Case Name:   John C. Scranton vs. E*TRADE Securities LLC.

Case No.:       1-13-CV-245579

 

This is a putative class action by plaintiff John C. Scranton (“Plaintiff”), individually and on behalf of other customers of defendant E*TRADE Securities LLC (“Defendant”) who purchased “put” options.  According to the operative Second Amended Class Action Complaint (“SACAC”), there are two types of options: “put” options and “call” options.  A put option gives the buyer of the option the right to sell a particular asset at a specific price (the “strike price”) on or before a certain date (the “expiration date”).[1]  By purchasing an option, a buyer is not obligated to buy or sell the asset but merely has the right to do so, but option holders will exercise this right as long as doing so would be profitable because an option that expires unexercised becomes worthless.[2]  Put options are said to be “in the money” when the current market value of the underlying security is below the put’s strike price.[3]  Because an underlying security always has a current market value, at any given point in time a put is always “in the money,” “out of the money” (current market value is greater than the put’s strike price) or “at the money” (current market value is equal to the put’s strike price).[4]

 

Plaintiff further alleges that in a variety of consumer-oriented materials (e.g., various sections of the “Help Center” of Defendant’s website[5]), Defendant explicitly promised customers that it would “automatically exercise” their options if it would result in the consumer getting at least $.01 in profit.[6]  Despite these promises however, if trading in the underlying security was halted, Defendant did not automatically exercise the options, and would only exercise the options during a trading halt if expressly requested to do so by the customer.[7]  Plaintiff alleges this practice lulls Defendant’s customers into a false sense of security with respect to whether their expiring “in the money” options would be exercised.[8]

 

Plaintiff alleges that on January 12, 2011, he purchased put options on 1,000 shares of a company called Duoyuan Global Water Inc. (“DGW”) for a total of $377.00, and the strike price on the options was $7.50 with an expiration date for June 18, 2011.[9]  On February 18, 2011, he purchased an additional 1,000 shares of DGW, but sold 2,000 shares on April 5, 2011 at $3.22 per share.[10]  On April 19, 2011, trading in DGW shares was suspended, and on that date, DGW stock closed at a price of $3.88 per share; trading did not resume until January 26, 2012, when the stock opened at $2.25 per share.[11]  Plaintiff alleges because Defendant had promised that “in the money” options would be “automatically exercised,” he took no actions to ensure that his DGW puts were exercised upon expiration.[12]  Plaintiff alleges that on the June 18, 2011 expiration date, Defendant broke its promise to Plaintiff and failed to exercise the puts, even though they were clearly “in the money” by a large amount (e.g., at least $3.62 (or 48%)), well over the $.01 threshold at which Defendant promised its customers it would exercise their expiring options.[13]  At no point before June 18, 2011 did Defendant contact Plaintiff to ask him for instructions in light of the fact that it was not exercising the puts despite its promise to the contrary.[14]  As a result, the puts expired unexercised, and Plaintiff lost the $7,5000 that he would have received had Defendant honored its promise to exercise his puts.[15]

 

Plaintiff seeks to represent a class of “[a]ll E*TRADE customers who[] purchased puts through E*TRADE that were at least $.01 in the money upon expiration, and who suffered losses due to E*TRADE’s failure to exercise those in-the-money options upon expiration during trading halts on the securities underlying those options.”[16]

 

The original Class Action Complaint was filed on April 30, 2013.  On September 20, 2013, Plaintiff filed his First Amended Class Action Complaint (“FACAC”) asserting five “Counts” for: (1) violation of the California Unfair Competition Law (“UCL”) (Cal. Bus. & Prof. Code, § 17200 et seq.); (2) violations of the Consumer Legal Remedies Act (“CLRA”) (Cal. Civ. Code, § 1750 et seq.); (3) fraud; (4) negligent misrepresentation; and (5) breach of fiduciary duty.

 

On December 20, 2013, the Court sustained with leave to amend Defendant’s demurrer to the FACAC.  The Court held that based on disclosures made in the judicially-noticed Options Clearing Corporation (“OCC”) options booklet entitled “Characteristics of Risks and Standardized Options” (“OCC Disclosure Document”) and the “E*TRADE Pro User” agreement between Plaintiff and Defendant, Defendant’s alleged promise to automatically exercise options that were “in the money” on their expiration date was not rendered or false or misleading where trading is suspended on the expiration date because in that situation, there is no current market value for the underlying asset.  The Court found no fraudulent concealment of failure to disclose because the “pop-up” window referred to in the FACAC referred customers to the OCC Disclosure Document, which cautions option holders that while trading is halted, the option holder may have to decide whether to exercise without knowing the current market value of the underlying assets.  The Court also found that in the Customer Agreement, Plaintiff disclaimed liability for losses arising out of or relating to a cause which Defendant did not have direct control, including “suspension of trading.”  The Court observed in footnote that Plaintiff’s claims may be barred by the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”).  Finally, the Court held that Defendant’s concurrent motion to strike was moot.

 

On January 31, 2014, Plaintiff filed the operative SACAC, which asserts seven Counts for: (1) breach of fiduciary duty; (2) breach of the covenant of good faith and fair dealing; (3) violation of UCL; (4) in the alternative, violations of New York’s Consumer Protection Statute (N.Y. Gen. Bus. Law §§ 349, et seq.); (5) violations of the CLRA; (6) fraud; and (7) negligent misrepresentation.

 

The SACAC alleges substantially the same theories and claims as the FACAC but adds a few new allegations in response to the deficiencies identified in the demurrer.  The SACAC alleges that an underlying security “always has a current market value” because it is either “in the money,” “out of the money,” or “at the money”;[17] the phrase “current market value” is not defined in Defendant’s Customer Agreement or in the OCC Disclosure Document referred to in the Customer Agreement, and industry practice and common sense dictate that “the current market value of the underlying security is assumed to be no higher than the stock price on the last day on which the security traded”;[18] under current OCC regulations, puts expire on Saturdays, and since stocks do not trade on Saturday, typically “current market value” is determined by reference to the closing price on the preceding Friday;[19] when trading is halted, industry practice is such that “the current market value for purposes of exercising options is assumed to be equal to the ‘last trading price’ (meaning the price on the last day the stock was traded) on the date of suspension, and in case more than that price”;[20] both the OCC and Defendant operate according to this industry practice;[21] in Plaintiff’s case, Defendant used the last trading price of DGW stock throughout the trading halt both to asses the stock’s “current market value” and to asses the value of options for which DGW was the underlying security, and thus, Plaintiff’s E*TRADE account showed the value of his puts as $3,900 until the day of their expiration, despite the fact that trading was halted on the underlying DGW stock, and when Plaintiff called to discuss why his DGW puts had not been exercised, Defendant’s own customer service representative referred to the puts as “in the money” despite the trading halt;[22] Defendant uses the last trading price of halted securities for other purposes relating to its customers’ accounts, including determining whether its customers are in compliance with Defendant’s requirements for margin accounts;[23] the OCC normally exercises puts on behalf of its “clearing members” (approximately 115 large institutions that participate in the OCC’s clearing services) that are more than $.01 “in the money,” and in the event of a trading halt, OCC rules provide that the clearing member (e.g., Defendant) is responsible for providing instructions to the OCC if the member desires the OCC to exercise the member’s clients’ puts (e.g., Plaintiff’s DGW puts), which means that nothing in the OCC rules prevents Defendant from automatically exercising “in the money” puts on behalf clients during a trading halt.[24]  The SACAC also contains a section of allegations under the heading “No Preemption Under Federal Securities Litigation Uniform Standards Act (“SLUSA”)”.[25]

 

Defendant once again demurs to the SACAC and moves to strike portions thereof.

 

Judicial Notice

 

Defendant’s request for judicial notice of the SACAC (RJN Exh. 1), the Court’s December 20, 2013 Order After Hearing on the demurrer to the FACAC (RJN Exh. 2), and the FACAC (RJN Exh. 3) is GRANTED as to the existence of these court records.  (See Cal. Evid. Code, § 452, subd. (d).)  Defendant’s request for judicial notice of the OCC Disclosure Document (RJN Exh. 4) and the E*TRADE Pro User Agreement (RJN Exh. 6) is also GRANTED as to the existence of these documents.  The OCC Disclosure Document is referenced in the Customer Agreement attached as Exhibit 3 to the SACAC, and the E*TRADE Pro User Agreement is referenced in paragraph 6 of the SACAC.  (See Ascherman v. Gen. Reinsurance Corp. (1983) 183 Cal.App.3d 307, 310-311.)  Defendant’s request for judicial notice of a published and generally available historical stock price graph and charts for DGW (RJN Exh. 5) is GRANTED because DGW’s historical stock price is a fact that is not reasonably subject to dispute and capable of immediate and accurate determination by resort to sources of reasonably indisputable accuracy.  (Cal. Evid. Code, § 452, subd. (h); In re Marriage of Brigden (1978) 80 Cal.App.3d 380, 385, fn. 3.)

 

In a supplemental request, Defendant seeks judicial notice of: (1) OCC Rule 805(j) and (2) Financial Industry Regulatory Authority (“FINRA”) Rule 5260.  Defendant argues the Court may take judicial notice of these rules under California Evidence Code section 452 subdivisions (b) and (h) because the OCC and FINRA are Self-Regulatory Organizations exercising authority delegated and under the direct supervision of the Securities and Exchange Commission.  Defendant argues OCC Rule 805(j) is relevant because Plaintiff makes an incomplete citation to it in his opposition, and FINRA Rule 5260 is relevant to the issue of whether there can be a current market value for a security when a trading halt is in place.  The request is GRANTED as to the existence of these regulatory rules.  (Cal. Evid. Code, § 452, subds. (b), (h); Lewis v. Lynch, Pierce, Fenner, & Smith, Inc. (1986) 183 Cal.App.3d 1097, 1104 [judicial notice of rules published by FINRA predecessor].)

 

Demurrer

 

Defendant argues the misrepresentation claims fail because Plaintiff’s options were not “in the money” on the June 18, 2011 expiration date due to the trading halt on DGW stock (Apr. 19, 2011—Jan. 26, 2012), which meant that DGW stock had no “current market value” on the expiration date.  Defendant argues that Plaintiff’s attempt to re-define “in the money” in the SACAC fails because he contradicts that OCC Disclosure Document’s facial terms, trading on DGW was halted many weeks prior to the option’s expiration date, and the allegation that Defendant recorded the last trading price of Plaintiff’s options position for some other purposes does not mean it was a reliable indicator of its then-current market value or showed the current market value of the underlying DGW stock.  Defendant argues the Customer Agreement is a complete bar to Plaintiff’s claims because: (1) in the Customer Agreement, Plaintiff disclaimed liability for any claims that arise out of relate to the suspension of trading; (2) Plaintiff expressly agreed that Defendant would have no obligation to exercise any options absent specific instructions from him; (3) Plaintiff agreed not to hold Defendant liable for any losses resulting from his own failure to act or to give Defendant instructions regarding rights that expire; Plaintiff acknowledged that he was a “self-directed investor” and that Defendant would not provide him with any investment advice or recommendations; and (4) Plaintiff specifically acknowledged that options trading is highly speculative and contains a high degree of risk and would be subject to market rules and the OCC Disclosure Documents, which he promised to read and fully understand.

 

Defendant further argues that Plaintiff’s claims are barred by the SLUSA because: (1) this is a “covered class action” (a lawsuit in which one or more named parties seek to recover damages on a representative basis and questions of law or fact common to those persons predominate over individual ones); (2) each of Plaintiff’s causes of action is based on state statutory or common law and is predicated upon alleged misrepresentations or omissions of material fact and alleged acts of deception by Defendant; and (3) the purported misrepresentations are alleged to have been made in connection with the purchase or sale of a covered security, and Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit (2006) 547 U.S. 71 (“Dabit”) held that misrepresentation claims of persons holding and failing to sell securities are in connection with the purchase and sale of a covered security.

 

Defendant argues Plaintiff’s consumer protection claims under the UCL, CLRA and New York Consumer Protection Statute fail because Plaintiff fails to allege reliance on the E*TRADE website statements.  Defendant argues Plaintiff’s CLRA claim based on an omission fails as a matter of law because: (1) Defendant did not omit any fact contrary to its alleged representations; (2) Plaintiff fails to identify any duty on Defendant’s part to disclose more about the unusual circumstances of a trading halt; (3) Plaintiff does not allege – and specifically disclaims – that he relied on any statement made by Defendant when he purchased his stock options; and (4) ancillary services in connection with stock options do not fall within the CLRA’s ambit.  Defendant argues the UCL claim fails because: (1) under the parties’ contract, New York law governs their relationship; (2) it does not allege an incipient violation of the antitrust law for purposes of UCL unfairness, and there was nothing fraudulent or likely to deceive about Defendant’s conduct; and (3) the UCL is inapplicable to claims based on securities transactions as a matter of law.  Defendant argues Plaintiff’s claim under New York’s Consumer Protection Statute fails because: (1) Plaintiff fails to plead a false or deceptive practice; and (2) claims arising out of securities transactions are not the type of consumer transactions for which the statute was intended to provide a remedy.

 

Defendant argues Plaintiff’s claim for breach of the covenant of good faith and fair dealing is defective because: (1) Defendant made no promise to exercise “in the money” stock options during a trading halt; and (2) the claim contradicts the express terms of the Customer Agreement regarding the exercise of stock options.

 

Defendant argues Plaintiff’s fraud and negligent misrepresentation claims fail because: (1) Plaintiff fails to allege that Defendant made any statement to him about exercise of options in the event trading was halted; (2) Plaintiff cannot plead reasonable reliance in light of the disclosures in the Customer Agreement and OCC Disclosure Document; (3) the allegations defeat any notion that Defendant acted with intent to deceive given that Defendant allegedly would have received a fee had Plaintiff exercised; and (4) under New York law, Plaintiff must plead the existence of a fiduciary or other special relationship to state a claim for negligent misrepresentation, but a broker-client relationship does not necessarily create a special or fiduciary relationship, and here, Plaintiff was responsible for his investment decisions.

 

Finally, Defendant argues that Plaintiff’s breach of fiduciary duty claim fails because: (1) it is predicated on a purported misrepresentation that did not occur; (2) it is barred by the SLUSA; (3) under New York law, no fiduciary duty arises from a customer’s relationship with a brokerage firm where the customer controls his or her own account, and here the Customer Agreement states that Plaintiff is responsible for providing Defendant with instructions regarding options exercise and that Defendant is under no duty to make any personalized or individualized assessment for Plaintiff; and (4) under California law, the duty of a securities broker that does not provide investment advice and merely executes customer instructions is limited to those instructions and avoiding misrepresentations.

 

Analysis:  A demurrer tests the sufficiency of the plaintiff’s complaint, i.e., whether the complaint states facts sufficient to constitute a cause of action upon which relief may be based.  (Kong v. City of Hawaiian Gardens Redevelopment Agency (2002) 108 Cal.App.4th 1028, 1037, citing Cal. Code Civ. Proc. § 430.10(e).)  “A demurrer can be used only to challenge defects that appear on the face of the pleading under attack; or from matters outside the pleading that are judicially noticeable.”  (Weil & Brown, Weil & Brown, Cal. Practice Guide: Civil Procedure Before Trial (The Rutter Group 2007) ¶ 7:8, p. 7-7 [emphasis in original], citing Blank v. Kirwan (1985) 39 Cal.3d 311, 318.)  The “face of the complaint” includes matters shown in exhibits attached to the complaint and incorporated by reference.  (See Frantz v. Blackwell (1987) 189 Cal.App.3d 91, 94.)  “A demurrer tests the pleadings alone and not the evidence or other extrinsic matters.”  (Skf Farms v. Superior Court (1984) 153 Cal.App.3d 902, 905.)  However, on a demurrer, the court may consider material documents referred to in the allegations of the complaint.  (City of Port Hueneme v. Oxnard Harbor Dist. (2007) 146 Cal.App.4th 511, 514.)

 

As with the FACAC, the SACAC’s claims are based primarily on Defendant’s written promise on its website that it would automatically exercise all options that were “in the money” on their expiration date.[26]  The SACAC acknowledges that whether put options are “in the money” depends on the “current market value” of the underlying security.[27]  Likewise, the OCC Disclosure Document, which Plaintiff had to acknowledge having read and understood in the Customer Agreement attached as Exhibit 3 to the SACAC, defined “in the money” as follows:  “A put option is said to be in the money if the current market value of the underlying interest is below the exercise price of the option.”[28]

 

In the “pop-up” window printout attached as Exhibit 2 to the SACAC, there is an “Important Note” referring customers to the OCC Disclosure Document for more information on OCC rules governing the automatic exercise of in-the-money equity options at expiration.[29]  In the Customer Agreement attached as Exhibit 3 to the SACAC, the customer acknowledges having read and understood the terms, conditions and risk of options trading set forth in the OCC Disclosure Document.[30]  The OCC Disclosure Document not only defines “in the money” based on the underlying asset’s current market value,[31] but expressly cautions that “[i]f the option is exercisable while trading has been halted in the underlying interests, option holders may have to decide whether to exercise without knowing the current market value of the underlying interests.  This risk can become especially important if an option is close to expiration, and failure to exercise will mean that the option will expire worthless.”[32]

 

In Piemonte v. Chicago Bd. Options Exchange, Inc. (S.D.N.Y. 1975) 405 F.Supp. 711, the plaintiff sued a securities options auctioneer and others on behalf of holders of option contracts for alleged misrepresentations and breach of fiduciary duty based on statements made in the prospectus of the securities options auctioneer after some of the plaintiff’s options were not exercised during a trading halt by the Securities and Exchange Commission.  The plaintiff alleged the prospectus “failed to disclose to investors the risk which they face should the option expire on a day on which the underlying shares were suspended from trading.  The plaintiff claims that investors should have been told that in such a case they would have to decide whether to exercise or not, without any indication of the market value of the underlying stock.”  (Piemonte, supra, 405 F.Supp. at pp. 714-715.)  The U.S. District Court granted the securities options auctioneer’s motion for summary judgment, finding the statements in the prospectus were not actionable as misrepresentations as a matter of law because the prospectus adequately apprised prospective investors of the risks that they undertook by investing.

 

The investor is also repeatedly warned that his option becomes worthless if not exercised before its expiration.  Furthermore, there is emphasized under the heading Additional Risks on page 6, the passage quoted above pertaining to the possibility of a suspension of trading in the underlying stock.  The investor is thus put on notice that on certain days there may be no transactions in the underlying stock.  [¶]  Once warned of this fact, the investor should realize that at certain times there may be no current market price for the underlying stock and that as a result he must guess as to both the value of his option, and whether he should exercise.

 

(Id. at pp. 716-717.)

 

“Current market value” reasonably implies present or active trading on a market, and Piemonte supports Defendant’s position that during a trading halt of stock, there is no current market price for the stock, and thus, the value of the related option is subject to guesswork.  (See also, Sonnenberg v. United States (2d Cir. 1959) 268 F.2d 537, 538 [“shares had no market value in 1941; they were not listed on any stock exchange, nor were there outstanding offers for them”; Coleman & Co. Secs., Inc. v. Giaqunito Family Trust (S.D.N.Y. 2002) 236 F.Supp.2d 288, 310 [“shares essentially had no market value, as they were not publicly traded”].)

 

The instant case is somewhat distinguishable from Piemonte because of the allegation that Defendant promised to “automatically exercise” all options that were “in the money” on the exercise date.[33]  However, the website pages that contained Defendant’s alleged promise also referred the customer to the OCC Disclosure Document, which addresses the circumstance of not “knowing the current market value of the underlying interests” during trading halts.  Under Piemonte, these disclosures are sufficient to preclude Defendant’s liability for misrepresentations and omissions with regard to the exercise of put options during trading halts.

 

As Plaintiff points out in his opposition brief, because this is a demurrer, the Court must assume the truth of the SACAC’s allegations that it is industry practice, as well as Defendant’s own practice, to use the last trading price to determine current market value in the event of a trading halt.  However, even if we accept this allegation of industry practice, it does not change the fact that the alleged promise to automatically exercise options that are “in the money” (based on the current market value) is not rendered false or misleading given the relevant definitions and disclosures made.  Plaintiff does not allege that Defendant made any representations regarding industry practice during trading halts such that options holders could reasonably expect the last trading price to be used as a substitute for current market value.  Nor is there any basis to conclude that an options holder could reasonably rely on their own understanding of industry practice in order to interpret the “automatically exercised” promise given the relevant definitions and disclosures made.  Furthermore, an industry practice using the last trading price essentially as a substitute for current market value is still, in the rationale of Piemonte, a “guess” as to the option’s value.  It is not the actual current market value for purposes of determining whether the option is “in the money,” and Defendant’s promise to “automatically exercise” is based on current market value under the express definitions of “in the money.”

 

Regarding the SACAC’s allegation concerning the OCC’s “exercise by exception” process, even if it is the clearing member’s (e.g., Defendant) responsibility to provide instructions to the OCC if the member wants to exercise the member’s clients’ puts, the issue here is not what Defendant could have done under industry or other practices to guess at the current market value of the underlying stock during a trading halt, but whether Defendant misrepresented what it would do in the event of a trading halt while promising to “automatically exercise” options that were “in the money.”  Because the determination of whether an option is “in the money” relies on knowing (not guessing) the current market value, and the SACAC’s exhibits show that sufficient disclosures were made regarding the risks of trading halts, the SACAC does not allege a sufficient false representation or omission by Defendant.

 

Thus, Plaintiff fails to sufficiently allege a false representation and/or fraudulent omission to support his causes of action for fraud, negligent misrepresentation, and violation of the UCL,[34] CLRA, and New York Consumer Protection Statute.

 

The allegations that Defendant could have used the last trading price or consulted Plaintiff during the trading halt[35] could give rise to a claim for breach of fiduciary duty, since arguably, a reasonably prudent broker would have the obligation to take action to prevent Plaintiff’s option from expiring worthless.  The relationship between a stock broker and principal is considered to be fiduciary in nature, imposing on the broker the duty of acting in the highest good faith toward the principal.  (See Duffy v. Cavalier (1989) 215 Cal.App.3d 1517, 1531; Twomey v. Mitchum, Jones & Templeton, Inc. (1968) 262 Cal.App.2d 690, 708-709.)  In Twomey, the appellate court tacitly accepted the premise that a broker may not have an obligation to determine the principal’s financial situation and needs where the “sole obligation of the broker-dealer is to carry out the stated objectives of the customer” and the broker “is acting merely as agent to carry out purchases or sales selected by the customer, with or without the broker’s recommendation”, but the Twomey court went on to find that evidence showed the broker’s recommendations “were for all practical purposes the controlling factor in the transactions.”  (Twomey, supra, 262 Cal.App.2d at p. 719.)  In Petersen v. Sec. Settlement Corp. (1991) 226 Cal.App.3d 1445, 1455-1456, the Court of Appeal cited Twomey and similar federal authorities finding no fiduciary duty on clearing agents/brokers in order to hold that there was no fiduciary duty on the clearing broker because the relationship was confined to the simple performance of transactions ordered by a customer or his investment advisor.

 

Here, the SACAC’s allegation that Defendant had fiduciary duties to consult with Plaintiff regarding the exercise of its discretion when circumstances required[36] is conclusory.  The suggestion that Defendant had a fiduciary obligation to use the last trading price during trading halts is unpersuasive because the SACAC contains no allegations suggesting that the relationship between Plaintiff and Defendant involved anything more than Defendant’s exercise of options as ordered by Plaintiff.  Furthermore, in the Customer Agreement, attached as Exhibit 3 to the SACAC, it states:

 

I ACKNOWLEDGE THAT I ALONE AM RESPONSIBLE FOR DETERMINING THE SUITABILITY OF MY INVESTMENT CHOICES IN LIGHT OF MY PARTICULAR CIRCUMSTANCES.  I UNDERSTAND THAT E*TRADE SECURITIES ASSUMES NO RESPONSIBILITY FOR SUCH DETERMINATION.  As a self-directed investor, I assume full responsibility for each and every transaction in or for my Account and for my own investment strategies and decisions.  I understand and agree that E*TRADE Securities and its affiliates will have no liability whatsoever for the results of my investment strategies, transactions and decisions.

….

Unless otherwise specified in writing E*TRADE Securities does not and will not provide me with any legal, tax, estate planning or accounting advice.  Except with respect t the Premium Services described in (b) below, E*TRADE Securities does not and will not provide me with any advice regarding the suitability, profitability or appropriateness for me of any security, investment, financial product, investment strategy or other matter.  Unless otherwise specified in writing, I acknowledge that E*TRADE Securities employees are not authorized to give any such advice, and except with respect to the Premium Services described in (b) below, I will neither solicit nor rely on any investment advice from any E*TRADE Securities employee.  Unless otherwise specified, any information provided through the Service other than the Premium Services described in (b) below will not be used or considered by me as a recommendation that I buy, sell or hold a particular security or pursue any particular investment strategy. . . . I also acknowledge that E*TRADE Securities neither assume responsibility for nor guarantees the accuracy, currency, completeness or usefulness of information, commentary, recommendations, advice, investment ideas or other materials that may be accessed by me through the Service. . . . If I choose to rely on such information, I do so solely at my own risk.  I understand that except with respect to the Premium Services described in (b) below, the research, analysis, news or other information made available through the Service is not personalized or in any way tailored to reflect my personal financial circumstances or investment objectives and the securities and investment strategies discussed may not be suitable for me.[37]

 

Moreover, Defendant points out that in the Customer Agreement, Plaintiff disclaimed liability for “any Losses arising out of or relating to a cause over which E*TRADE Securities or its affiliates do not have direct control, including…suspension of trading[.]”[38]  Plaintiff argues this provision does not apply because the SACAC alleges that Defendant “direct control” over whether to exercise Plaintiff’s options during the trading suspension on the underlying stock, and Defendant also had the ability to make a good faith determination whether Plaintiff’s options were “in the money” and to consult Plaintiff about his put options.  The phrase “any Losses arising out of or relating to” is broadly worded, and it cannot be disputed that the suspension of DGW stock was out of Defendant’s control, or that the claims in the SACAC arise out of or relate to the suspension of DGW stock.  That Defendant could have guessed at the current market value, used a substitute value like DGW’s last trading price, or consulted with Plaintiff before the expiration date does not remove Plaintiff’s claims from the scope of this provision of the Customer Agreement.  This same provision of the Customer Agreement encompasses Plaintiff’s cause of action for breach of the covenant of good faith and fair dealing.

 

Defendant also raises SLUSA preemption.  “An action will be dismissed under SLUSA if it (1) is a ‘covered class action’; (2) is based on state law; (3) involves a ‘covered security’; and (4) alleges a ‘misrepresentation or omission of a material fact’ or use of ‘any manipulative or deceptive device … in connection with the purchase or sale of a covered security.’  [Citations.]  A ‘covered class action’ is a lawsuit in which damages are sought on behalf of more than 50 people.  [Citation.]  A ‘covered security’ is one traded nationally and listed on a regulated national exchange.  [Citation.]   In determining whether an alleged misrepresentation or omission ‘coincides’ with a securities transaction, courts look at ‘the gravamen’—whether the complaint, as a whole, involves an untrue statement or substantive omission of a material fact, and whether that conduct coincides with a transaction involving a covered security.  [Citations.]  The court focuses on the substance of the claim, not the plaintiffs’ characterization of it.  [Citation.]”  (Wells Fargo Bank, N.A. v. Superior Court (2008) 159 Cal.App.4th 381, 386.)

 

There is no dispute that the instant action is a “covered class action” that is based on state law and involves a “covered security.”[39]  Plaintiff argues the claims are not preempted by SLUSA because they do not allege misrepresentations made “in connection with” the “purchase or sale” of a covered security.  Plaintiff argues that under the recent U.S. Supreme Court decision in Chadbourne & Park LLP v. Troice (2014) 134 S. Ct. 1058, SLUSA does not preempt ordinary state law contract and related claims that are not predicated on misrepresentations but only a promise and failure to perform (e.g., breach of fiduciary duty and breach of covenant of good faith and fair dealing), and SLUSA preemption for misrepresentation claims only lies when the misrepresentations or omissions are material to a decision to purchase or sell a security, and the party buying or selling is a party other than the fraudster.  Plaintiff contends that because Defendant is both the fraudster and the entity purchasing and selling the securities, it cannot invoke SLUSA preemption.

 

This Court previously commented in a footnote to its December 20, 2013 Order that under Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit (2006) 547 U.S. 71, Plaintiff’s claims were likely preempted by SLUSA.  In Dabit, the U.S. Supreme Court held that “holder” misrepresentation claims by brokers of an investment banking firm alleging that the firm’s biased investment recommendations induced them to retain or delay selling certain securities were sufficiently “in connection with the purchase and sale” of covered securities for purposes of SLUSA.  Here, Plaintiff similarly alleges that Defendant’s misrepresentation caused him to fail to manually exercise his options while DGW trading was suspended, which sufficiently “ ‘coincide[s]’ with a securities transaction” for purposes of SLUSA preemption.

 

Although Plaintiff argues that Troice narrowed the scope of SLUSA preemption, Troice “[did] not…modify Dabit” (see Troice, supra, 134 S. C. at p. 1066) and does not compel a different result here.  Troice involved consolidated class actions alleging a Ponzi scheme from false representations that CDs (uncovered securities) in a particular bank were backed by covered securities.  The Supreme Court majority (7-2) held that the claims were not preempted by SLUSA.

 

A fraudulent misrepresentation or omission is not made “in connection with” such a “purchase or sale of a covered security” unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a “covered security.”  We add that in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U. S. 71, 126 S. Ct. 1503, 164 L. Ed. 2d 179 (2006), we held that the Litigation Act precluded a suit where the plaintiffs alleged a “fraudulent manipulation of stock prices” that was material to and “‘coincide[d]’ with” third-party securities transactions, while also inducing the plaintiffs to “hold their stocks long beyond the point when, had the truth been known, they would have sold.”  [Citations.]  We do not here modify Dabit.

. . . .

 

The language requires the dismissal of a state-law-based class action where a private party alleges a “misrepresentation or omission of a material fact” (or engages in other forms of deception, not relevant here) “in connection with the purchase or sale of a covered security.” [Citation.]  The phrase “material fact in connection with the purchase or sale” suggests a connection that matters.  And for present purposes, a connection matters where the misrepresentation makes a significant difference to someone’s decision to purchase or to sell a covered security, not to purchase or to sell an uncovered security, something about which the Act expresses no concern.  [Citation.]  Further, the “someone” making that decision to purchase or sell must be a party other than the fraudster.  If the only party who decides to buy or sell a covered security as a result of a lie is the liar, that is not a “connection” that matters.

 

… [E]very securities case in which this Court has found a fraud to be “in connection with” a purchase or sale of a security has involved victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition.  [Citations.]

 

(Troice, supra, 134 S. Ct. at p. 1066, italics omitted.)

 

Plaintiff argues Troice is on-point because here, the SACAC contains no allegations that the misrepresentations or omissions were material to any purchase or sale decision, and the decision to refrain from purchasing or selling covered securities was the fraudster’s (Defendant).  These points are not well-taken.  Based on the express allegations of the SACAC, Defendant’s alleged misrepresentations led Plaintiff not to exercise his options and thereby not sell the stock.  “Because E*TRADE had promised that in-the-money options ‘will be automatically exercised,’ Plaintiff took no actions to ensure that his DGW puts were exercised upon expiration.”[40]  This connection is sufficient for SLUSA preemption because the misrepresentation can be said to have “[made] a significant difference to [Plainitff’s] decision to purchase or to sell a covered security… .”  (Troice, supra, 134 S. Ct. at p. 1066.)

 

Plaintiff argues that his claims are not based on misrepresentations, but on false promises, and therefore they are more like traditional state law breach of contract claims that do not fall within the scope of SLUSA preemption.  However, the SACAC is replete with allegations of misrepresentation and omissions of material fact, and Plaintiff does not assert a cause of action for breach of contract based on the promise that “in the money” puts would be “automatically exercised.”  As for the section of the SACAC entitled “No Preemption Under Federal Securities Litigation Uniform Standards Act (“SLUSA”)”, these conclusory allegations designed solely to avoid SLUSA preemption are not dispositive of the issue.  “In determining whether an alleged misrepresentation or omission ‘coincides’ with a securities transaction, courts look at ‘the gravamen’—whether the complaint, as a whole, involves an untrue statement or substantive omission of a material fact, and whether that conduct coincides with a transaction involving a covered security.  [Citation.]  The court focuses on the substance of the claim, not the plaintiffs’ characterization of it. [Citation.]”  (Wells Fargo Bank, N.A. v. Superior Court (2008) 159 Cal.App.4th 381, 386.)  Here, the substance of Plaintiff’s claims is that Defendant’s promise to “automatically exercise” “in the money” puts was misleading and omitted material facts regarding trading halts.

 

For all of these reasons, the demurrer to the SACAC is SUSTAINED.  Because Plaintiff does not explain how the SACAC can be amended to avoid the deficiencies discussed above, the demurrer is sustained WITHOUT LEAVE TO AMEND.  The concurrently filed motion to strike is MOOT.

 

[1] Second Amended Class Action Complaint (“SACAC”) ¶ 11.

[2] SACAC ¶ 2.

[3] SACAC ¶ 12.

[4] SACAC ¶¶ 12-13.

[5] SACAC Exhs. 1-2.

[6] SACAC ¶ 2.

[7] SACAC ¶ 2.

[8] SACAC ¶¶ 2-3.

[9] SACAC ¶¶ 29-30.

[10] SACAC ¶ 31.

[11] SACAC ¶¶ 32-33.

[12] SACAC ¶ 34.

[13] SACAC ¶ 35.

[14] SACAC ¶ 36.

[15] SACAC ¶ 37.

[16] SACAC ¶ 39.

[17] SACAC ¶ 13.

[18] SACAC ¶ 16.

[19] SACAC ¶ 17.

[20] SACAC ¶ 18.

[21] SACAC ¶¶ 19-21.

[22] SACAC ¶ 22.

[23] SACAC ¶ 23.

[24] SACAC ¶ 24.

[25] SACAC ¶¶ 106-109.

[26] SACAC ¶¶ 49, 6268, 78, 84, 91, 99.  The SACAC does not appear to allege oral misrepresentations by Defendant.  Although Plaintiff alleges that an E*TRADE customer services representative referred to Plaintiff’s puts as “in the money,” this statement was allegedly made after the expiration date and is cited only in support of Plaintiff’s allegation of Defendant’s practice with regard to the current market value of stock during a trading halt.  (See SACAC ¶ 22.)

[27] SACAC ¶ 12.

[28] Occ Discl. Doc., RJN Exh. 4 at p. 14, original emphasis.

[29] SACAC Exh. 2.

[30] SACAC Exh. 3 at p. 51.

[31] OCC Disc. Doc., RJN Exh. 4 at p. 14.

[32] OCC Disc. Doc., RJN Exh. 4 at p. 141, emphasis added.

[33] In Piemonte, the Clearing Corporation’s rules provided that an option holder could exercise the option only by causing his broker to file a written exercise notice with the Clearing Corporation on the prescribed form on or before the fixed expiration date.  (See Piemonte, supra, 405 F.Supp. at p. 713.)  Notably, the Customer Agreement at issue in the instant matter similarly states that “E*TRADE Securities has no obligation to exercise any option absent specific instructions from me.”  (See Customer Agmt. at p. 52, Exh. 3 to SACAC.)  However, the Court must also accept Plaintiff’s allegation that Defendant promised to automatically exercise any options that were “in the money” on the expiration date, even if this could be understood to conflict with the quoted portion of the Customer Agreement.

[34] Besides alleging violation of the UCL’s fraudulent prong, the SACAC also alleges violation of the unfair prong.  However, this claim of unfairness is based on “E*TRADE’s misrepresentations.”  (See SACAC ¶ 73.)  Here, the Court finds no misrepresentation to support the claim for unfair business practice.

[35] See SACAC ¶¶ 26, 51, 53, 54, 63, 65, and 70.

[36] SACAC ¶ 51.

[37] SACAC Exh. 3 at pp. 31-32.  Plaintiff does not allege that he received Premium Services from Defendant for purposes of establishing a fiduciary relationship.

[38] SACAC Exh. 3 at pp. 29-30.

[39] See SACAC ¶¶ 106, 109.

[40] SACAC ¶ 34, italics added.