaintiffs will have to prove that each class member lacks
knowledge of the “longstanding industry-wide practice” not to
pay customers part the benefits earned. Because the members’
claims are based upon the failure to disclose the amount of the
balances, the defendants, not the plaintiffs, may be required to
prove that adequate notice was given. The defendants’ assertion
that a notice appearing on the reverse-side of the account
Statements adequately discloses to the customer “the right to
12a
Appendix A
use” and “the customers’ right to withdraw such balances on
demand” is dispositive on this issue is premature. (Def. Memo.
p. 28 and 39). They argue individual issues will predominate
in raising their defenses because notice, waiver, and estoppel
all require proof that each class members knew about the use of
the balances, knowingly relinquished their right to any benefits
earned, and thereby, caused them to rely upon a customer’s
actual or implied consent. While certain class members may be
more sophisticated or knowledgeable than others about the use
of free credit balances, those facts are not so particular to
individual class members that subclasses cannot be created to
address this problem. Inferences can be drawn from the
defendants’ written notice, therefore, it may be implied, as to
certain class members, that they knew or should have known
about the use of free credit balances. (Derenco, Inc. v. Benj.
Franklin Federal Savings & Loan Assn., supra 577 P.2d 477
[Sup Ct Oregon, 1977]). Whatever differences do exist with
regard to actual knowledge, these can be proven at the same
time as individual damages are proven. (Compare, Stellema v.
Vantage Press, supra 109 AD2d at 426). Thus, this is not a
basis for denying class certification on the issue of liability.
(Ray v. Marine Midland Grace Trust, 35 NY2d 146, 154 [1974];
Dura-Bilt Corp. v. Chase Manhattan Corp., supra, 89 FRD
87 [SD NY 1981)).
Based upon these allegations, it may or may not be found
that plaintiffs have a quasi-contract right to an accounting for
the benefits earned. The circumstances surrounding the parties’
relationship will no doubt encompass a duty to disclose, and if
the failure to disclose is found to unjustly enrich the defendants,
then plaintiffs and the class members may be entitled to equitable
or monetary relief. (See, Derenco, Inc. v. Benj. Franklin Federal
Savings & Loan Assn., supra 577 P.2d 477 [Sup Ct Oregon,
1977}).
13a
Appendix A
On the question of damages, individual issues clearly
predominate over common issues. Since if damages are found,
a determination may depend upon the amount of free credit
balances existing on an account, whether the balances were used,
or the members’ type of account. However, this is no reason to
deny class certification because under such circumstances the
court has the authority to order a bifurcated trial with respect to
liability and damages. (Friar v. Vanguard Holding Corp., supra
78 AD2d at 99).
As to the second aspect of the claim for breach of duty,
plaintiffs have failed to show that a common “method and
procedure” was adopted by the defendants whereby free credit
balances were unnecessarily created, delayed or retained.
(Amended Complaint, p. 12 at § 20). Each of the eleven
defendants’ policies and procedures for handling its customers’
accounts will have to be examined in order for plaintiffs to
prove their claim. By their very nature, no two free credit
balances appear to be the same, and they can be created through
any number of methods. Whether or not they were improperly
handled by defendants will depend on proof that each type
account imposes a similar duty, and that each type of transaction
free credit balances were unlawfully retained on a customer’s
account. On each type, it will have to be proven that a free
credit balance existing overnight or longer has been unnecessary
delayed or retained.
There is no common overriding standard or common set
of facts which will allow this determination to be made other
than on a case by case basis, and this court cannot envision
how separate individualized trials will not ensue. Plaintiffs do
not propose how they plan to manage a trial cn this aspect of
their claims. Their conclusory statement that subclasses may be
14a
Appendix A
created, ignores the very real possibility that a trial on this issue
is likely to splinter into separate “mini-trials” in hope of
resolving these individual issues. Therefore, the court finds that
separate trials must be had, since class certification is not
appropriate as to this aspect of members’ claims.
On the questions of law, plaintiffs allege that this court
should not focus on the class and their contacts to this and
other states because New York law will apply to all class
members’ claims based upon defendants contacts to New York,
and this state’s interest in the securities industry. The parties
also dispute who should bear the burden of showing whether
significant differences exist in the substantive law of the several
States.
In Phillips Petroleum Co. v. Shutts, (472 US 797 [1985])
the Supreme Court held that Kansas could not apply its own
law in a nationwide class action involving a failure to make
royalty payments on natural gas leases. The leased land was
located in eleven states and the three named plaintiffs resided in
Kansas or Oklahoma and owned leases in Texas and Oklahoma.
The Court held that a state court “may not take a transaction
with little or no relationship to the forum and apply the law of
the forum in order to satisfy the procedural requirement that
there be a ‘common question of law’ ”. (/d. at 821).
Constitutionally, a state court must have “significant aggregation
of contacts”, or “contacts creating state interests” to the claims
asserted by each member of the plaintiff class for the forum to
apply its laws. (Jd. at p. 821).
While Castano v. American Tobacco Company, supra,
involves a nation-wide products liability class action and the
facts are distinguishable from the present case, the Fifth Circuit’s
15a
Appendix A
discussion on variations in state law is instructive. The court
found that the class action movant has the burden of proof to
show the variations in state law when a class action involves
multiple jurisdictions (at p. 742). Citing Walsh v. Ford Motors
Co. (807 F.2d 1000, 1017 [DC Cir 1986], cert. denied, 482
US 915 [1987]), the court noted it cannot accept plaintiffs’
assertion “on faith” that there is no variation in state laws, and
that “through an extensive analysis” of state law variances is
needed. (/d.).
These cases are consistent with New York’s choice-of-law
principles, and the burdens of proof under CPLR § 901(a).
Much like the test in Shutts, New York courts apply the laws of
the state having the most significant contacts with the occurrence
and with the parties. (Babcock v. Jackson, 12 NY2d 473, 482
[1963]; Auten v. Auten, 308 NY 155, 160 [1954]). As
previously stated, CPLR § 901 (a) places the burden on the
movant to show that its prerequisites have been met, (/nfra, at
p. 4), and to establish the identity of the class. (Gottlieb v. March
Shipping Passenger Servs., 67 AD2d 879 [1st Dept 1979]; See
also Katz v. NVF Co., supra 100 AD2d at 474; Bloom v.
Cunard Line Ltd., 76 AD2d 237, 240 [Ist Dept 1980]). Not
discounting that New York is arguably the financial capital of
the United States, and where defendants do all or most of their
business; plaintiffs’ papers fail to support their own allegations
that New York has significant contacts to the class members’
claims.
As was recognized by plaintiffs, the contacts which must
exist should be distinguished given that this case is for breach
of fiduciary duty case, and is not a securities case. (Arizona
Papers). Plaintiffs knew of 425,000 accounts existing in
Arizona, and had some information about where defendants
16a
Appendix A
transact their business on their customers accounts. However,
instead of establishing the members’ contacts, or where the claims
accrued, they offer the defendants’ papers submitted on their
Arizona motion to dismiss for forum non convenience, where
the focus was on the defendants and their contacts outside of
the forum state. This does not demonstrates how these contacts
connect to the class members and their claims.
Plaintiffs have admitted that “the same conflict of law issues
would still need to be addressed .... by the court analyzing
and applying the law of various jurisdictions[.]” (Pl. Resp.
Motion to Dismiss, p. 8). Four state laws (New York, Maryland,
Illinois, and California) have been identified in the choice of
law provisions; and three other states are mentioned as where
some of defendants’ facilities are located. In this case, the court
sees no reason why plaintiffs should not bear the burden of
showing through a thorough conflict of law analysis that
common questions of law predominate. Plaintiffs cite a single
federal decision stating that there are no variations of state laws
on breach of fiduciary duty, a couple of cases on unjust
enrichment, and none of the states’ applicable statutes of
limitation. They have failed to substantially identify the legal
issues under the state laws which may apply. In absence of
such a record, this court cannot decide whether or not it is
arbitrary or unfair to override the contract provisions, or whether
New York law may apply to all claims. Therefore, plaintiffs
have not shown that common questions of law predominate.
The typicality requirement of CPLR § 901 (a) (2) has not
been satisfied because plaintiffs have not shown that their claims
arise from a common course of conduct and that common
questions of law predominate. (See, Friar v. Vanguard Holding
Corp., supra 78 AD2d at 99; 2 Weinstein-Korn-Miller NY Civ
17a
Appendix A
Prac ¥ 901.14). As was discussed above, while the claims are
derived from the same course of conduct by the defendants,
they have failed to show that New York’s substantive law will
be used in determining the rights of class members. (Bittner v.
Metropolitan life Ins. Co., NYLJ p. 27 col 6, J. Gammerman
12/19/94). Therefore, on this record, the court cannot find that
their claims are substantially similar so as to satisfy the typicality
requirement (Compare, Weinberg, v. Hertz Corp., 116 AD2d |!
[ist Dept 1986]; Brandon v. Chefetz, supra, 106 AD2d 162
[lst Dept 1985}).
The adequacy of representation, under CPLR § 901 (a) (4),
requires: (1) the representative plaintiffs will fairly and
adequately protect the interests of the class — that is they are
familiar with their claims and that they do not have substantial
interests that are antagonistic to or conflict with those of the
members of the class — and (2) the attorney for the class is
qualified, experienced and generally able to conduct the
litigation. (Jn re Lilco Securities Litigation, supra, 111 FRD at
672 [Ed NY 1986]; Dura-Bilt Corp. v. Chase Manhattan Corp.,
supra, 89 FRD at 102 [SD NY 1981)}).
As plaintiffs correctly note, it is not required that they have
any significant understanding of the legal or factual basis on
which a complex case rests in order to maintain a class action.
(Dura-Bilt Corp. v. Chase Manhattan Corp., supra). They must
demonstrate a sufficient understanding of the nature of the case
in order to vigorously pursue the prosecution of the litigation.
Plaintiffs have shown that they have a basic understanding of
the nature of this case and the financial resources to prosecute
the litigation. However, plaintiffs’ counsel’s conclusory
allegation that the named plaintiffs share substantially the same
interests with that of the absent class members, without having
18a
Appendix A
addressed whether their interests are consistent with those
“entities” that they seek to represent is suspect at best.
Counsel for the plaintiffs have not made it at all clear who
they seek to represent. That the class members are all account
holder’s and the customer of defendants is no basis on which
this court can determine whether or not their interests are
consistent. If these “entities” are institutional investors, their
decision-makers may be influenced by considerations that would
not affect individuals, or reach decisions which may be the
product of an internal corporate compromise, and thus, what
may be in the best interest of individuals may not be so for the
corporate class members. (See, Jn re Lilco Securities Litigation,
supra; Hansberry v. Lee, 311 US 32, 42 [1940]). But this is
based purely speculation, since plaintiffs have failed to identify
or describe how the class members’ interests are consistent.
Therefore, at this juncture, the court cannot find that plaintiffs
have satisfied this requirement or shown that a class action is
the superior method in reaching a disposition on theses claims.
Although plaintiffs allege, without demonstrating, that the
class members’ claims are small, it is conceivable that large
entities, such as institutional investors may have sizeable claims.
Again, plaintiffs’ conclusory allegations do not address whether,
in such event, the “economic reality dictates that [this] suit
proceed as a class action at all ... [because] the maximum
damages recoverable by any single plaintiff [or class member]
would be hardly enough to enable [it] to conduct to completion
the protracted and complicated litigation to establish [its] claim.”
[cite omitted]. (Gilman v. Merrill Lynch, Pierce, Fenner &
Smith, supra, 93 Misc.2d at 948).
19a
Appendix A
Based upon the forgoing, this court finds plaintiffs have
not satisfied all of the prerequisites of CPLR § 901(a).
Depending on the facts developed, the plaintiffs may renew
this motion, after appropriate discovery. Accordingly, plaintiffs’
motion for class certification is denied without prejudice to
renew.
The forgoing constitutes the decision and order of the court.
Dated: Sept. 26, 1996
ENTER
s/ Charles E. Ramos
be Ft
20a
APPENDIX B — MOTION AND MEMORANDUM
DECISION OF THE SUPREME COURT OF THE STATE OF
NEW YORK, NEW YORK COUNTY IN SANDRA BALLAN v.
PRUDENTIAL SECURITIES, INC. FILED JUNE 24, 1997
SUPREME COURT OF THE STATE OF NEW YORK —
NEW YORK COUNTY
PRESENT: Hon. Herman Cahn PART 49
Justice
INDEX NO. 122747/95
MOTION DATE 3/10/97
MOTION SEQ. NO. 002
MOTION CAL. NO. 3
SANDRA BALLAN
nts
PRUDENTIAL SECURITIES, INC.
‘2 <
Upon the foregoing papers, it is ordered that this motion
[stamp] MOTION IS DECIDED IN ACCORDANCE WITH
ACCOMPANYING MEMORANDUM DECISION IN
MOTION SEQUENCE
Dated: 6/18/97 s/ Herman Kahn
J.S.C.
Check one: FINAL DISPOSITION
[1] NON-FINAL DISPOSITION
2la
Appendix B
SUPREME COURT: NEW YORK COUNTY
IAS: PART 49
IN RE
PRUDENTIAL SECURITIES INC.
SWEEP LITIGATION
Index No. 122747/95
Seq. No. 002
CAHN, J:
This consolidated action arises from the alleged unlawful
conduct of defendant Prudential Securities, Inc. (“Prudential’’)
with respect to monies and free credit balances purportedly
withheld from its customers for unduly long periods of time.
Prudential moves for an order, pursuant to CPLR 3211(a) (1)
and (7), 3013 and 3016(b), dismissing the complaint based
upon documentary evidence, failure to state a cause of action,
and failure to plead fraud with sufficient particularity. In addition,
Prudential contends that a recent decision of the Appellate
Division, First Department, entitled The Estate of Braunstein v.
Merrill Lynch, Pierce, Fenner and Smith, Inc., _. Ad2d __ [Ist
Dept. 1997], 657 NYS2d 12), which holds that state law claims
against broker-dealers based upon their use of customer free
credit balances are preempted by federal securities regulations,
mandates the dismissal of plaintiffs’ action.
In the securities industry, free credit balances are customers’
funds held by brokerage firms which are subject to immediate
cash payment to customers on demand, generally resulting from
22a
Appendix B
sales of securities, dividends, interest, or other transaction. A
“sweep” is generally the transfer of idle cash balances in
customers’ accounts into short-term income-generating
investment vehicles such as money funds or bank short-term
collective investment funds. In this action, plaintiffs claim that
Prudential engaged in a practice of delaying the transfer of
plaintiffs’ free credit balances into money market funds for its
own profit, and that such conduct constitutes an unjust
enrichment, a breach of fiduciary duty, and a breach of the
duty of good faith and fair dealing implied under its customer
contracts.
On plaintiffs’ own admission the only meaningful difference
between this case and Braunstein is that here plaintiffs only sue
one brokerage firm and in Braunstein plaintiffs sued several.
The wrongs alleged in both cases are exactly the same. Therefore,
Braunstein is determinative here, and plaintiffs’ state claims are
preempted by federal law. (See also, Guice v. Charles Schwab
& Co., 89 NY2d 31 ([{1996]).
In light-of the foregoing the court need not and does not
address that branch of defendant’s motion to dismiss the
complaint on state law grounds.
ORDERED that defendant’s motion to dismiss is granted,
and it is further
ORDERED that the Clerk is directed to enter judgment
accordingly.
Dated: June 18, 1997
s/ Herman Cahn
} Pe. oe
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