Supreme Court KO’s State Securities Suits

A unanimous U.S. Supreme Court last week slammed the door shut on state class action suits by shareholders who claim that they held on to a security—but didn’t purchase or sell it—as a result of a fraudulent statement.

Plaintiffs’ lawyers had argued that the Securities Litigation Uniform Standards Act of 1998, which bars state class actions “in connection with the purchase or sale” of securities, contained a loophole for holders of stock. Lower courts had been split on the question, with the New York-based 2nd Circuit Court of Appeals saying that SLUSA doesn’t include shareholders who merely hold on to securities, and the 7th Circuit in Chicago saying the opposite.

The U.S. Supreme Court came down squarely in favor of the 7th Circuit, holding that allowing class actions by holders to proceed in state courts would frustrate the intent of SLUSA.

“The misconduct of which respondent complains here—fraudulent manipulation of stock prices—unquestionably qualifies as fraud ‘in connection with the purchase or sale’ of securities,” Justice John Paul Stevens wrote in case, Merrill Lynch, Pierce, Fenner & Smith v. Dabit. Stevens’ opinion was joined by every single justice on the court except for its newest justice, Samuel Alito, who was not on the bench when the case was argued.

Threat Abated

Kasner

Jay Kasner, who successfully argued the Supreme Court case for Merrill Lynch, says that “the impact of court’s decision will be that public companies that want to access our capital market will no longer have to operate under the threat of securities class actions in state courts under 50 different laws.”

According to Kasner, a lawyer with Skadden, Arps, Slate, Meagher & Flom, the Supreme Court “makes clear in a number of places [in its opinion] that the purposes behind Congress seeking to reform federal securities class action litigation is a goal that should be furthered by courts. The court makes a number of observations about evils Congress has found in terms of nuisance litigation.”

Elizabeth Schwartz, a partner with Perkins Coie, says the court’s decision logically derives from Congress’ intent in 1995 when it enacted the Private Securities Litigation Reform Act. “The intent was pretty clear: to close down those kind of incredibly expensive, time-consuming and in many cases frivolous class actions,” she says. “And SLUSA was meant to close the loophole that the plaintiffs’ found after the PSLRA.”

Freeman

William Freeman, a partner with Cooley Godward, says the court’s decision is “a welcome reaffirmation of the Supreme Court’s longstanding concern about the unique and serious dangers that frivolous securities cases pose for businesses and for the economy as a whole.”

According to Freeman, the justices are “reasserting the right of the courts to place appropriate limits on securities lawsuits based on underlying policy objectives because the original right to sue was judge-made. The court has reinforced the congressional purposes of [SLUSA], which was to prevent plaintiffs from making an end-run around the restrictions that Congress had imposed on class actions in the [PSLRA].”

‘Purchase Or Sale’

The case stems from a 2002 investigation into alleged conflicts of interest between research analysts and investment bankers. Seizing upon the information uncovered in the investigation, Shadi Dabit, a former Merrill Lynch broker, filed a purported class-action suit on behalf of shareholders in Oklahoma, claiming that Merrill Lynch had violated state law. (Although the suit was actually heard in a federal court based on diversity jurisdiction, it was a state law claim.)

DECISION

Below is an excerpt from the Supreme Court's decision in the Dabit case:

Congress can hardly have been unaware of the broad construction adopted by both this Court and the SEC when it imported the key phrase—“in connection with the purchase or sale”—into SLUSA’s core provision. And when “judicial interpretations have settled the meaning of an existing statutory provision, repetition of the same language in a new statute indicates, as a general matter, the intent to incorporate its … judicial interpretations as well.” Application of that presumption is particularly apt

here; not only did Congress use the same words as are used in Sec. 10(b) and Rule 10b–5, but it used them in a provision that appears in the same statute as Sec. 10(b). Generally, “identical words used in different parts of the same statute are … presumed to have the same meaning.”

The presumption that Congress envisioned a broad construction follows not only from ordinary principles of statutory construction but also from the particular concerns that culminated in SLUSA’s enactment. A narrow reading of the statute would undercut the effectiveness of the 1995 Private Securities Litigation Reform Act and thus run contrary to SLUSA’s stated purpose, viz., “to prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives” of the 1995 Act …

Respondent’s preferred construction also would give rise to wasteful, duplicative litigation. Facts supporting an action by purchasers under Rule 10b–5 (which must proceed in federal court if at all) typically support an action by holders as well, at least in those States that recognize holder claims. The prospect is raised, then, of parallel class actions proceeding in state and federal court, with different standards governing claims asserted on identical facts. That prospect, which exists to some extent in this very case, squarely conflicts with the congressional preference for “national standards for securities class action lawsuits involving nationally traded securities.”

In concluding that SLUSA pre-empts state-law holder class-action claims of the kind alleged in Dabit’s complaint, we do not lose sight of the general “presum[ption] that Congress does not cavalierly pre-empt state-law causes of action.”

But that presumption carries less force here than in other contexts because SLUSA does not actually pre-empt any state cause of action. It simply denies plaintiffs the right to use the class action device to vindicate

certain claims. The Act does not deny any individual plaintiff, or indeed any group of fewer than 50 plaintiffs, the right to enforce any state-law cause of action that may exist.

Moreover, the tailored exceptions to SLUSA’s pre-emptive command demonstrate that Congress did not by any means act “cavalierly” here. The statute carefully exempts from its operation certain class actions based on

the law of the State in which the issuer of the covered security is incorporated, actions brought by a state agency or state pension plan, actions under contracts between issuers and indenture trustees, and derivative actions brought by shareholders on behalf of a corporation. The statute also expressly preserves state jurisdiction over state agency enforcement proceedings. The existence of these carve-outs both evinces congressional sensitivity to state prerogatives in this field and makes it inappropriate for courts to create additional, implied exceptions.

Source

Merrill Lynch et al v. Dabit (March 21, 2006)

The trial judge initially dismissed the suit on grounds that it was preempted by SLUSA. But Dabit amended his complaint to narrow the class of plaintiffs only to those who “owned or held” securities, not those who purchased or sold them. The suit was then transferred to the Southern District of New York, which has a special litigation panel to hear such cases.

In New York, Dabit’s suit was again dismissed because it was precluded by SLUSA. On appeal, however, the 2nd Circuit held that Dabit’s state-law claims that did not involve the purchase or sale of securities could go forward.

In reversing the 2nd Circuit, the Supreme Court noted that in 1995 Congress adopted the PSLRA, which “targeted … perceived abuses of the class action vehicle in litigation involving nationally traded securities,” by making it much more difficult to file securities class actions in federal court. The PSLRA “had an unintended consequence: It prompted at least some members of the plaintiffs’ bar to avoid the federal forum altogether,” Stevens noted. “Rather than face the obstacles set in their path by the [PSLRA], plaintiffs and their representatives began bringing class actions under state law, often in state court.”

To “stem the shift” from federal to state court, Congress enacted SLUSA in 1998, Stevens observed. SLUSA prohibited state law actions on behalf of 50 or more people alleging fraud “in connection with the purchase or sale” of securities.

Class actions brought by holders of securities “pose a special risk of vexatious litigation,” Stevens said. “It would be odd, to say the least, if SLUSA exempted that particularly troublesome subset of class actions from its preemptive sweep.”

‘Needs To Be Fixed’

Kaplan

Mitchell Kaplan, a partner with Choate, Hall & Stewart, says Stevens’ decision provides “a nice little précis on how we got to where we are in private securities litigation today.”

Stevens “is essentially saying that the court continues to believe that it makes some sense to ‘cabin’ the number of instances in which private plaintiffs can bring class actions,” Kaplan says. “The court’s reasoning is completely consistent with what led Congress to first pass the [PSLRA] and then, when the class action bar sought to get around it, to enact SLUSA so as not to permit the class action bar to evade the checks on securities class actions that had been created by the [PSLRA].”

Frumento

Aegis Frumento, of Duane Morris, says he wasn’t surprised by the result of the Supreme Court’s decision but found it interesting that the justices unanimously focused on the policy behind the SLUSA, rather than just on the text of the statute. “The court could have said, ‘There is a hole in the statue. It’s not our job to plug Congress’ holes.’ They could have punted it back to Congress.”

The case is the latest in a “trend going back 10 years,” Frumento says. “In every instance where there has been a choice between a more expansive view of the private right of action under Rule 10b-5 and a more restrictive view—the court has taken the more restrictive view … In essence, the court has been adopting the view that securities litigation in this country is broken in some way, shape or form and needs to be fixed.”

Although plaintiffs’ lawyers were hopeful for a Supreme Court victory, they were braced for the defeat the court handed them in the Merrill Lynch case. Several plaintiffs’ lawyers who spoke to Compliance Week at the time the case was argued in January said that the justices seemed inclined to rule against state class actions by holders. Those lawyers could not be reached for comment last week.