May 23, 2016
On May 16, 2016, the U.S. Supreme Court issued an important opinion concerning Section 27 of the Securities Exchange Act of 1934, which creates exclusive federal jurisdiction over "all suits . . . brought to enforce any duty or liability created by the [Exchange Act]" or the rules and regulations thereunder. In Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning (2016), the Court interpreted Section 27 to be no broader than the jurisdictional grant in 28 U.S.C. § 1331(a), for claims "arising under" federal law. The Court did so despite what it acknowledged were "linguistic distinction[s]" between the two statutes, largely out of a desire for predictability and ease in administration of federal jurisdictional statutes.
Merrill Lynch therefore limited potential avenues for routing state law claims implicating the Exchange Act to federal court, where defendants benefit from the full set of safeguards enacted by the Private Securities Litigation Reform Act of 1995. Merrill Lynch suggests that plaintiffs will continue to attempt to raise such claims in state court when they perceive an advantage in doing so. Merrill Lynch also provides a reminder, however, that when claims pleaded under state law necessarily raise substantial and disputed issues of federal law, removal on the basis of federal question jurisdiction may nonetheless be an appropriate strategy.
The plaintiff in Merrill Lynch brought claims under New Jersey state law for alleged "naked short selling" of securities in order to manipulate their price downwards (essentially, by artificially increasing the pool of tradeable shares). SEC Regulation SHO addresses that practice, as plaintiff’s complaint explicitly stated. However, plaintiff "chose not to bring any claims under federal securities laws or rules," instead invoking only state law causes of action while "cataloguing past accusations against Merrill Lynch for flouting [Regulation SHO’s] requirements and suggesting that the transactions at issue had again violated the [federal] regulation."
Following removal, the district court denied plaintiff’s motion to remand. The Third Circuit reversed, holding that (1) the state law claims did not satisfy the general federal question statute, Section 1331, because none "necessarily raised" a federal issue, and (2) Section 27 covers only those cases involving the Exchange Act that would satisfy the "arising under" test of Section 1331. The second holding deepened a circuit split, which the Supreme Court granted certiorari to resolve.
In an opinion written by Justice Kagan and joined by five other justices, the Court affirmed the Third Circuit’s holding that the test for jurisdiction under Section 27 was the same as under Section 1331. Under that test, even where no federal claim is expressly pleaded, a federal court has jurisdiction of a state law claim that "necessarily raise[s] a stated federal issue, actually disputed and substantial, which a federal forum may entertain without disturbing any congressionally approved balance" of federal and state power. See Grable & Sons Metal Products, Inc. v. Darue Eng’g & Mfg., 545 U. S. 308, 314 (2005).
The Merrill Lynch Court concluded that the text of Section 27 supported applying the test under Grable, even though the Court acknowledged that Section 27 used "completely different language" than Section 1331. The Court reasoned that the "brought to enforce" language of Section 27 emphasized what the suit was "designed to accomplish," and did not reflect an intent for expansive jurisdiction over suits that merely "implicitly" asserted breach of or "mention[ed]" an Exchange Act duty. That broader reading, the Court held, would untenably create federal jurisdiction based on the "atmospheric" or "incidental" allegations of a complaint, such as when plaintiff alleged that the defendant was "a bad actor who infringed that statute on another occasion."
Interestingly, the Court addressed the textual differences between Section 27 and Section 1331 by noting that analysis under the latter was "linguistically ungrounded" in any event, and that Congress’s use of the "brought to enforce" language in Section 27 provided no reason to depart from the "settled" approach under Section 1331. The Court also noted that it had interpreted similar "brought to enforce" language to be coextensive with "arising under" jurisdiction. Pan Am. Petroleum Corp. v. Superior Court of Del. for New Castle Cty., 366 U. S. 656 (1961) (Section 22 of the Natural Gas Act); see also Matsushita Elec. Industrial Co. v. Epstein, 516 U.S. 367, 380 (1996) (using "arising under" language to describe Section 27).
The Court also acknowledged that Section 27’s grant of exclusive federal jurisdiction sought to promote uniformity in interpretation of the Exchange Act (as did the PSLRA generally, and the Securities Litigation Uniform Standards Act of 1998). However, that policy was coupled with Congress’s allowance of state law securities claims. And, Merrill Lynch concluded, it did not trump the desire for predictability and readily administrable rules of jurisdiction, which the Court has described as a "major virtue," Hertz Corp. v. Friend, 559 U.S. 77, 94 (2010), nor the concern for "state court prerogatives" to hear state law claims. Indeed, the Court concluded that, if anything, the provision for exclusive jurisdiction favored an even "stronger" reluctance to endorse a "broad reading" of the federal statute.
In interpreting Section 27 to extend no broader than Section 1331, Merrill Lynch appears to have limited a potential path to federal court, which had been endorsed by at least one Court of Appeals that had interpreted Section 27 as a broader jurisdictional grant than the general federal question statute. Accordingly, Merrill Lynch may well encourage securities plaintiffs to rely on a combination of state law causes of action and federal law "atmospherics," in pursuit of the perceived advantages of state fora.
Nonetheless, Merrill Lynch also provides an important reminder that defendants faced with ostensibly state law claims should rigorously analyze removal possibilities, and evaluate whether the claims might satisfy the Grable test for federal question jurisdiction. That sometimes occurs in multi-jurisdictional litigation, for example when stockholder derivative plaintiffs assert state law claims for purported breaches of fiduciary duty in the wake of federal securities class actions and assert that the duty breached was created by a specific federal law. Similarly, it would appear that removal of claims against federally created self-regulatory organizations, see supra n.3, would remain proper under the Grable test.
Merrill Lynch may also have significance beyond the jurisdictional issue per se. The Court’s opinion might potentially facilitate orderly management of multi-jurisdictional litigation through its recognition that the exclusive grant of jurisdiction in the federal securities laws does not moot the need for deference to properly instituted state-court actions. For example, if stockholder derivative plaintiffs seek to avoid or duplicate actions in state court by filing federal claims arising under Section 14(a) of the Exchange Act, Merrill Lynch may provide support for defendants seeking to stay the federal actions in favor of parallel state cases, instead of incurring the burden and expense of duplicative litigation.
 At the same time, the Court declined plaintiff’s invitation to read Section 27 more narrowly than Section 1331, noting that "[o]n rare occasions . . . a suit raising a state law claim rises or falls on the plaintiff’s ability to prove the violation of a federal duty." If so, the Grable test could allow for jurisdiction. The Court also rejected a competing approach advanced in a concurrence by Justice Thomas (joined by Justice Sotomayor). Because of Section 27’s exclusive jurisdiction provision, the concurrence would have dispensed with the Grable test’s other elements and focused solely on whether the state law claim necessarily raised an Exchange Act issue.
 Sparta Surgical Corp. v. NASD, 159 F.3d 1209 (9th Cir. 1998); see also Hawkins v. NASD, 149 F.3d 330 (5th Cir. 1998) (affirming denial of remand for claims that "may be categorized" as actions to enforce liability created by federal securities laws).
 See, e.g., Wietschner v. Gilmartin, 2003 U.S. Dist. LEXIS 18997, at *7 (D.N.J. Jan. 13, 2003) (claims for breach of fiduciary duty were "primarily based upon defendant-directors’ failure to adequately monitor . . . financial disclosures in accordance with federal securities laws," including Section 10(b) of the Exchange Act); Gobble v. Hellman, 2002 U.S. Dist. LEXIS 26833, at *11 (N.D. Ohio Mar. 26, 2002) (denying remand because "Plaintiff has [explicitly] alleged that Defendants violated the Federal Exchange Act . . . and these violations constitute a breach of their fiduciary duties"); Landers v. Morgan Asset Mgm’t, 2009 U.S. Dist. LEXIS 30891, at *19-31 (W.D. Tenn. Mar. 31, 2009) (denying remand where plaintiffs "explicitly asked the Court to evaluate Defendants’ actions in light of requirements imposed by federal securities law," and "Plaintiffs have asserted no source of Defendants’ duty of care other than federal securities laws"); Staehr v. W. Capital Res., Inc., 2010 WL 4338652, at *3 (D. Minn. Sept. 24, 2010), report and recommendation adopted 2010 WL 4321542 (D. Minn. Oct. 26, 2010) (complaint requesting "judicial determination of . . . rights, duties and obligations relating to [a] Proxy Statement" necessarily invoked Section 14(a) of the Exchange Act).
 One other aspect of the Merrill Lynch opinion may stand out to the securities bar: the Court acknowledged that its prior opinion in Pan American Petroleum relied in part on a committee report describing Section 22 of the NGA as conferring federal jurisdiction "over cases arising under the act." No analogous report existed with regard to Section 27, but the Merrill Lynch Court found that irrelevant, stating it could not "give two identically worded statutory provisions, passed less than five years apart, markedly different meanings." That reasoning may have relevance to the ongoing litigation concerning the so-called Extender Statute under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, which refers only to statutes of limitations and not statutes of repose, as does another "extender" provision enacted three years earlier in 1986 amendments to the Comprehensive Environmental Response, Compensation, and Liability Act. The Supreme Court in CTS v. Waldburger, 134 S. Ct. 2175 (2014), relied partly on a committee report in concluding that the CERCLA provision did not displace statutes of repose, and several courts of appeals have recently considered whether the lack of a similar report for FIRREA has any significance. Merrill Lynch suggests that it does not.
The following Gibson Dunn lawyers prepared this client alert: Alex Mircheff and Patrick Doust.
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