Tuesday, April 27, 2021

TD Ameritrade overturns class certification in best execution fraud suit

By John M. Jascob, J.D., LL.M.

The Eighth Circuit Court of Appeals has reversed an order certifying the class in a suit alleging that TD Ameritrade’s order routing practices violated the broker-dealer’s duty of best execution. The plaintiff failed to establish the predominance requirement for certifying a class under Federal Rule of Civil Procedure 23 because the algorithm proposed by the plaintiff’s expert to assess execution quality would still not account for all unusual market conditions that might cause transactions to depart from the best available price. Accordingly, common issues did not predominate over individual questions of fact because determining whether each customer suffered economic loss as a result of the order routing practices would entail an order-by-order inquiry (Ford v. TD Ameritrade Holding Corp., April 23, 2021, Colloton, S.).

A customer of TD Ameritrade sued as lead plaintiff for a group of investors who purchased and sold securities through TD Ameritrade between 2011 and 2014. The plaintiff alleged that TD Ameritrade’s order routing practices violated the company’s duty of best execution by systematically sending customer orders to trading venues that paid the company the most money, rather than to venues that provided the best outcome for customers. Specifically, the plaintiff alleged that TD Ameritrade, its parent company, and its chief executive officer violated Exchange Act Section 10(b) and Rule 10b-5 by leaving orders unfilled, filling orders at a sub-optimal price, and filling orders in a manner that adversely affected performance after execution, causing customers to suffer economic loss.

On reviewing the motion for class certification, a magistrate judge recommended denying certification, concluding that the proposed class did not satisfy the predominance requirements of Rule 23(b)(3) because determining whether each TD Ameritrade customer suffered economic loss as a result of the company’s order routing practices would entail individualized inquiries. The district court, however, issued an order certifying the class, determining that the plaintiff’s expert had developed an algorithm that could solve the predominance problem by making automatic determinations of economic loss for each customer.

No technological solution. On appeal, the Eighth Circuit panel observed that the expert’s algorithm proposed to assess execution quality by using class trading history data provided by TD Ameritrade and data about the state of the market at the time of each trade. The expert proposed to establish that a “better” price was obtainable for each executed trade by comparing the trade’s actual price with the National Best Bid and Offer (NBBO) price. The experts for the parties agreed, however, that certain transactions required exclusion from the algorithm’s analysis to account for instances when TD Ameritrade could not have prevented execution at a price inferior to the NBBO due to volatile or otherwise unusual market conditions.

While the plaintiff’s expert contended that his algorithm could filter out these transactions by using third-party historical stock market information that identifies periods when stocks were traded during unusual market conditions, the court observed that there is no definitive list of unusual market conditions that account for transactions that depart from the best available price. As a result, the algorithm’s use of published market data would not identify all legitimate exclusions, leaving the trier of fact to resolve disputes among the experts through individualized determinations about the appropriateness of particular exclusions. “Despite advances in technology,” the court stated, “individual evidence and inquiry is still required to determine economic loss for each class member.”

In addition, the court opined, the class as defined by the district court constituted an impermissible “fail-safe class.” By defining the class to include only those customers who were harmed by TD Ameritrade’s alleged failure to seek best execution, the district court certified a class in which membership depends upon having a valid claim on the merits. This sort of class is impermissible, the court stated, because it allows putative class members to seek a remedy but not be bound by an adverse judgment.

Accordingly, the appellate panel reversed the district court’s order certifying a class and remanded the matter for further proceedings.

The case is No. 18-3689.