Brokerage employees say firms' away account policies are illegal handcuffs
In McDaniels, et al. v. Wells Fargo Investments, LLC, et al. (9th Circuit, April 10, 2013), Plaintiffs are former employees of Wells Fargo, Morgan Stanley, and Merrill Lynch:
While employed at Wells Fargo, Morgan Stanley, and Merrill Lynch, the employees were denied the ability to open self-directed brokerage accounts at other firms. The employer firms argued that federal law requires brokerage firms to promulgate rules and regulations reasonably designed to supervise their employees in order to deter the misuse of material, nonpublic information. Accordingly, the employers claimed that their denial of employee requests to open outside self-directed trading accounts promoted sound compliance policies and furthered the federal requirement to properly supervise.
In the summer of 2010, the employees filed four class actions asserting that the blanket denial of outside self-directed trading accounts violated the "forced patronage" provisions of Section 450(a) of the California Labor Code by forcing each employee to patronize the employer in the purchase of a thing of value.
California Labor Code
(a) No employer, or agent or officer thereof, or other person, may compel or coerce any employee, or applicant for employment, to patronize his or her employer, or any other person, in the purchase of any thing of value.
(b) For purposes of this section, to compel or coerce the purchase of any thing of value includes, but is not limited to, instances where an employer requires the payment of a fee or consideration of any type from an applicant for employment for any of the following purposes:
(1) For an individual to apply for employment orally or in writing.
(2) For an individual to receive, obtain, complete, or submit an application for employment.
(3) For an employer to provide, accept, or process an application for employment.
Section 451. Any person, or agent or officer thereof, who violates this article is guilty of a misdemeanor.
Section 452. Nothing in this article shall prohibit an employer from prescribing the weight, color, quality, texture, style, form and makeof uniforms required to be worn by his employees.
In defense of their actions, the defendant firms argued the federal law preempted the state's Forced Patronage statute, which they further cited as an obstacle to their necessary and appropriate use of discretion in the adoption of compliance policies in order to deter insider trading and other abuses.
After the district courts dismissed the four class action, the 9th Circuit AFFIRMED the lower courts' ruling. The 9th Circuit found that the federal Securities Exchange Act, and related self-regulatory organizations rules, preempt the enforcement of California's Forced Patronage statute against brokerage houses that forbid their employees from opening outside trading accounts.
Bill Singer's Comment
As I have followed these cases, I fully anticipated the district and circuit courts' dismissal. Although the issue presented was an interesting one, it seemed a foregone conclusion that the preemption doctrine would not permit California state law to interfere with federal securities laws and self-regulatory organizations' rules. While I personally believe that many brokerage firms deny outside accounts in order to enjoy commissions from forced customers, it is an equally compelling explanation that given the pervasiveness of insider trading on Wall Street, brokerage firms are in a better position to monitor that potential misconduct if all trading occurs in-house and on their books. Admittedly, outside accounts involve the transmission of duplicate confirms to the employing brokerage firm; however, such a process does complicate effective supervision and delays the timely detection of misconduct.