Crago v. Charles Schwab & Co., Inc.

Background

Lead Plaintiffs Robert Wolfson and Frank Pino, together with plaintiff K. Scott Posson, brought a proposed class action against Charles Schwab & Co. and Schwab Corp. The plaintiffs alleged that, between July 13, 2011, and December 31, 2014, Schwab routed more than 95% of its retail trade orders to UBS Securities LLC under an Equities Order Handling Agreement. The plaintiffs alleged that this routing arrangement conflicted with Schwab’s duty of best execution—the duty to use reasonable diligence to seek the most favorable terms reasonably available for a customer’s transaction.

The plaintiffs also alleged that Schwab made material misrepresentations by stating that it followed the duty of best execution and omitted important information about the agreement with UBS. They asserted claims under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5. The proposed class consisted of Schwab clients who placed qualifying non-directed equity orders routed to UBS under the agreement and received price disimprovement.

Class-Certification Standard

Under Federal Rule of Civil Procedure 23, plaintiffs seeking class certification must establish four requirements: numerosity, commonality, typicality, and adequacy of representation. They must also satisfy at least one additional Rule 23(b) requirement. The court noted that the plaintiffs had the burden to affirmatively demonstrate compliance with these requirements.

Presumption of Reliance

A private securities-fraud claim under Section 10(b) and Rule 10b-5 includes reliance on the alleged misrepresentation or omission. The plaintiffs argued that they were entitled to a presumption of reliance under Affiliated Ute Citizens of Utah v. United States, which can apply in cases primarily involving a failure to disclose.

The court rejected that argument. It relied on the Ninth Circuit’s decision in In re Volkswagen “Clean Diesel” Marketing, Sales Practices, & Products Liability Litigation, which held that the presumption does not apply when a case includes affirmative misrepresentations that allow reliance to be proven through ordinary evidence. The court found that the plaintiffs alleged both that Schwab failed to disclose the agreement with UBS and that Schwab affirmatively stated it was providing best execution. The plaintiffs also alleged that they relied on those affirmative statements. The court further noted that Schwab’s account agreements referred to the agreement with UBS, although the plaintiffs alleged that those references mischaracterized the agreement’s nature.

The court therefore concluded that this was not a case primarily involving omissions for purposes of the reliance presumption. The plaintiffs would have to prove reliance through individualized evidence.

Rule 23(a)

Schwab did not contest numerosity or adequacy, but it contested commonality and typicality. The court did not reach typicality because it found that commonality was lacking.

The court explained that the central reliance question was whether each investor read and relied on Schwab’s alleged statements when making each particular trade. Although that question could be asked of every investor, it would not have a single classwide answer. Each proposed class member would need to provide individualized proof of reliance.

The court also pointed to the plaintiffs’ different reasons for using Schwab, including the quality of Schwab’s platform, lower commissions, and family recommendations. Some class members might have continued using Schwab even if they had known that Schwab was not providing best execution. Given the millions of trades at issue, the court concluded that individualized reliance evidence prevented the claims from being productively litigated together and that commonality was not satisfied.

Rule 23(b)

The plaintiffs sought certification under Rule 23(b)(1)(A) and Rule 23(b)(3). The court held that certification under Rule 23(b)(3) was also unavailable because common questions would not predominate over individual ones. In the court’s view, because the reliance presumption did not apply, individualized reliance questions would overwhelm the common questions in the proposed securities-fraud class action.

Disposition

The court denied the motion for class certification under Rules 23(a), 23(b)(1)(A), and 23(b)(3). The court also denied as moot Schwab’s motion to exclude the testimony of the plaintiffs’ expert, Haim Bodek, because the court denied class certification based on the lack of commonality and predominance concerning reliance. The court granted the plaintiffs’ unopposed administrative motion for permission to exceed the page limit in their reply brief concerning class certification.