NYGAARD, Circuit Judge.
The issue on appeal is whether the over-the-counter customer order execution practices of several large stock brokers constituted securities fraud. The district court concluded that these practices were not fraudulent and granted summary judgment in favor of the defendants. We will affirm.
I.
The facts of this case are set forth thoroughly in the district court's opinion, In re Merrill Lynch Securities Litig., 911 F. Supp. 754 (D.N.J. 1995). Succinctly stated, plaintiffs are investors who purchase and sell so-called "over the counter" securities which are traded on a computerized price quotation system known as NASDAQ. They claim that the peculiarities of this market have given securities dealers an opportunity — upon which they have capitalized — to inflate their profit margins at the expense of customers, resulting in inferior execution prices vis-a-vis other dealers who have access to superior, privately quoted prices. These practices, plaintiffs allege, violated the defendants' duty of best execution, but were never disclosed by the dealers, thus amounting to a securities fraud under section 10 of the Securities Exchange Act of 1934, 15 U.S.C. §(s) 78j(a) and Rule 10-b5 promulgated thereunder, 17 C.F.R. Section(s) 240.10b-5.
The NASDAQ, which is now the second-largest securities market in the United States, is different from the New York and American Stock Exchanges, because it is a dealer-created, rather than an auction, market. In an auction market, buy and sell orders actually "meet" on the exchange floor, with prices being set by the continuous interaction of those orders, under the supervision of market "specialists." This type of market has traditionally been used for widely traded securities.
Dealer markets, on the other hand, rely on "market makers" to set prices and maintain the liquidity of securities. This system arose out of literal, over-the-counter trading of stocks that were not as widely traded as those listed on the NYSE or AMEX. In a dealer market, each market maker decides the prices at which it will buy and sell a security; the difference between the listed "ask" and "bid" prices is known as the "spread," from which the market maker is compensated for its efforts and risk.
Under that system, of course, as long as timely, accurate information is available regarding each market maker's prices, orders will naturally gravitate towards the dealer with the most favorable prices, and this will establish a single, albeit two-price, market for each security traded. NASDAQ (which stands for National Association of Securities Dealers Automated Quotation) is the information system that relays market makers' pricing information to buyers and sellers. NASDAQ quotes the National Best Bid and Offer — known in the industry as the "NBBO" — price for every stock on the system.
Because of recently created sources of additional, non-public pricing information, however, the NBBO may no longer always be counted upon to display the "best" price. Systems such as SelectNet and Instinet, which are not available to all investors or even to all dealers, may be quoting a more favorable price than the NBBO at any given moment. Appellants allege that, not only were better prices displayed in many instances, but that the defendant dealers knew such prices were available, yet continued to book their orders at the inferior, NBBO price at the same time that they were trading at the more favorable price for their own accounts.
In addition, in many instances dealers are able to obtain more favorable prices by "crossing" the customer's order with the order of another customer. For example, assume that a dealer quotes an "ask" price of $32 1/4 and an "bid" price of $32 for shares of XYZ Corporation. A customer places an order to purchase 100 shares, but, unbeknownst to him, the dealer has an outstanding limit order from another customer to sell at 32 1/8. That dealer could simply cross the two orders and execute the trade at 32 1/8, saving the customer $12.50. The dealer would not incur any market risk on such a transaction. Appellants allege that it is a fraud for the defendant dealers to continue to execute trades at the NBBO price, appropriating the full "spread" as a fee for their services.
The district court granted summary judgment to defendants, for two principal reasons. First, it held that defendants made no actionable misrepresentations, because the duty of best execution is ill-defined and there is no widely accepted view that execution of trades at the NBBO price fails to satisfy that duty; thus, it would be improper to find that defendants omitted or concealed material facts. 911 F. Supp. at 771. Second, the court held that, even if defendants omitted information, they could not, as a matter of law, have acted with the requisite scienter. Id. at 772.
II. A.
To make out a securities fraud claim under Section(s) 10 of the Securities Act of 1934 and Rule 10b-5, plaintiffs must show: (1) a misrepresentation or omission of a material fact in connection with the purchase or sale of a security; (2) scienter on the part of the defendant; (3) reliance on the misrepresentation; and (4) damage resulting from the misrepresentation. Sowell v. Butcher Singer, Inc., 926 F.2d 289, 296 (3d Cir. 1991). Although the district court held that there was no misrepresentation or omission of a material fact, we will assume, without deciding, that the trading practices here constituted an otherwise actionable misrepresentation, because we conclude that the district court correctly decided that scienter was lacking as a matter of law, and appellants' securities law claims fail on that basis alone.
The element of scienter has been defined as "a mental state embracing intent to deceive, manipulate or defraud." Ernst Ernst v. Hochfelder, 425 U.S. 185, 193 n.12, 96 S. Ct. 1375, 1381 n.12 (1976). Scienter can also be established by a showing of recklessness, which is defined as "an extreme departure from the standards of ordinary care, . . . which presents a danger of misleading . . . that is either known to the defendant or is so obvious that the actor must have been aware of it." Healey v. Catalyst Recovery, Inc., 616 F.2d 641, 649 (3d Cir. 1980) (quoting Sundstrand v. Sun Chemical Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)). The recklessness standard comprehends actions very close to intentional conduct; mere indifference to the consequences of a statement is not sufficient. Healey, 616 F.2d at 649.
Appellants assert, nevertheless, that the record before the district court contained sufficient evidence from which a rational factfinder could infer scienter. The district court disagreed, opining that because the duty of best execution is not "established," but ambiguous, the failure to disclose that all orders were being executed at the NBBO price could not, as a matter of law, have involved scienter. We agree.
Appellants attempt to refute the district court's reasoning by arguing that "the absence of a regulation prohibiting a specific practice does not mean such practice cannot be considered fraudulent." Specifically, they rely on our decision in Ettinger v. Merrill Lynch, Pierce, Fenner Smith, Inc., 835 F.2d 1031 (3d Cir. 1987), which they assert is "directly on point." We are not persuaded.
It is true that Ettinger involved a securities firm that failed to disclose excessive markups, but there the similarity to this case ends. The dealer in Ettinger argued that its compliance with Rule 10b-10 insulated it from a material misrepresentation attack under Rule 10b-5, and we held simply that such compliance did not preclude a 10b-5 action. Id. at 1036. Moreover, Ettinger involved a markup practice that both the SEC and the courts had already condemned — the duty in that instance, unlike here, was clear. See id. at 1033. And finally, scienter was not even an issue in Ettinger. It had been waived in the district court. Id. at 1036 n.7. Ettinger is inapposite.
Appellants also cite several cases which allegedly stand for the proposition that violations of Section(s) 10(b) can occur when a broker-dealer fails to execute customer orders at the best possible price. Two of those cases, however, involved execution practices that no reasonable dealer could have possibly believed proper. See Barnett v. United States, 319 F.2d 340, 345 (8th Cir. 1963) (excessive mark-ups of between 25 and 67% not disclosed; customer order never executed at advertised price, while dealer was trading same security for its own account at superior price); Opper v. Hancock Securities Corp., 250 F. Supp. 668, 673 (S.D.N.Y.), aff'd, 367 F.2d 157 (2d Cir. 1966) (dealer claimed to be searching unsuccessfully for buyer to purchase customer's stock, while at the same time trading in that same stock profitably for its own account). Three other cases interpose a third-party dealer in the transaction, thus increasing the customer's expense; this practice had already been condemned by long-standing judicial and regulatory authority. See Sinclair v. SEC, 444 F.2d 399, 400 (2d Cir. 1971); In re Delaware Management Co., 43 SEC 392, 399-400 (1967); In re Hoit Rose Co., 1969 SEC LEXIS 244 (1969). As the district court recognized, the most instructive case on the issue of scienter is Platsis v. E.F. Hutton Co., 946 F.2d 38 (6th Cir. 1991). There, a broker failed to disclose its production credits, spreads or markups, while at the same time it was profiting from customer transactions against its own inventory. The district court found, after trial, that defendants had acted with scienter, but the court of appeals reversed because there was no established regulatory duty to disclose and intent to deceive could not thus be established by omission. Here, as in Platsis, the dealers were under no established duty to execute trades at other than the NBBO price or to disclose their execution practices. Indeed, it appears that the industry as a whole used the NBBO to satisfy the duty of best execution. Under the reasoning of Platsis, then, which we adopt, there was no scienter. Accord Shivangi v. Dean Witter Reynolds, Inc., 825 F.2d 885, 889 (5th Cir. 1987) (failure to disclose sales compensation did not involve scienter when no court or regulator had ever held that information material and there was no evidence that its disclosure was normal industry practice).
Indeed, the only authority appellants are able to cite with facts similar to the present case is an unpublished district court opinion in typescript, Lesko v. Merrill Lynch, Pierce, Fenner Smith, Inc., No. C78-1740 (N.D. Ohio June 22, 1979), in which the court opined, with very little analysis, that a deliberate policy of sending all orders to the AMEX rather than "seeking the best price in the available markets" stated a claim for securities fraud. That court did not discuss scienter, and is thus inapposite, whatever its relative persuasiveness.
The district court and appellees maintain that this circuit already follows a Platsis-like rule. In Christidis v. First Pennsylvania Mortgage Trust, 717 F.2d 96 (3d Cir. 1983), plaintiffs sued an accounting firm, alleging that it fraudulently failed to prepare financial statements in accordance with generally accepted accounting principles. Although scienter as such was not an issue, we affirmed the dismissal of the complaint for lack of particularity in pleading fraud under Fed. R. Civ. P. 9(b). Id. at 100. We do not read Christidis as itself adopting the proposition that failure to disclose cannot involve scienter where there is no clear duty to do so and the practice at issue is common in the industry. It was simply a case involving the pleading standard for allegations of fraud. Nevertheless, we think that Platsis is persuasively reasoned and we adopt it here.
On the other hand, in Chasins v. Smith, Barney Co., 438 F.2d 1167 (2d Cir. 1970), a broker failed to disclose that it was making a market in certain securities it strongly recommended, and then sold, to plaintiff. Although scienter was not directly at issue in Chasins, the court did opine that all brokerage firms had followed the same practice and had never thought such disclosure was required. Moreover, the SEC had never prosecuted any firm for this violation. Indeed, as here, the practice at issue in Chasins was later addressed by regulation. Id. at 1171 n. 5.
Nevertheless, we decline to apply Chasins to this fact pattern. First, the holding there did not address scienter. See Architectural League v. Bartos, 404 F. Supp. 304, 315 (S.D.N Y 1975) ("All that . . . Chasins holds . . . is that failure to disclose market-maker status was . . . the omission of a material fact. The omission of a material fact, without more, does not violate Rule 10b-5. All other elements, including scienter, must be proven[.]"). Second, in Chasins, appellant's contention that nobody thought disclosure was required was demonstrably false, having been impeached by appellant's own witness. 438 F.2d at 1171. That is not the case here. Finally, and most importantly, in Chasins the dealer was strongly recommending that the customer buy certain securities in which the dealer itself was making the market. The dealer thus had an undisclosed conflict of interest of major proportions; to the extent that the customer followed its "advice," the dealer made more money. See Simon v. Merrill Lynch, Pierce, Fenner Smith, Inc., 482 F.2d 880, 885 (5th Cir. 1973) (distinguishing Chasins on this basis); Batchelor v. Legg Co., 52 F.R.D. 553, 557 (D. Md. 1971) (similar).
We therefore hold that, where defendants are under no affirmative legal duty to disclose their order execution practices and those practices are widely followed within the securities industry, as a matter of law there is no scienter when defendants fail to disclose those practices.
B.
In this case, although it appears on the surface that appellants have adduced evidence that the nondisclosures at issue here were not common industry practice, closer examination reveals that contention to be unsupported. Appellants first cite the deposition testimony of Paul M. Lacy, a retired securities trader, for the proposition that "other broker-dealers do not execute customer orders with exclusive reference to the NBBO." His testimony supports nothing. Mr. Lacy retired before the beginning of the class period (November 1992), and therefore cannot offer any competent, firsthand testimony about industry practices as they existed at the times material to this litigation. Of even greater significance, Lacy did not even testify about the practices of other securities dealers in general or even his former firm in particular, but testified only about his own practices as a trader within that firm.
Appellants also rely on proposed SEC rules on order execution as confirmation of Lacy's testimony [A 609]. See Order Execution Obligations, 60 Fed. Reg. 52,792 (1995) (to be codified at 17 C.F.R. pt. 240) (proposed Oct. 10, 1995). That document recites that traders use "a variety of systems and procedures" to satisfy best execution. Id. at 52,794. If traders use a variety of systems, however, that bolsters the district court's conclusion that there was no clear duty to supplement the NBBO price and that failure to disclose the practice of executing all trades at the NBBO price could not have involved scienter.
Appellants likewise refer us to the opinions of a trader and a former SEC commissioner who believe that the duty of best execution requires affirmative efforts to supplement the NBBO with other sources of pricing. See National Market System: Hearings Before the Subcomm. on Telecommunications Finance of the Comm. on Energy Commerce, 103d Cong., Serial No. 103-67, at 355 (1993) (statement of securities dealer Bernard L. Madoff that he believes it is the obligation of a market maker to achieve price improvement whenever possible and does so in fifty percent of all trades); Declaration of former SEC Commissioner Richard Y. Roberts, [A777] ("[i]t would be inconsistent with the duty of best execution for a broker-dealer to advantage itself by automatically executing customer orders at the NBBO when superior prices are reasonably available"). This evidence, however, is insufficient.
To prevail on summary judgment, one need not show that every dealer executes trades at the NBBO price, but merely that enough dealers do so that the duty to supplement the NBBO price is ambiguous and scienter is negated. There is more than ample evidence of that. David S. Ruder, a former Chairman of the SEC, member of the NASD board and law professor at Northwestern University, stated by affidavit that trades at the NBBO price satisfied the duty of best execution and that the general custom and practice of firms in the industry was to execute at the NBBO price [A225-27]. T. Grant Callery, General Counsel to NASD, also stated by affidavit that NASD views the NBBO price as satisfying the best execution duty [A 458]. Finally, Hugh Quiqley, a trader at Merrill Lynch, declared that he had observed the trading practices of every major firm in the industry and observed that the standard practice was to trade at the NBBO [A 497].
Finally, while this case was pending on appeal, the SEC finalized new regulations pertaining to order execution which address directly the practices at issue here. See generally Self-Regulatory Organizations; National Association of Securities Dealers; Order Granting Partial Approval and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 1 to Proposed Rule Change Relating to Implementation of the Commission's Order Handling Rules, 62 Fed. Reg. 2415 (Jan. 16, 1997). Under these new rules, which became effective on January 20, 1997, market makers must display a customer's limit order when the price of that order is superior to the current NBBO quote. Moreover, any superior prices quoted on electronic communications networks such as SelectNet and Instinet must be listed as part of the NBBO price. See SEC News Release 97-3, New Trading Rules for NASD and the Exchanges, 1997 WL 21042 (Jan. 20, 1997). By these regulatory changes, dealers will essentially be required to eliminate the practices that appellants complain of in this case. We believe, as did the district court, that the fact that the Securities and Exchange Commission perceived the need to address these order execution practices through the regulatory process indicates strongly, if not conclusively, that the "duty" to cross orders and to look beyond the NBBO for pricing information was ambiguous, indeed speculative, during the class period. Regulatory agencies would not spend the time, money and effort in promulgating regulations if the duty it sought to impose were already clear under established law.
We do not mean to imply, however, that the duty of best execution is in any way unenforceable in a private action under Section(s) 10(b) of the 1934 Act. Where the duty is clear, or where a practice is obviously fraudulent and not pervasive throughout the securities industry, the mere lack of regulations directly addressing the practice at issue will not constitute a bar to such a suit.
III.
In sum, the evidence in this record is legally insufficient for a rational jury to infer that defendants failed to disclose their "NBBO-only" execution policy knowing that it was fraudulent not to do so, or that they recklessly ignored massive evidence suggesting that it was. Accordingly, the district court correctly found no scienter and properly entered summary judgment for defendants. We will affirm.