The most important thing to happen in securities litigation in the last twenty years is the stark narrowing of the relief available in federal courts. Between the Private Securities Litigation Reform Act of 1995 (PSLRA) and the Supreme Court’s elevation of the standards for specificity in pleading in Bell Atlantic Corp. v. Twombly and Ashcroft v. Iqbal, a securities plaintiff’s task in getting past a motion to dismiss is well-nigh herculean. So it is easy to understand why the plaintiffs’ bar would search for a way to keep those cases in state court. This morning’s decision in Merrill Lynch, Pierce, Fenner & Smith v. Manning suggests they may have found one.
The case involves allegations that Merrill Lynch (the defendant) engaged in manipulative “short selling.” The plaintiff (Greg Manning) seeks relief under the New Jersey RICO statute, New Jersey securities laws, and a variety of common-law obligations involving unjust enrichment, interference with contractual relations and the like. The complaint points out that the conduct also violated the SEC’s Regulation SHO (promulgated under the Exchange Act), although it does not seek relief under that regulation or any other provision of federal law.
Reading that summary, you might ask how the case ended up in federal court. The parties agree that the case does not state any cause of action under federal law, so it plainly does not come within the general “federal question” jurisdiction of 28 U.S.C. § 1331. Defendant Merrill Lynch, though, removed the case from the New Jersey state courts where Manning brought it. Merrill Lynch invokes a provision of the federal Securities Exchange Act (Section 27), which gives federal courts “exclusive” jurisdiction over cases brought to “enforce” the “duties” created under the federal statute. In the view of Merrill Lynch, the case is so closely related to the obligations imposed by the federal securities laws that it should be regarded as one that “enforce[s]” those laws and thus one that is within the “exclusive” jurisdiction of the federal courts.
As it turns out, the lower courts were correct to reject Merrill Lynch’s argument; the Court sent the case back to the state courts. Writing for the Court, Justice Elena Kagan took the simplest possible path, holding that the statutory reference to cases that are “brought to enforce” the federal securities laws is coextensive with the general grant of federal question jurisdiction over cases that “aris[e] under” federal law. Clearly high on the Court’s motivations is the desire to select a standard that is predictable and administrable; importing the well-defined “arising under” standard into this context should make it easy to resolve the great mass of cases.
The Court also pointed out that nine other statutes have the same “brought to enforce” language; the Court has already adjudicated cases under two of them, and has applied the standard “arising under” test for each of them. The Court’s opinion emphasized that it would complicate things needlessly to adopt a different standard here.
Doctrinally, the “arising under” test has two steps. The first step (following a famous decision by Justice Holmes) brings into federal court all cases in which federal law “creates the cause of action”; Manning’s case clearly gets past that step because he has chosen only New Jersey causes of action. The second step is much less precise, reflecting the existence through the years of an almost vanishingly small group of cases in which the Court has thought it appropriate for federal courts to hear cases presenting state-law causes of action. The Court formalized the test for that second step a few years ago in Gunn v. Minton, establishing a four-part test that permits federal jurisdiction only if the case necessarily raises a federal issue, which is actually disputed, substantial, and over which federal jurisdiction would not “disturb any congressionally approved balance of federal and state power.” As applied here, that test plainly does not support jurisdiction, because the case does not necessarily present any issue of federal law – the ability of the plaintiffs to recover is entirely independent of the question whether the alleged short sales violated federal securities laws.
At bottom, the problem for Merrill Lynch is that it failed to convince the Justices of any reason why the Court should interpret the securities laws to be hostile to state securities law enforcement. It is plain that the defendants want the cases in federal court because of the perception that federal courts are more hostile to securities litigation than state courts. If the Court views the securities laws as not only providing limited relief in federal courts, but reflecting an intent that state courts be barred from providing more expansive relief, then it would make sense to pull these cases into federal court. But the long tradition of parallel state securities law enforcement made it difficult for the Justices to draw that conclusion.
The most interesting part of the Court’s logic involves its perception of the “arising under” test. As the argument made clear, the Justices view that test, generally speaking, as drawing a line between cases that are “worth” having in federal court and those that are not. But if that test is the ideal way to define cases that are “worth” having in federal court, then it follows almost as a matter of course that it would be the best way to read the “brought to enforce” statutes – sweeping in all cases that actually press the causes of action created by federal law, with a small window for the jurisprudential oddity of a state-created cause of action so closely bound up with federal law that the Justices want it in federal court. When we recognize that as the Court’s baseline understanding of “arising under,” it is apparent that Merrill Lynch’s arguments were doomed from the beginning.
I should close by mentioning that Justice Kagan’s opinion was not entirely unanimous. The only two not to join were an unusual pair – Justices Clarence Thomas and Sonia Sotomayor – who agreed with the result, but would have interpreted the “brought to enforce” language slightly more broadly than the parallel “arising under” language. Even for them, though, it was conclusive that the plaintiff’s case could stand or fall without the resolution of any question of federal law. Thus, the Court was unanimous in rejecting Merrill Lynch’s plea for protection from the New Jersey courts.
PLAIN ENGLISH: The question in this case is whether people can bring securities cases in state court complaining about conduct that violates the federal securities laws. Merrill Lynch says the cases have to proceed in federal court (where they are very hard to win). The Supreme Court disagrees, and says that the cases can stay in state court.
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