Thursday, July 14, 2011

Is there a private cause of action for violations of NYSE, NASD rules?

Chief Justice Woodfin Jones
Addressing an issue on which there is little Texas state appellate case law, the Third Court of Appeals, in an opinion written by its chief justice, says there is no private cause of action for violations of NYSE and NASD rules.

Fernea v. Merrill Lynch Pierce Fenner & Smith, Inc. 
(Tex.App.- Austin, July 12, 2011)(Opinion by Chief Jones) 

Violation of NASD and NYSE Rules 

In his first two issues, Fernea asserts that the trial court erred in granting summary judgment on his claim that Merrill Lynch violated three securities-industry rules--two promulgated by the NASD and one by the NYSE. He argues that he is entitled to bring a private cause of action against Merrill Lynch for its alleged violations and that a fact question exists as to whether Merrill Lynch violated the rules in question. [Fn3] In its motion for summary judgment, Merrill Lynch argued that Congress did not intend to create a private cause of action for a violation of NASD and NYSE rules or, in the alternative, that its evidence conclusively proved that no violation took place.
Private Cause of Action
The San Antonio Court of Appeals is the only Texas appellate court that has addressed whether there is a private cause of action for violation of securities-industry rules. Relying on a federal district court opinion from the Southern District of Texas, and without further discussion, the court of appeals held that "there is no independent cause of action for NASD violations." Milan v. Dean Witter Reynolds, Inc., 90 S.W.3d 760, 767 (Tex. App.--San Antonio 2002, pet. denied) (citing Porter v. Shearson Lehman Bros., Inc., 802 F. Supp. 41, 63 (S.D. Tex. 1992)). The Fifth Circuit has not addressed the issue, see Lang v. French, 154 F.3d 217, 222 n.26 (5th Cir. 1998), and federal district courts in Texas are split, compare Cook v. Goldman, Sachs & Co., 726 F. Supp. 151, 156 (S.D. Tex. 1989) (implied private cause of action exists), with Porter, 802 F. Supp. at 63 (implied private cause of action does not exist), and Lange v. H. Hentz & Co., 418 F. Supp. 1376, 1383 (N.D. Tex. 1976) (same).

Fernea relies on two cases to support his assertion that Congress intended to create a private cause of action: Buttery v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 410 F.2d 135, 142 (7th Cir. 1969), and Cook, 726 F. Supp. at 156. The great weight of authority, however, holds against inferring a private cause of action for violations of NASD and NYSE rules. We find the cases Fernea cites for the opposite view unpersuasive.Buttery, a Seventh Circuit case, was decided prior to three key Supreme Court decisions setting forth the test for implying statutorily based private causes of action. See Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 15 (1979) ("The question whether a statute creates a cause of action, either expressly or by implication, is basically a matter of statutory construction."); Touche Ross & Co. v. Redington, 442 U.S. 560, 568 (1979) ("As we recently have emphasized, the fact that a federal statute has been violated and some person harmed does not automatically give rise to a private cause of action in favor of that person. Instead, our task is limited solely to determining whether Congress intended to create the private right of action." (internal quotation marks omitted)); Cort v. Ash, 422 U.S. 66, 78 (1975) (establishing four-factor test later compressed and refined by Touche Ross and Transamerica). Despite being handed down a decade after Transamerica, Cook, a Texas federal district court opinion, relied heavily on Buttery, its progeny, and other cases that pre-date Cort. The Cook court did not discuss whether Buttery was still good authority considering that Transamerica largely rejected the test that the Buttery court had employed. See Transamerica, 444 U.S. at 15-16 ("While some opinions of the Court have placed considerable emphasis upon the desirability of implying private rights of action in order to provide remedies thought to effectuate the purposes of a given statute, what must ultimately be determined is whether Congress intended to create the private remedy asserted, as our recent decisions have made clear."). Thus, like Buttery, Cook's authority is questionable.

Post-Transamerica decisions employing that case's reasoning consistently hold that Congress did not intend to create a private cause of action for violations of self-regulating organizations' rules. See, e.g., In re Verifone Sec. Litig., 11 F.3d 865, 870 (9th Cir. 1993) (dismissing claims for violations of NASD and NYSE rules because "[i]t is well established that violations of an exchange rule will not support a private claim"); Hosworth v. Blinder, Robinson & Co., 903 F.2d 186, 200 (3rd Cir. 1990) (no private right of action for violation of NASD rules); Craighead v. E.F. Hutton & Co., 899 F.2d 485, 493 (6th Cir. 1990) (same); Thompson v. Smith Barney, Harris Upham & Co., 709 F.2d 1413, 1419 (11th Cir. 1983) (same); Jablon v. Dean Witter & Co., 614 F.2d 677, 681 (9th Cir. 1980) ("Based upon the standards in Touche Ross and Transamerica, we conclude there is no implied right of action for an NASD rule violation."); Porter, 802 F. Supp. at 63; Emmons v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 532F. Supp. 480 (S.D. Ohio 1982) (under Cort, no implied right of action under NYSE or NASD rules); Klitzman v. Bache Halsey, 499 F. Supp. 255 (S.D.N.Y. 1980) (no private right of action under NASD rules). Even the NASD's own arbitration panel has recognized that no private cause of action exists for violating its rules. See Penzer v. Advest, Inc., No. 92-00400, 1993 WL 603507, at *5 (NASD Nov. 5, 1993) ("[C]ase law supports the conclusion that no private right of action exists for breach of NASD rules." (citing SSH Co. v. Shearson Lehman Bros., Inc., 678 F. Supp. 1055, 1058 (S.D.N.Y. 1987))).

We agree. Although we need not revisit here the detailed analyses performed in the cases cited above, we will briefly summarize them. The relevant inquiry is to determine whether Congress intended to create a private cause of action for a violation of NASD and NYSE rules in the Securities and Exchange Act of 1934 by employing the usual rules of statutory construction. See Transamerica, 444 U.S. at 15; Jablon, 614 F.2d at 681; see also Touche Ross, 442 U.S. at 568 (describing inquiry in determining Congressional intent). As the Jablon court and others have noted, Congress specifically provided for private causes of action for violations of some securities rules, yet did not provide a cause of action for violations of NASD and NYSE rules. See Jablon, 614 F.2d at 681. Accordingly, we conclude that Congress did not intend to create a private right of action here.Id. at 680-81; see also Touche Ross, 442 U.S. at 568 ("The source of plaintiffs' [private right of action] must be found, if at all, in the substantive provisions of the 1934 Act which they seek to enforce . . . .").

Because there is no private cause of action for violation of NYSE and NASD rules, the trial court did not err in granting summary judgment in favor of Merrill Lynch as to that claim. We overrule Fernea's first and second issues.

Fn 2. The NASD is a "a self-regulatory organization overseeing securities transactions." In re Next Fin. Group, Inc., 271 S.W.3d 263, 265 (Tex. 2008) (per curiam). Although the NASD "absorbed the enforcement arm of the New York Stock Exchange and became the Financial Industry Regulation Authority (FINRA) on July 30, 2007," see McArdle v. Jack Nelson IRA, No. 03-08-00057-CV, 2010 WL 1253571, at *1 n.1 (Tex. App.--Austin Mar. 31, 2010, no pet.) (mem. op.), we will still refer to the NASD and the NYSE for convenience. Pursuant to SEC regulations, licensed securities brokers must register with and abide by the organization's guidelines. Id.; see also 17 C.F.R. § 240.15b7-1 (2009).

Fn 3. Although Fernea does not state whether his private cause of action arises under federal securities law or Texas law, self-regulating securities organizations are entities created and governed by federal statute and regulation. Accordingly, we assume that any private cause of action would arise from federal securities law. 

SOURCE: Austin Court of Appeals -  03-09-00566-CV  - 7/12/11
CASE STYLE: David Fernea v. Merrill Lynch Pierce Fenner & Smith, Inc.
Appeal from 200th District Court of Travis County

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