3 Brokerages Face Double Risk in Lawsuits : Securities: Two class actions allege unfair dealing in Nasdaq stocks. The firms deny any wrongdoing.
Three big Wall Street brokerages face a potential double whammy in class-action lawsuits filed by investors over allegedly unfair practices in Nasdaq stock trading.
The three firms, Merrill Lynch, PaineWebber and Dean Witter Reynolds, along with 30 other brokerages, face a massive class-action lawsuit in federal court in Manhattan. The suit accuses them of violating antitrust laws by secretly colluding to increase the spreads on Nasdaq stocks. Spreads essentially are dealers’ profit margins.
But there is also a much lesser-known class action pending against the three big firms in federal court in New Jersey. This suit is based on an entirely different legal theory, one that several securities law experts and an economist said may be easier to prove. As a result, the three firms face a double risk of big damage awards from recent mounting allegations of unfair dealing on Nasdaq.
The three firms--all of which deny any wrongdoing--are pressing to have the New Jersey case merged with the New York one. But the lawyers who filed the New Jersey case are fighting hard to prevent that from happening, and so are the 30 defendants named in the New York case but not the New Jersey case. A court hearing on merging the cases is set for May 19.
Instead of antitrust law, the New Jersey suit is based on a fundamental tenet of securities law: the duty of a brokerage firm to get its customers the best available price when buying or selling stock. The suit contends that the three brokerage firms routinely violated the so-called best execution rule, denying small investors access to better prices for Nasdaq stocks, even as the firms traded for their own accounts at better rates.
John C. Coffee Jr., a Columbia University law professor, said the case based on antitrust law faces a major hurdle: Lawyers must prove that there was an actual agreement among the Nasdaq dealers to keep spreads wide. Obtaining proof of such agreements is often difficult, he said.
But Coffee and David Lipton, a law professor at Catholic University in Washington, said showing that a brokerage firm was simultaneously charging customers one price while getting a better price for itself would be much easier to prove, although such a case may face a number of other pitfalls.
U.S. District Judge Robert W. Sweet is due to rule soon on a motion by the 33 brokerage firms to dismiss the New York case.
Meanwhile, Nasdaq and its dealers continue to face investigations by the Justice Department’s antitrust division and the Securities and Exchange Commission. They are looking into possible price fixing on Nasdaq and other alleged improprieties.
Nasdaq and the dealers have strongly denied that there is any price fixing. Merrill, PaineWebber and Dean Witter all denied the allegations in the New Jersey suit and insisted that they always put customers’ interests first.
David Whitcomb, a Rutgers University economist who is an expert on stock markets, said that “in the over-the-counter market (Nasdaq), retail customers get the worst prices.”
When dealing with small investors, brokerage firms typically will buy or sell Nasdaq stocks only at their quoted bid or asked price. The bid is the price a dealer offers to buy a stock. The asked is the higher price at which a dealer offers to sell. The difference between the two is known as the spread. For Nasdaq stocks, the spread is often much wider than for comparable stocks listed on the New York Stock Exchange.
Dealers themselves and institutional investors, however, have access to trading systems that routinely allow them to get prices inside the spread. And it is their use of systems, known as Selectnet and Instinet among others, that are at the heart of the allegations in the New Jersey case.
Selectnet is owned by Nasdaq. Instinet, which now handles about 20% of the trading volume in Nasdaq stocks, is owned by Reuters Holdings. Both systems contain limit orders at prices inside the spread, posted by institutional investors and brokerage firms. Limit orders are orders to buy or sell at a specified price. But most brokerage firms rarely give small investors access to these trading systems, which critics charge is a way the firms ensure that small investors continue to pay the full spread.
The suit charges that “defendants executed trades for their own accounts at prices superior to prices they obtained for their customers.”
Market experts say dealers themselves often post better prices for a stock on Selectnet and Instinet while continuing to charge their own retail customers the full spread.
Karen L. Morris, a partner in law firm Morris & Morris in Delaware, which brought the New Jersey suit, said that case was limited to the three big brokerage firms because investors came forward with complaints against them and, “based on our investigation, those are the three firms we could develop a good-faith basis for pleading” the case.
However, she said her firm and a New Jersey law firm that has joined in the case would consider expanding it if other investors came forward with strong allegations against other brokerage houses.
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