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Crago v. Charles Schwab & Co., Inc.

United States District Court, N.D. California

June 13, 2017

ROBERT CRAGO, et al., Plaintiffs,
CHARLES SCHWAB & CO., INC., et al., Defendants.




         Defendant Charles Schwab & Co., Inc. (“Schwab”) moves to dismiss plaintiffs Robert Wolfson and Frank Pino's putative class action complaint for securities fraud. Because plaintiffs fail to make adequate pleadings of falsity, scienter, economic loss, loss causation, or reliance, their complaint is dismissed with leave to amend.

         II. BACKGROUND[1]

         Defendant Schwab is a large retail broker-dealer that places stock trade orders on behalf of clients like plaintiffs Wolfson and Pino. When Schwab receives a trade order from a client, it must route the order to a venue for execution. In so doing, it operates under a duty of best execution, which encompasses, among other things, a duty to use reasonable diligence to secure in any trade the most favorable terms and price possible.

         Accordingly, Schwab has made various representations that it is committed to securing best execution for its clients. For instance, it has indicated on its website its intention to provide “exceptional execution” and “the best possible execution, ” and claims to “regularly monitor the execution quality provided by different exchanges and liquidity providers.” Compl. ¶ 25. It also asserts in the 2015 Schwab One Account Agreement clients were required to sign:

Schwab considers a number of factors in evaluating execution quality among market centers, including the execution price and opportunities for price improvement . . . Price improvement occurs when an order is executed at a price more favorable than the displayed national best bid or offer. Schwab regularly monitors the execution quality provided by various market centers to ensure orders are routed to markets and firms that have provided high-quality executions over time.

Compl. ¶ 28.

         In 2004, UBS Securities LLC (“UBS”) acquired Schwab's capital markets division, and the two companies entered into an Equities Order Handling Agreement whereby Schwab agreed to route at least 95% of its non-directed stock trade orders to UBS. In exchange, UBS would pay Schwab $100 million a year in payment for order flow (“PFOF”). The agreement, which ran until 2012, provided for penalties if Schwab did not meet the 95% threshold. In 2011, Schwab extended the agreement into 2014. Pursuant to the agreement, from 2004 to 2014, Schwab directed at least 95% of its clients' non-directed orders to UBS. For the first quarter of 2012 through the third quarter of 2014, Schwab routed between 93% and 99% of each quarter's non-directed trade orders to UBS. In the first quarter of 2015, Schwab routed 73% of non-directed trade orders to UBS, and from the second quarter of 2015 to the first quarter of 2016, Schwab routed roughly 50% of such orders to UBS. According to plaintiffs, this overwhelming majority of non-directed orders being routed to a single venue was anomalous among retail brokers. In the 2015 Account Agreement, Schwab disclosed:

Schwab may receive remuneration, such as liquidity or order flow rebates, from a market center to which orders are routed. In addition, part of the consideration received by The Charles Schwab Corporation for the sale of its capital markets business to UBS in 2004 related to an order routing agreement with UBS, which has been extended. Quarterly information regarding the market centers to which we route orders and the remuneration received is available on our website at or in written form upon request. Information regarding the specific routing destination and execution time of your orders for up to a six-month period is also available upon request.

Id. ¶ 29.

         Beginning in 2015, Schwab, Fidelity, and Scottrade began disclosing to the Financial Information Forum (“FIF”) information including: “(1) average order size; (2) price improvement percentage; (3) average savings per order; and (4) average execution speed.” Compl. ¶ 66. The information disclosed pertained to S&P 500 stocks and other exchange-listed stocks, and covered only market orders - orders that execute immediately - as opposed to nonmarketable limit orders, which execute only when a stock price reaches a certain threshold. Based on these disclosures, on July 14, 2015, website KOR Trading published an analysis indicating Schwab's average price improvement lagged substantially behind that of Fidelity, which apparently stopped accepting PFOF in 2014 and routed its orders to a more diverse array of venues than did Schwab.

         Plaintiffs point to numerous reasons price improvement would suffer from Schwab's bulk order routing to UBS, including Schwab clients' resulting exposure to “dark pools” and high-frequency traders, and the ability of UBS to become an “internalizer” and profit from a captive retail order flow. In addition to the KOR Trading report, plaintiffs rely on various articles and academic studies indicating PFOF (of the sort Schwab allegedly engaged in) will result in lost price improvement for clients. They also identify statements by SEC officials raising the risk that PFOF creates a conflict of interest and results in lost price improvement.

         Plaintiffs allege they have suffered lost price improvement as a result of Schwab's bulk order routing to UBS, and accordingly allege Schwab's statements about its best execution priorities were false. They also allege Schwab fraudulently promulgated the false statements with scienter - knowing they were false or acting with reckless disregard to the truth. Plaintiffs claim certain statements by Schwab Chairman Charles R. Schwab and Schwab CEO Walter Bettinger raise a strong inference of scienter. These statements include: a 2013 statement by Charles Schwab and Bettinger criticizing high frequency trading, and subsequent remarks by Bettinger appearing to walk back that position; a 2000 statement by Schwab to the Senate Banking Committee about the conflicts of interest PFOF creates; and a 2014 statement by Bettinger denying Schwab directed trade orders on the basis of PFOF.

         On July 13, 2016, Robert Crago initiated this putative class action by filing a class action complaint. After a contested motion, Wolfson and Pino were appointed lead plaintiffs. The pair claims to have placed thousands of non-directed stock orders during the class period, and hundreds or thousands in each relevant year. They filed an amended class action complaint on January 20, 2017, advancing one claim for relief for Schwab's alleged violation of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder by the SEC. The action is brought on behalf of a purported class comprised of: “All clients of Schwab between July 13, 2011 and July 13, 2016 who placed orders that were routed to UBS by Schwab pursuant to the Equities Order Handling Agreement.” Compl. ¶ 121. On March 10, Schwab filed this motion to dismiss plaintiffs' amended complaint.[2]


         “A pleading that states a claim for relief must contain . . . a short and plain statement of the claim showing that the pleader is entitled to relief . . . .” Fed.R.Civ.P. 8(a)(2). “[D]etailed factual allegations” are not required, but a complaint must provide sufficient factual allegations to “state a claim to relief that is plausible on its face.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. v. Twombly, 550 U.S. 544, 555, 570 (2007)) (internal quotation marks omitted). “A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. Federal Rule of Civil Procedure 9(b), meanwhile, requires that, “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” To satisfy this pleading standard, a plaintiff must allege the “who, what, where, when, and how” of the alleged misconduct. Cooper v. Pickett, 137 F.3d 616, 627 (9th Cir.1997) (citation and internal quotation marks omitted). The Rule 9(b) pleading standard “applies to all elements of a securities fraud action.Oregon Pub. Employees Ret. Fund v. Apollo Grp. Inc., 774 F.3d 598, 605 (9th Cir. 2014). In actions governed by the Private Securities Litigation Reform Act (“PSLRA”), such as this one, these pleading standards are subject to further refinement, as discussed in more detail below.

         Federal Rule of Civil Procedure 12(b)(6) provides a mechanism to test the legal sufficiency of the averments in a complaint. Dismissal is appropriate when the complaint “fail[s] to state a claim upon which relief can be granted.” Fed.R.Civ.P. 12(b)(6). A complaint in whole or in part is subject to dismissal if it lacks a cognizable legal theory or the complaint does not include sufficient facts to support a plausible claim under a cognizable legal theory. Navarro v. Block, 250 F.3d 729, 732 (9th Cir. 2001). When evaluating a complaint, the court must accept all its material allegations as true and construe them in the light most favorable to the non-moving party. Iqbal, 556 U.S. at 678. When a plaintiff has failed to state a claim upon which relief can be granted, leave ...

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