Order Flow Cases: Jurisdiction, Preemption and Securities Laws; Outside Counsel
New York Law Journal, Vol. 213, May 9, 1995
10 Pages Posted: 12 Jun 2019 Last revised: 13 Jun 2019
Date Written: June 11, 2019
Primary jurisdiction and preemption issues arise in securities class action litigation when alleged violations of state law arise from conduct that is either explicitly or implicitly regulated by the federal securities laws.
These are two distinct theories: one is a matter of administrative law and judicial economy (primary jurisdiction); the other is a matter of constitutional law involving the Supremacy Clause (preemption). To date, there has not been extensive case law involving preemption and the federal securities laws (other than in the blue sky and tender offer areas) and there has been almost no case law on primary jurisdiction and the federal securities laws.
This article discusses these issues in the context of the order flow cases. In the eight ongoing order flow cases pending in state courts in Illinois, Massachusetts, Minnesota and New York, the plaintiffs have challenged the practice of certain broker-dealers that make monetary and non-monetary payments to retail brokers, particularly discount brokers, for the purpose of inducing the retail brokers to send orders to the defendants for execution.
The order flow cases provide a good way to examine the preemption and primary jurisdiction issues because they have begun to generate a body of case law.
The practice of paying for order flow started in the over-the-counter market with payments made by market makers (i.e., dealers in OTC securities) to their regional correspondent brokerage firms. Market maker firms later began to make payments for order flow to other retail brokers until the practice of paying for order flow became common in the OTC market.
While payment for order flow in the OTC market has a long standing history, it is only in the past seven years that it has spread to listed securities, starting with payments by third market makers and then by some regional specialists. The Securities and Exchange Commission believes that some integrated broker-dealer firms may now be paying for order flow. The amount paid per share for an order is relatively small, one or two cents per share, although the aggregate amounts can be high as between 15 percent and 20 percent of the order flow in listed stock is routed pursuant to cash payment arrangements.
Payment for order flow has been the subject of extensive study by the SEC, NASD and other self-regulatory organizations, the Congress and legal and financial academics. A series of alleged problems involving the structure of the securities markets, state agency law and the federal securities laws have been identified by these commentators. The result has been the recent promulgation by the SEC of new disclosure standards for payments for order flow.
The SEC decided to mandate a three tier approach to disclosure. In a companion release to the one promulgating the new rules and amendments, the SEC proposed rules to further broaden the amount of disclosure.
Suggested Citation: Suggested Citation