THELTON E. HENDERSON, United States District Judge.
On July 27, 2016, Plaintiffs filed a Motion for Partial Summary Judgment re: MSI Duty to Supervise Bock and Evans ("Pls.' Mot.") (ECF No. 41). After carefully considering the parties' written and oral arguments, the Court GRANTS IN PART and DENIES IN PART Plaintiffs' motion for the reasons set forth below.
This class action is related to another class action separately filed in this Court: Milliner v. Bock Evans Financial Counsel, Ltd., No. 15-cv-1763 TEH (the "Bock Evans Class Action").
In the present motion, Plaintiffs seek a ruling from this Court that MSI owed Plaintiffs a duty to supervise its registered representatives, Bock and Evans, including a duty to supervise their outside investment advisory activities. Pls.' Mot. at 2.
Summary judgment is appropriate when "there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a). Material facts are those that may affect the outcome of the case. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). A dispute as to a material fact is "genuine" if there is sufficient evidence for a reasonable jury to return a verdict for the nonmoving party. Id. The court may not weigh the evidence and must view the evidence in the light most favorable to the nonmoving party. Id. at 255, 106 S.Ct. 2505.
A party seeking summary judgment bears the initial burden of informing the court of the basis for its motion, and of identifying those portions of the pleadings or materials in the record that demonstrate the absence of a genuine issue of material fact. Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). Where the moving party will have the burden of proof at trial, it "must affirmatively demonstrate that no reasonable trier of fact could find other than for the moving party." Soremekun v. Thrifty Payless, Inc., 509 F.3d 978, 984 (9th Cir. 2007). However, on an issue for which its opponent will have the burden of proof at trial, the moving party can prevail merely by "pointing out to the district court ... that there is an absence of evidence to support the nonmoving party's case." Celotex, 477 U.S. at 325, 106 S.Ct. 2548. If the moving party meets its initial burden, the opposing party must then set out specific facts showing a genuine issue for trial to defeat the motion. Anderson, 477 U.S. at 250, 106 S.Ct. 2505.
As a preliminary matter, "the existence of a legal duty in a given factual situation is a question of law for the courts to determine." Hayes v. Cty of San Diego, 736 F.3d 1223, 1232 (9th Cir. 2013) (citation
While MSI's duty to Plaintiffs may be determined as a matter of law, here, the determination of the scope of that duty depends on whether the Court may consider the rules of self-regulatory organizations to define the scope of that duty. Therefore, the Court first turns to the statutes and regulations governing MSI and, second, whether it may look to self-regulatory rules in defining MSI's duty to Plaintiffs.
The Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78a-78lll (2015), "created a system of supervised self-regulation in the securities industry whereby [SROs] such as the [National Association of Securities Dealers ("NASD")] or the [New York Stock Exchange ("NYSE")] could promulgate their own governing rules and regulations, subject to oversight by the Securities and Exchange Commission." Credit Suisse First Bos. Corp. v. Grunwald, 400 F.3d 1119, 1128 (9th Cir. 2005).
Under the Exchange Act, SROs are required to file all proposed rules with the Securities and Exchange Commission ("Commission"), along with a statement justifying the basis and purpose of the proposed rule. 15 U.S.C. § 78s(b)(1) (2015). In turn, for most proposed rules
The Exchange Act requires, among other things, that broker-dealers register with the Commission before engaging in securities transactions. 15 U.S.C. § 78o (2015). Additionally, the Exchange Act requires broker-dealers to maintain membership with an SRO. Id. § 78o(b)(8); Kleinser v. Sec. Exch. Comm'n, 539 Fed.Appx. 7, 9 (2d Cir. 2013). Individuals who work for a registered broker-dealer are recognized as "associated persons", 15 U.S.C. 78(c)(18) (2015), or "registered representatives", SEC. Exch. COMM'N, Guide to Broker-Dealer Registration, https://www.sec.gov/divisions/marketreg/bdguide.htm (last updated July 29, 2016). Registered representatives,
The Financial Industry Regulatory Authority, Inc. ("FINRA")
While "[i]t is well established that violation of an exchange rule will not support a private claim," In re Verifone Sec. Litig., 11 F.3d 865, 870 (9th Cir. 1993), courts have often looked to such rules in defining the scope of common law duties. Indeed, while the Ninth Circuit has not directly addressed whether SRO rules can define the scope of a common law duty, it has recognized that SRO rules "reflect the standard to which all brokers are held." Mihara v. Dean Witter & Co., Inc. 619 F.2d 814, 824 (9th Cir. 1980) Moreover, several other courts have gleaned guidance from SRO rules in defining the scope of a
In light of these authorities, the Court holds it can properly consider the FINRA rules governing MSI to determine whether it had a duty to supervise the investment advisory activities of its registered representatives. Hence, the Court now turns to address the application of FINRA rules to MSI.
As an initial matter, MSI is registered with FINRA. Marshall Decl., Ex. A. MSI does not contest the application of FINRA regulations to itself. In fact, MSI concedes that "Broker-Dealers are required to be members of FINRA and are subject to regulations promulgated by both the SEC and FINRA pursuant to the Securities Exchange Act...." Def.'s Opp'n at 5. It is also undisputed that Bock and Evans were both registered representatives of MSI at the time they advised Plaintiffs regarding their investments. See Marshall Decl. at Exs. B-C. The crux of Plaintiffs' argument lies in the application of FINRA Rule 3280 to MSI. FINRA Rule 3280(a) provides: No person associated with a member shall participate in a private securities transaction except in accordance with the requirements of this Rule. A "private securities transaction" is defined in FINRA Rule 3280(e)(1) as "any securities transaction outside the regular course or scope of an associated person's employment with a member...." FINRA Rule 3280(b) provides:
Upon receiving written notice in accordance with section (b), the broker-dealer is required to advise the associated person, in writing, whether the member approves or disapproves the person's participation in the proposed transaction. FINRA Rule 3280 (c)(1). Most relevant to this case, if the broker-dealer approves such a transaction, "the transaction shall be recorded on the books and records of the member and the member shall supervise the person's participation in the transaction as if the transaction were executed on behalf of the member." FINRA Rule 3280(c)(2) (emphasis added).
Here, there is no dispute that Bock and Evans disclosed their outside investment advisory activities to MSI. Marshall Decl., Exs. L-M. Nor is there a dispute that MSI approved the activities, or that Bock and Evans were to receive asset-based fees for these activities. Id. Rather, the dispute among the parties is whether Bock and Evans' outside activities were for "selling compensation", thus requiring MSI to supervise the transactions of MSI as their own. Thus, the Court turns to address this issue.
Section (e)(2) of FINRA Rule 3280 defines "selling compensation" as:
MSI argues that FINRA Rule 3280 did not impose an obligation on it to supervise Bock and Evans' activities because selling compensation must be "in connection with or as a result of the purchase or sale of a security." Def.'s Opp'n at 8. Here, MSI argues, Bock and Evans' compensation was fee-based rather than tied to any particular transaction because "[t]he fees did not change whether BEFC made one trade in a quarter or a hundred trades in a quarter"; therefore, their activities were not rendered for selling compensation and did not create a duty to supervise. Id. at 8-9. Not so.
A number of Notice to Members ("NTMs") issued by NASD address the application of FINRA Rule 3280 where a registered representative is also a registered investment advisor ("RR/RIA").
Id. (emphasis added). Additionally, on the issue of "selling compensation", NTM 91-32 states:
Id. (emphasis added).
Second, in NTM 94-44 (1994), the NBCC determined that § 40 "applies to any transaction in which the dually registered person participated in the execution of the trade." The notice defined "execution" as "participation that goes beyond a mere recommendation." More importantly, NTM 94-44 explicitly confirmed that if an RR/RIA received asset-based management fees for participating in the execution of a transaction on behalf of a customer, the transaction would be subject to § 40, thereby requiring the broker-dealer to record and supervise the transactions. Id.
Third, NTM 96-33 (1996) reaffirmed that if a broker-dealer's registered representative is engaged in outside investment advisory activities for an asset-based fee and the broker-dealer approves the activities, the broker-dealer must "supervise activity in the affected accounts as if it were its own." The notice also states that the broker-dealer's recordkeeping and supervisory procedures "must enable the member to properly supervise the RR/IA by aiding in the member's understanding of the nature of the service provided by an RR/IA, the scope of the RR/IA's authority, and the suitability of the transactions."
Lastly, NTM 01-79 (2001) states "if a firm approves an associated person's participation in a securities transaction, the firm assumes certain critical regulatory responsibilities that go along with offering and selling securities to customers.... [T]he firm must exercise appropriate supervision over the associated person in order to prevent violations of the securities laws."
This Court holds that the NTMs accompanying FINRA Rule 3280 undoubtedly establish that MSI had a duty to supervise Bock and Evans' outside advisory investment activities. These NTMs are clear that, for purposes of applying FINRA Rule 3280, selling compensation includes asset-based fees. Therefore, if a broker-dealer approves the outside advisory investment activities of its registered individuals who receive asset-based fees, the broker-dealer must properly supervise the activities as its own. Such is the case here.
MSI attempts to downplay the significance of the NTMs by arguing the NTMs were "necessarily rejected" when they were not explicitly integrated into FINRA Rule 3280 upon its adoption. Def.'s Opp'n at 9. MSI's argument is as follows: First, NASD Rule 3040 defined selling compensation as "transactional in nature." Second, subsequent NTMs "seem to advocate a change in the definition of `selling
FINRA adopted NASD Rule 3040 as FINRA Rule 3280 "without any substantive changes", explicitly stating that the new rule's definition of the term "selling compensation" is "substantively identical to the definitions in NASD Rule 3040." Proposed Rule Change to Adopt FINRA Rule 3280, 80 Fed. Reg. 52530, 52531 (Aug. 31, 2015). Because FINRA adopted NASD Rule 3040 in its entirety, without change, it follows that the NTMs related to NASD Rule 3040 continue to apply to FINRA Rule 3280. Consequently, MSI's argument that the above-mentioned NTMs were impliedly rejected fails.
The Commission's interpretation of FINRA Rule 3280 supports the Court's holding. The Ninth Circuit has previously granted the Commission deference in determining the meaning of SRO rules. For example, in Krull v. Sec. Exch. Comm'n, 248 F.3d 907 (9th Cir. 2001), the court considered whether the Commission had properly upheld a violation of an NASD rule. In affirming the Commission's determination, the court recognized the Commission's responsibility "to approve all rules, policies, practices, and interpretations prior to implementation" and held "[b]ecause of the Commission's expertise in the securities industry, we owe deference to its construction of NASD's Rules of Fair Practice." Id. at 911-12 (citing Alderman v. Sec. Exch. Comm'n, 104 F.3d 285, 288 (9th Cir. 1997)). Thereafter, the Krull court proceeded to quote an SEC administrative case, In re Winston H. Kinderdick, 46 S.E.C. 636, 1976 WL 162399, *1, 1976 SEC LEXIS 783, at *8 (Sept. 21, 1976), in which the Commission elaborated on trading that violated a specific NASD rule, to support the court's application of the rule. Krull, 248 F.3d at 912-13.
Likewise, here, the Commission has issued statements directly interpreting NASD Rule 3040 to apply to registered representatives who engage in outside investment advising activities for asset-based fees. For example, in In the Matter of the Application of Keith L. Mohn, SEC Release No. 42144, 1999 WL 1036827, at *5 (Nov. 16, 1999), the Commission acknowledged that, according to NTM 94-44, NASD Rule 3040 applies to any transaction in which an RR/RIA participated in the execution of the trade. Also, in Definition of Terms, SEC Release No. 44291, 2001 WL 1590253 (May 11, 2001), the SEC cited NTM 96-33 in stating:
Id. at *52 n. 289. Both of these interpretations clearly illustrate the Commission's understanding that FINRA Rule 3280 requires broker-dealers to supervise the advisory activities of their registered representatives.
Courts have also granted deference to an SRO's interpretation of its own rules,
MSI also argues that the Investment Advisory Agreement between Plaintiffs and BEFC releases MSI from the obligation to supervise Bock and Evans because the agreement made it clear that "any investment advice or recommendations made by Bock and Evans, were made solely in their capacity as Investment Advisers for BEFC and not in their capacity as Registered Representatives of MSI." Def.'s Opp'n at 1-2. Also, MSI points to several documents arguing they illustrate MSI's very limited role in the relevant transactions while establishing Bock and Evans as the primary actors to whom the plaintiffs granted substantial authority. Def.'s Opp'n at 2, 4, 6, 11-12.
These arguments also fail. Notably, none of the above-mentioned NTMs, nor the Commission's interpretation of these NTMs, recognize a distinction between RR/IAs acting as registered representatives or as investment advisors. Also, a broker-dealer cannot contract itself out of its SRO obligations. Section 78cc of the Exchange Act prohibits "[a]ny condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of a self-regulatory organization...." 15 U.S.C. § 78cc (2015) (emphasis added). The words of § 78cc are clear: any agreement releasing a broker-dealer from complying with its obligations under FINRA rules is void as a matter of law. Here, where FINRA rules specifically require MSI to supervise the advisory activities of its registered representatives, MSI cannot argue that agreements or documents between the parties release it from its supervisory obligations under FINRA. The Court's application of § 78cc is consistent with the Commission's rejection of independent contractor relationships for purposes of the Exchange Act. Matter of William v. Giordano, 1996 WL 21031, at *4.
Next MSI cites to Petersen v. Sec. Settlement Corp., 226 Cal.App.3d 1445, 277 Cal.Rptr. 468 (1991), arguing that MSI's minimal participation relieves it from liability. In Petersen, an elderly couple sued a brokerage firm after they followed the advice of their broker to invest their money into penny stocks and lost the entire value of the investment. Id. at 1449, 277 Cal.Rptr. 468. The broker worked for Guildcor Financial, Inc. ("Guildcor") but the transaction was carried out by Securities Settlement Corporation ("SSC"), which functioned as a clearing broker for Guildcor. Under a clearing agreement between SSC and Guildcor, SSC agreed to
Petersen is easily distinguishable from this case. First, unlike the parties in Petersen, where the broker-dealer was completely removed from the plaintiffs, here, the broker-dealer has a direct relationship with the Plaintiffs — BEFC required clients to open a brokerage account with MSI. Marshall Decl. Ex. J at 14. Second, unlike Petersen where the advising broker was unaffiliated to the broker-dealer that actually carried out the transactions, here, Bock and Evans were both registered representatives of the broker-dealer that carried out the transactions. Not to mention that MSI received actual notice of Bock and Evans' outside advisory activities. Thus, while FINRA Rule 3280 may not have applied in Petersen, it directly applies here. Lastly, the Petersen case was decided on January 18, 1991 — prior to the release of NTMs relevant to this case; therefore, Petersen sheds no light on the application of these NTMs. In sum, Petersen is inapposite to this case.
In opposing summary judgment, MSI also argues the motion should be denied because "the parties are in the midst of a discovery dispute" in which "Plaintiffs have produced no documents whatsoever during the course of this action — literally zero." Def.'s Opp'n at 14-15. MSI attests it has had to obtain several documents from BEFC, including the Investor Advisory Agreement between the Plaintiffs and BEFC. Id. at 15. It also alleges that the discovery dispute has delayed the scheduling of the Plaintiffs' depositions. In short, MSI argues because of the risk there may be other crucial documents in Plaintiffs' possession, which define the relationship between MSI and Plaintiffs, summary judgment is inappropriate at this time.
MSI's argument fails for one main reason: MSI's scope of duties would not be affected by discovery relating to the relationship of the parties. The core, relevant (and undisputed) facts are that (1) MSI was a broker-dealer registered with FINRA; (2) Bock and Evans were registered
Plaintiffs' motion also seeks a determination from the Court that MSI was a "control person" of Bock and Evans under Section 20(a) of the Exchange Act. 15 U.S.C. § 78t(a) (2015). Pls.' Mot. at 2. Section 20(a) provides:
In support of Plaintiffs' argument that section 20(a) of the Act deems MSI a control person, Plaintiffs cite Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990). In Hollinger, the Ninth Circuit was addressing whether Titan — a registered broker-dealer regulated by the Commission and by the NASD — could be held vicariously liable as a "controlling person" under § 20(a) for the securities laws violations of its registered representative. Id. at 1572. In particular, the court was addressing whether Titan exercised "actual power or influence" over the registered representative. The court determined that "[b]ecause a sales representative must be associated with a registered broker-dealer in order to have legal access to the trading markets, the broker-dealer always has the power to impose conditions upon that association, or to terminate it." Id. at 1573-74. As a result, the court held that to establish a broker-dealer as a controlling person the plaintiff "need only show that [the registered representative] was not himself a registered broker-dealer but was a representative employed by or associated with a registered broker-dealer." Id. at 1574.
Plaintiffs argue that, here, where it is undisputed that Bock and Evans were registered representatives of MSI, Hollinger requires the Court to determine it was a control person of Bock and Evans. Pls.' Mot. at 25. Even though Hollinger supports Plaintiffs' argument for finding MSI a control person of Bock and Evans, and while the Court acknowledges Hollinger has not been expressly overruled, more recent Ninth Circuit case law establishes that control person liability requires more than a showing of actual power or influence over the employee — as would be present in a relationship between a broker-dealer and a registered representative. To establish control person liability, the plaintiff must prove two elements: (1) a primary violation of federal securities laws; and (2) that the defendant exercised actual power or control over the primary violator. Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir.2000). This test has been used by the Ninth Circuit for some time. See, e.g., In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046, 1052 (9th Cir. 2014); Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 990 (9th Cir. 2009); No. 84 Employer-Teamster Joint Council Pension Tr. Fund v. Am. West Holding Corp., 320 F.3d 920, 945 (9th Cir. 2003).
Here, the Plaintiffs have failed to plead (and much less prove) MSI violated federal securities laws. Plaintiffs' complaint alleges five claims for relief. None of them alleges
For the foregoing reasons, the Court GRANTS Plaintiffs' motion as to MSI's duty to supervise Bock and Evans, and DENIES Plaintiffs' motion as to establishing MSI as a "control person" under § 20(a) of the Exchange Act.
