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

Opinions of the United
1998 Decisions States Court of Appeals
for the Third Circuit

1-30-1998

Newton v. Merrill Lynch
Precedential or Non-Precedential:

Docket 96-5045

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Filed January 30, 1998

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

NO. 96-5045

KENNETH E. NEWTON; MLPF&S CUST. BRUCE ZAKHEIM
IRA FBO BRUCE ZAKHEIM

v.

MERRILL, LYNCH, PIERCE, FENNER & SMITH, INC.;
PAINEWEBBER INC.; DEAN WITTER REYNOLDS
(D.C. No. 94-cv-05343)

JEFFREY PHILLIP KRAVITZ

v.

DEAN WITTER REYNOLDS, INC.
(D.C. No. 95-cv-00213)

MLPF&S Cust. FPO -- Bruce Zakheim IRA FBO Bruce
Zakheim, Jeffrey Phillip Kravitz, and Gloria Binde r,
Appellants

On Appeal From the United States District Court
For the District of New Jersey

Argued October 24, 1996

BEFORE: STAPLETON and NYGAARD, Circuit Judges ,
and MAZZONE,* District Judge

Reargued En Banc October 29, 1997

_________________________________________________________________
*Hon. A. David Mazzone, United States District Judge for the District of
Massachusetts, sitting by designation.
BEFORE: SLOVITER, Chief Judge, BECKER, STAPLETON,
MANSMANN, GREENBERG, SCIRICA, NYGAARD, ALITO,
ROTH and LEWIS, Circuit Judges

(Opinion Filed January 30, 1998)

Norman S. Poser
Brooklyn Law School
250 Joralemon Street
Brooklyn, NY 11210

Karen L. Morris (Argued)
Morris & Morris
1105 North Market Street
Suite 1600
Wilmington, DE 19801
Attorneys for Appellants

Matthew D. Anhut
Jonathan N. Eisenberg
Kirkpatrick & Lockhart
1800 Massachusetts Avenue, N.W.
Washington, D.C. 20036-5891
Attorneys for Appellee
Merrill, Lynch, Pierce,
Fenner & Smith, Inc.

Joseph A. Boyle
Kelley, Drye & Warren
5 Sylvan Way
Parsippany, NJ 07054

Bruce Coolidge
Robert B. McCaw (Argued)
Wilmer, Cutler & Pickering
2445 M Street, N.W.
Washington, D.C. 20037-1420
Attorneys for Appellee
PaineWebber, Inc.

2
 Frank M. Holozubiec
Kirkland & Ellis
153 East 53rd Street
Citicorp Center
New York, NY 10022
Attorney for Appellee
Dean Witter Reynolds

Richard H. Walker
Eric Summergrad
Susan F. Wyderko
Jacob H. Stillman
Mail Stop 6-6
Securities & Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attorneys for Amicus Curiae
Securities & Exchange
Commission

OPINION OF THE COURT

STAPLETON, Circuit Judge:

I.

Plaintiff-Appellants are investors who purchased and sold
securities on the NASDAQ market, the major electronic
market for "over-the-counter" securities, during the two
year period from November 4, 1992 to November 4, 1994
("the class period"). The defendants are NASDAQ market
makers. NASDAQ is a self-regulating market owned by the
National Association of Securities Dealers ("NASD"), subject
to oversight by the Securities and Exchange Commission
("SEC").

An "over-the-counter" market like NASDAQ differs in
important respects from the more familiar auction markets,
like the New York and American Stock Exchanges. The
NYSE and AMEX markets are distinguished by a physical
exchange floor where buy and sell orders actually"meet,"
with prices set by the interaction of those orders under the

3
supervision of a market "specialist." In a dealer market like
NASDAQ, the market exists electronically, in the form of a
communications system which constantly receives and
reports the prices at which geographically dispersed market
makers are willing to buy and sell different securities.
These market makers compete with one another to buy and
sell the same securities using the electronic system;
NASDAQ is, then, an electronic inter-dealer quotation
system.

In a dealer market, market makers create liquidity by
being continuously willing to buy and sell the security in
which they are making a market. In this way, an individual
who wishes to buy or sell a security does not have to wait
until someone is found who wishes to take the opposite
side in the desired transaction. To account for the effort
and risk required to maintain liquidity, market makers are
allowed to set the prices at which they are prepared to buy
and sell a particular security; the difference between the
listed "ask" and "bid" prices is the"spread" that market
makers capture as compensation.

The electronic quotation system ties together the
numerous market makers for all over-the-counter securities
available on NASDAQ. All NASDAQ market makers are
required to input their bid and offer prices to the NASD
computer, which collects the information and transmits, for
each security, the highest bid price and lowest ask price
currently available. These prices are called the"National
Best Bid and Offer," or NBBO. The NASD computer,
publicly available to all NASDAQ market makers, brokers
and dealers, displays and continuously updates the NBBO
for each offered security.

Plaintiffs allege that technological advances made it
feasible during the class period for the defendant market
makers to execute orders at prices quoted on private on-
line services like SelectNet and Instinet and that those
prices were frequently more favorable to their investor
clients than the NBBO price. According to plaintiffs, the
defendants regularly used these services and knew that
prices better than NBBO were often available through them.
Even though they knew that their investor clients expected
them to secure the best reasonably available price,

4
plaintiffs say, the defendants executed plaintiffs' orders at
the NBBO price when they knew that price was inferior and
when they, at the same time, were trading at the more
favorable price for their own accounts. In this way, they
were able to inflate their profit margins at the expense of
their investor clients. This practice is alleged to violate
section 10 of the Securities Act of 1934, 15 U.S.C.S 78j,
and Rule 10b-5 promulgated thereunder, 17 C.F.R.
S 240.10b-5.

The plaintiffs also charge defendants with two other
violations of section 10 and Rule 10b-5. Market makers
who simultaneously hold a market order for both sides of a
transaction may obtain more favorable prices than the
NBBO by "crossing" these in-house orders. Transactions
handled in this way are executed within the spread, giving
both the purchaser and seller a better price. Similarly, a
customer order can be matched by a market maker with an
in-house limit order on the other side of the transaction.
Since a limit order specifies a particular price at which to
execute a transaction, matching another customer order at
that price may beat the currently displayed NBBO quote for
that security. Plaintiffs allege that the failure of the
defendants to execute orders of their clients in these ways
when feasible constitutes a fraudulent practice because, by
executing at the NBBO rather than matching customer
orders, the defendants capture the full market "spread" as
a fee for their services without incurring any actual risk in
the transaction.

II.

The defendants filed a motion to dismiss for failure to
state a claim upon which relief could be granted. At the
direction of the district court, this motion was converted
into a motion for summary judgment, which was ultimately
granted. See In re Merrill Lynch Securities Litigation, 911 F.
Supp. 754 (D.N.J. 1995). The district court rested its
decision on two principal grounds. First, the court
determined that the defendants made no misrepresentation.
Though recognizing that the defendants, by accepting
plaintiffs' orders, impliedly represented that they intended
to execute those orders in conformity with the "duty of best

5
execution," the court considered the scope of this duty
sufficiently ill-defined that execution at the NBBO could
not, as a matter of law, be found inconsistent with the
duty. The court concluded that in the face of uncertainty
about the scope of defendants' duty of best execution,
holding them liable would be "highly imprudent." 911 F.
Supp. at 771. Second, the court held that, even if
defendants made a material misrepresentation, they could
not, as a matter of law, have acted with the requisite
scienter.

To state a claim for securities fraud under S 10 of the
Securities Act of 1934 and Rule 10b-5, plaintiffs must
demonstrate: (1) a misrepresentation or omission of a
material fact in connection with the purchase or sale of a
security; (2) scienter on the part of the defendant; (3)
reliance on the misrepresentation; and (4) damage resulting
from the misrepresentation. See Sowell v. Butcher & Singer,
Inc., 926 F.2d 289, 296 (3d Cir. 1991). Because plaintiffs
have demonstrated that a genuine issue of material fact
exists as to the elements of their securities fraud claim, we
will reverse the district court.

III.

The parties agree that a broker-dealer owes to the client
a duty of best execution. They further agree that a broker-
dealer, by accepting an order without price instructions,
impliedly represents that the order will be executed in a
manner consistent with the duty of best execution and that
a broker-dealer who accepts such an order while intending
to breach that duty makes a misrepresentation that is
material to the purchase or sale. The parties differ,
however, on whether a trier of fact could conclude from this
record that the implied representation made by the
defendants included a representation that they would not
execute at the NBBO price when prices more favorable to
the client were available from sources like SelectNet and
Instinet.

As we explain hereafter, this difference can be resolved
only by determining whether, during the class period or
some portion thereof, it was feasible for the defendants to

6
execute trades through SelectNet and Instinet when prices
more favorable than the NBBO were being quoted there.
This is a matter concerning which the record reflects a
material dispute of fact. If such prices were reasonably
available and the defendants, at the time of accepting
plaintiffs' orders, intended to execute them solely by
reference to the NBBO, they made a material
misrepresentation in connection with the purchase or sale
of the securities involved. If a finder of fact could infer, in
addition, that the defendants' implied representation was
knowingly false or made with reckless indifference, it would
follow that summary judgment for the defendants was
inappropriate.

The duty of best execution, which predates the federal
securities laws, has its roots in the common law agency
obligations of undivided loyalty and reasonable care that an
agent owes to his principal.1 Since it is understood by all
that the client-principal seeks his own economic gain and
the purpose of the agency is to help the client-principal
achieve that objective, the broker-dealer, absent
instructions to the contrary, is expected to use reasonable
efforts to maximize the economic benefit to the client in
each transaction.

The duty of best execution thus requires that a broker-
dealer seek to obtain for its customer orders the most
_________________________________________________________________

1. See, e.g., Hall v. Paine, 112 N.E. 153, 158 (Mass. 1916) ("broker's
obligation to his principal requires him to secure the highest price
obtainable"); Restatement of Agency (Second)S 424 (1958) (agent must
"use reasonable care to obtain terms which best satisfy the manifested
purposes of the principal"). See also Opper v. Hancock Securities Corp.,
250 F.Supp. 668, 676 (S.D.N.Y.) ("[T]he duties of a securities broker are,
if anything, more stringent than those imposed by general agency law."),
aff 'd, 367 F.2d 157 (2d Cir. 1966). Moreover, as the district court
correctly recognized, the best execution duty "does not dissolve when the
broker/dealer acts in its capacity as a principal." 911 F.Supp. at 760.
Accord E.F. Hutton & Co., Exchange Act Rel. No. 25887, 49 S.E.C. 829,
832 (1988) ("A broker-dealer's determination to execute an order as
principal or agent cannot be `a means by which the broker may elect
whether or not the law will impose fiduciary standards upon him in the
actual circumstances of any given relationship or transaction.' ")
(citation
omitted).

7
favorable terms reasonably available under the
circumstances. See, e.g., Sinclair v. SEC, 444 F.2d 399, 400
(2d Cir. 1971) (fiduciary duty requires broker-dealer "to
obtain the best available price" for customers' orders);
Arleen W. Hughes, 27 S.E.C. 629, 636 (1948) ("A corollary
of the fiduciary's duty of loyalty to his principal is his duty
to obtain . . . the best price discoverable in the exercise of
reasonable diligence."), aff 'd sub nom. Hughes v. SEC, 174
F.2d 969 (D.C. Cir. 1949). Accord Order Execution
Obligations, Exchange Act Release No. 37,619A, 61 Fed.
Reg. 48290, 48322 (Sept. 12, 1996) ("Final Rules"). That is,
the duty of best execution requires the defendants to
execute the plaintiffs' trades at the best reasonably
available price.2 While ascertaining what prices are
reasonably available in any particular situation may require
a factual inquiry into all of the surrounding circumstances,
the existence of a broker-dealer's duty to execute at the
best of those prices that are reasonably available is well-
established and is not so vague as to be without
ascertainable content in the context of a particular trade or
trades.

As the SEC has recognized on a number of occasions, the
scope of the duty of best execution has evolved over time
with changes in technology and transformation of the
structure of financial markets.3 For example, before the
_________________________________________________________________

2. Other terms in addition to price are also relevant to best execution.
In
determining how to execute a client's order, a broker-dealer must take
into account order size, trading characteristics of the security, speed of
execution, clearing costs, and the cost and difficulty of executing an
order in a particular market. See, e.g., Payment for Order Flow,
Exchange Act Release No. 33,026, 58 Fed. Reg. 52934, 52937-38 (Oct.
13, 1993). When the plaintiffs state that better"prices" were reasonably
available from sources other than the NBBO, we understand that to
mean that, given an evaluation of price as well as all of the other
relevant terms, the trade would be better executed through a source of
liquidity other than the NBBO (e.g. SelectNet, Instinet, in-house limit
orders or market orders held by the defendants, or limit orders placed by
the public in the Small Order Execution System). Similarly, for
convenience, we use the phrases "best reasonably available price" and
"best terms" interchangeably.

3. See, e.g., Final Rules, 61 Fed. Reg. at 48322-23 ("The scope of this
duty of best execution must evolve as changes occur in the market that

8
creation of NASDAQ, a broker in an over-the-counter
market satisfied her duty of best execution by contacting at
least three market makers prior to executing a client's
order. See Order Execution Obligations, Exchange Act
Release No. 36,310, 60 Fed. Reg. 52792, 52793 (Oct. 10,
1995) ("Proposed Rules"). With the advent of NASDAQ and
the NBBO computer system providing instant access to the
best bid and offer available nationwide, the standard for
satisfying the duty of best execution necessarily heightened.
After the class period, the SEC issued rules that altered the
definition of the NBBO to include consideration of many of
the alternative sources of liquidity that plaintiffs claim
should have been consulted during the class period, such
as SelectNet and Instinet. See Final Rules, 61 Fed. Reg. at
48306-16. Prospectively, at least, this heightened the
standard still further.

Because the scope of the duty of best execution is
constantly evolving and because the "reasonably available"
component of the duty is fact dependent, broker-dealers
have long been required to conform customer order
practices with changes in technology and markets. For
example, the NASD's Rules of Fair Practice, adopted in
1968, required brokers in the over-the-counter market to
"use reasonable diligence to ascertain the best inter-dealer
market for the subject security and buy or sell in such
market so that the resultant price to the customer is as
favorable as possible under the prevailing market
conditions." NASD Manual (CCH), art. III S 1, P 2151.03
(1995) (Interpretation A). Included in the factors used to
satisfy the requirement of "reasonable diligence" are both
"the number of primary markets checked," and the
"location and accessibility to the customer's broker-dealer
of primary markets and quotations sources." Id.

Almost a year before the end of the class period, the SEC
staff issued a report entitled "Market 2000: An Examination
_________________________________________________________________

give rise to improved executions for customer orders, including
opportunities to trade at more advantageous prices. As these changes
occur, broker-dealers' procedures for seeking to obtain best execution for
customer orders also must be modified to consider price opportunities
that become `reasonably available.' ").

9
of Current Equity Market Developments." This report notes
that the SEC has consistently taken the position that the
evolving nature of the markets requires a broker-dealer to
"periodically assess the quality of competing markets to
ensure that its order flow is directed to markets providing
the most advantageous terms for the customer's order."
Market 2000 Report, 1994 SEC LEXIS 136, *11-12. As the
term "periodically assess" suggests and as the SEC
confirms in its amicus briefing before us, this segment of
the report was not speaking to the issue of whether, during
the class period, the duty of best execution included a
requirement that broker-dealers engage in an order-by-
order analysis of competing markets. It does, however,
expressly recognize a duty on the part of broker-dealers to
periodically examine their practices in light of market and
technology changes and to modify those practices if
necessary to enable their clients to obtain the best
reasonably available prices.

The plaintiffs' orders did not specify the price at which
they should be executed. It is a reasonable inference that
plaintiffs, in placing their orders, sought their own
economic advantage and that they would not have placed
them without an understanding that the defendants would
execute them in a manner that would maximize plaintiffs'
economic benefit from the trade. Given the objective of the
agency and the regulatory background we have reviewed,
we conclude that a trier of fact could infer that the
defendants' acceptance of the orders was reasonably
understood as a representation that they would not be
executed at the NBBO price when better prices were
reasonably available elsewhere. Accordingly, we must
examine the record evidence relevant to whether prices
quoted on private on-line services like SelectNet and
Instinet were reasonably available during the class period
and whether those prices were more favorable than the
NBBO when plaintiffs' orders were executed.

The evidence pointed to by plaintiffs indicates that (1)
SelectNet and Instinet were in existence throughout the
class period; (2) the quotations reported by these services
reflected buyers and sellers ready to trade at the quoted
prices; (3) the defendants themselves actively traded on

10
SelectNet and Instinet during the class period; and (4) other
respected members of the brokerage community, since
before the class period, have regarded these services as
providing reasonably available prices and have executed
orders through them when the prices reported were more
favorable to the client than the NBBO price. In addition, the
plaintiffs have tendered expert testimony confirming the
reasonable availability of execution sources other than the
NBBO during the class period.

With respect to whether SelectNet and Instinet prices
were more favorable at the time their orders were executed,
plaintiffs point to an SEC study of prices during the three
month period from April through June 1994. The SEC
found that "approximately 85% of the bids and offers
displayed by market makers in Instinet and 90% of the bids
and offers displayed on SelectNet were at better prices than
those posted publicly on NASDAQ." Final Rules, 61 Fed.
Reg. at 48308. Plaintiffs have also tendered evidence of a
few trades executed for them by defendants at the NBBO
where evidence of contemporaneous offers on Instinet and
SelectNet indicate that lower prices were available. Plaintiffs
have filed a Rule 56(f) affidavit indicating that they need
discovery in order to provide similar evidence with respect
to the remainder of their trades.4

To be sure, the defendants, with record support, insist
that consulting other sources besides the NBBO would
have added substantial expense and delay to the execution
of plaintiffs' orders, more than offsetting any improvements
that might have been available in terms of price. 5 This,
_________________________________________________________________

4. Defendants suggest that the lack of evidence of injury in all
plaintiffs'
transactions supports an affirmance on the basis of lack of standing. We
believe the evidence we have reviewed in text supports plaintiffs' claim
to
standing. Plaintiffs submitted evidence that would warrant a finding that
several trades were made on their behalf when better prices were
contemporaneously available from other sources. The SEC study of 1994
prices suggests that, more likely than not, there were other trades in
this
category. In any event, the plaintiffs have filed a Rule 56(f) affidavit
that
would preclude a summary judgment for defendants on this issue at this
time.

5. In particular, the defendants rely upon the existence during the class
period of the Small Order Execution System ("SOES"). SOES is an

11
however, does nothing more than create a material dispute
of fact which we are not permitted to resolve in favor of the
defendants at this juncture.

We believe the evidence is sufficient to allow a reasonable
trier of fact to conclude that, by the time of the class
period, both technology and over-the-counter markets had
developed to a point where it was feasible to maximize the
economic benefit to the client by taking advantage of better
prices than the NBBO. Summary judgment for defendants
on this element of plaintiffs' claim was therefore not
appropriate.

IV.

As we have noted, recovery on a federal securities fraud
claim requires a showing of scienter: a deliberate or
reckless misrepresentation of a material fact. See Ernst &
Ernst v. Hochfelder, 425 U.S. 185, 193 (1976); Eisenberg v.
Gagnon, 766 F.2d 770, 776 (3d Cir. 1985). The alleged
misrepresentation here is an implied representation made
by the defendants when they agreed to execute the
plaintiffs' orders that they intended to maximize the
_________________________________________________________________

electronic routing system that was created in 1984 to allow orders from
small investors to be automatically executed at the NBBO. Defendants
claim that since the NBBO was the exclusive source for trades executed
through SOES, the duty of best execution was presumptively met for
these trades. The evidence to which the defendants point supports their
position that execution at the NBBO was a common practice in handling
orders from small investors. It does not alone, however, require a finding
that trades at better prices through SelectNet or Instinet were not
reasonably available even for small orders or that a broker-dealer's duty
of best execution was automatically discharged by executions through
SOES. While size is undoubtedly a relevant factor in determining the
scope of the duty of best execution, for summary judgment purposes we
find the state of the record with respect to small orders no different
than
the record with respect to other orders. The affidavit of Richard Y.
Roberts, who served as the chairman of the SEC throughout the class
period, notes that, to his knowledge, the SEC did not take the position
that execution through SOES automatically satisfied the duty of best
execution, and indicates that, in his opinion, such a position would be
contrary to several SEC releases. At any rate, not all of plaintiffs'
orders
were executed through SOES.

12
plaintiffs' economic gain in the transaction. Since the
defendants knew of the plaintiffs' profit motivation, they
must have understood, according to the plaintiffs, that
plaintiffs would expect them to obtain a price more
advantageous to the plaintiffs than the NBBO when one
was readily available. If the defendants intended not to act
in a manner consistent with this expectation when they
accepted the orders and yet did not so advise plaintiffs,
plaintiffs insist that the defendants can be found to have
made an implied representation that they knew to be false.

We believe that a reasonable trier of fact couldfind this
chain of inferences persuasive based on a straight forward
economic analysis of the plaintiffs' relationship with the
defendants. In addition, however, plaintiffs rely upon
evidence showing that respected members of the brokerage
community recognized, even prior to the class period, that
trades were readily available from sources other than the
NBBO and that their clients expected them to take
advantage of those sources whenever it would benefit the
client. See, e.g., Declaration of Paul M. Lacy [A 718];
Declaration of Junius W. Peake [A 755]; Declaration of
Richard Y. Roberts [A 775]. Moreover, the plaintiffs have
shown that an SEC study found clear evidence of a two-
tiered market during the class period, in which NASDAQ
market makers routinely traded at one price with retail
clients like the plaintiffs and at a better price for
themselves through quotation services like SelectNet and
Instinet. See Final Rules, 61 Fed. Reg. at 48307-08. They
have further shown that the possibility that the duty of best
execution might require resort to sources other than the
NBBO was being actively debated during the class period
and that that debate ultimately resulted, shortly after the
class period, in a regulation effectively requiring as much.
Id.

All of this would allow a reasonable trier of fact to find
that the defendants' misrepresentation--namely, that they
would execute plaintiffs' trades in a manner maximizing
plaintiffs' economic gain--was at least reckless, if not
intentional. See Healey v. Catalyst Recovery of Penn., Inc.,
616 F.2d 641, 649 (3d Cir. 1980) (defining recklessness as
an extreme departure from ordinary care).

13
Defendants have countered with affidavits of other
respected members of the brokerage community stating
that their practice during the class period was the same as
that of the defendants. This evidence could, of course, be
regarded by a trier of fact as probative of the defendants'
state of mind when they accepted plaintiffs' orders. But
these affidavits do no more than raise a material issue of
fact as to whether the defendants knew of the expectation
plaintiffs claim to have had; they do not settle the matter.

At trial, the defendants would certainly be entitled to
argue to the jury that, because of industry practice, they
thought their clients would expect them to execute only at
the NBBO or that they never thought about their clients'
expectations. Moreover, any evidence, derived from
knowledge of industry practice or elsewhere, that the
plaintiffs were generally aware of the defendants' exclusive
reliance on the NBBO would, of course, be quite probative
of whether the plaintiffs had the expectations they claim.
But the defendants, in elevating the practice of a segment
of the industry to be outcome determinative, lose sight of
the fact that the basis for the duty of best execution is the
mutual understanding that the client is engaging in the
trade--and retaining the services of the broker as his agent
--solely for the purpose of maximizing his own economic
benefit, and that the broker receives her compensation
because she assists the client in reaching that goal. Based
on this mutual understanding and the absence of any
express limitations on the brokers' responsibility, a trier of
fact could find that the defendants, although intending to
execute with sole reference to the NBBO, understood that
they were expected to utilize sources other than the NBBO
when a better price was readily available.6
_________________________________________________________________

6. The foregoing analysis is generally applicable to plaintiffs' claim
that
it was reasonably feasible for defendants to "cross" customer orders on
opposing sides of a transaction and match customer orders with in-
house limit orders. Plaintiffs' record support, including affidavits from
respected members of the investment community, raises a disputed
issue of material fact as to whether these practices were reasonably
feasible during the class period. If the defendants intended to execute
plaintiffs' orders at the NBBO despite the reasonable availability of
these
alternative pricing sources, and if the defendants acted knowingly or
with reckless indifference to the falsity of their material
representations,
then plaintiffs have a securities fraud claim for these practices as well.

14
V.

In concluding as we do, we are not unmindful of the fact,
deemed determinative by the district court, that execution
of customer orders at the NBBO was a practice "widely, if
not almost universally followed" in the securities industry
during the class period. 911 F. Supp. at 772. Under the
district court's logic, a Section 10(b) defendant would be
entitled to summary judgment even if it were her regular
practice to knowingly violate the duty of best execution, so
long as she could identify a sufficient number of other
broker-dealers engaged in the same wrongful conduct to be
able to argue in good faith that the underlying duty was
"ambiguous." We cannot accept an analysis that would
produce such a result.

Even a universal industry practice may still be
fraudulent. See Chasins v. Smith, Barney & Co. , 438 F.2d
1167, 1171-72 (2d Cir. 1970) (non-disclosure of widespread
industry practice may still be non-disclosure of material
fact); Opper v. Hancock Securities Corp., 250 F. Supp. 668,
676 (S.D.N.Y.) (industry custom may be found fraudulent,
especially on first occasion it is litigated) aff 'd, 367 F.2d
157 (2d Cir. 1966); see also Vermilye & Co. v. Adams
Express Co., 88 U.S. 138, 146 (1874). Indeed, the SEC
recently completed an investigation in which it found that
certain practices by NASDAQ market makers, not at issue
here, were fraudulent even though they were widely
followed within the industry. See Report of Investigation
Pursuant to Section 21(a) of the Securities Exchange Act of
1934 Regarding the NASD and the NASDAQ Market, 1996
SEC LEXIS 2146 (Aug. 8, 1996).

As defendants emphasize, the practice of exclusive
reliance on the NBBO has never been held to be fraudulent
by any court or regulator. On the other hand, there is no
statute, rule, regulation, or interpretation, by the SEC or by
a court, that authoritatively establishes that, for all trades,
the NBBO exhausted the category of "reasonably available
prices" during the class period. This absence of precedent
did not, however, absolve the district court of the duty to
resolve the plaintiffs' securities fraud claim once it was
presented in this suit.

15
"In the final analysis, ultimate responsibility for
construction and enforcement of the securities laws must
rest with the court." Langert v. Q-1 Corp. , Fed. Sec. L. Rep.
(CCH) P 94,445, at 95,540, 1974 WL 377 (S.D.N.Y. Mar. 15,
1974). The district court was not deprived of this
enforcement authority just because no court or regulator
had previously chosen to exercise such authority with
respect to the practice challenged here. See, e.g., Chasins,
438 F.2d at 1171-72 (finding that defendant's failure to
disclose its market maker status was material omission
under Section 10(b), despite fact that SEC had never
previously held that such disclosure was required).

VI.

On the record before us, we believe a reasonable trier of
fact could conclude that the defendants misrepresented
that they would execute the plaintiffs' orders so as to
maximize the plaintiffs' economic benefit, and that this
misrepresentation was intentional or reckless because, at
the time it was made, the defendants knew that they
intended to execute the plaintiffs' orders at the NBBO price
even if better prices were reasonably available. A reasonable
trier of fact could thus find scienter with respect to a
material misrepresentation, as well as the other elements
essential to a Section 10(b) fraud claim. Accordingly, we will
reverse the summary judgment entered by the district court
and remand for further proceedings.

A True Copy:
Teste:

Clerk of the United States Court of Appeals
for the Third Circuit

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