Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit
Encyclopedia
Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71
(2006), was a case decided by the Supreme Court of the United States
involving the extent to which state law securities fraud
class action
claims were preempted
by the Securities Litigation Uniform Standards Act
of 1998 (SLUSA). The Court unanimously ruled that SLUSA barred state law "holder" claims, which are based on losses caused when a shareholder retains stock due to fraud instead of selling it, even though federal securities laws only provided a private cause of action
to those suffering losses caused by the purchase or sale of stock. The Court's decision resolved a split among the circuits
and closed a significant loophole in the coverage of SLUSA, which it based on the broad language used in the Act and the policies behind it.
became the target of an investigation by the Attorney General of New York, based on the suspicion that the firm's loyalty to its investment banking clients had caused it to render biased investment advice. Though Merrill Lynch settled that dispute, the investigation spurred a number of private securities fraud
class action
lawsuits, including one filed by Shadi Dabit, a former Merrill Lynch stock broker
, in the U.S. District Court for the Western District of Oklahoma.
prices by disseminating misleading research, and consequently using its misinformed brokers to artificially inflate the value of its investment banking clients' stock. In this alleged scheme, the research analysts issued unrealistically optimistic reports upon which the brokers relied in advising their clients and in deciding whether to hold on to their own stock, and that both the clients and brokers held on to their stock long past the point at which they would have sold if they had accurate information. By the time the truth was revealed around the time of the Attorney General's investigation, the price of the stocks had plummeted, causing the stockholders to lose value and the brokers to lose commission
when their misinformed clients took their business elsewhere. Dabit's complaint
claimed damages on behalf of himself and all class members against Merrill Lynch under Oklahoma
state law for breach of fiduciary duty.
then transferred all of the cases, included Dabit's, to the Southern District of New York for pre-trial consolidation.
, on the grounds that the claims were "squarely within SLUSA's ambit." However, this decision was reversed on appeal by the Second Circuit Court of Appeals
, one of the ruling judges being Sonia Sotomayor. The court ruled that the holder claims did not satisfy the SLUSA requirement that the fraud claims be brought "in connection with the purchase or sale" of securities. Though recognizing the typically broad interpretation that language has been given, the Second Circuit believed Congress
meant to incorporate the Supreme Court's limitation from Blue Chip Stamps v. Manor Drug Stores
, 421 U.S. 723 (1975), which ruled that only those suffering direct loss from the purchase or sale of stock had standing to sue under federal securities law. To the extent that Dabit's amended complaint alleged that Merrill Lynch had fraudulently induced the stockholders to retain their stock and not to purchase or sell it, the Second Circuit determined that his class action fell outside SLUSA's preemptive scope. The case was nonetheless remanded for dismissal with leave to amend again, because the amended complaint still did not necessarily exclude purchaser claims.
delivered the Court's opinion, which was joined by the other seven Justices participating in the case.
, which broadly prohibits any "deceptive device" or fraud "in connection with the purchase or sale of securities." Courts recognized a private cause of action under Rule 10b-5 since 1946 despite the lack of explicit language to this effect. However, the majority of courts limited this to plaintiffs asserting purchaser or seller claims, rather than holder claims. The Supreme Court adopted this limitation in Blue Chip Stamps
, despite the broad language in 10b-5 and despite the lack of a similar limitation upon government enforcement of the Rule. The Court found a policy for this limit in the "vexatiousness" that Rule 10b-5 litigation represented, which provided for substantial settlements in even weak cases due to the interference a pending lawsuit caused with normal business.
The Court believed that similar policy considerations prompted Congress in 1995 to pass the Private Securities Litigation Reform Act
, on the belief that, as a House Report
asserted, the class action device was being used to injure "the entire U. S. economy" by filing mere nuisance lawsuits, targeting deep-pocket defendants, making burdensome discovery requests, and through "manipulation by class action lawyers of the clients whom they purport to represent." The PSLRA imposed new restrictions such as damage caps and heightened pleading requirements on securities plaintiffs, and consequently prompted many to seek state court venues to avoid the new strictures. To prevent these state class actions from frustrating the purposes of the PSLRA, Congress then enacted SLUSA in 1998.
The Court also found that policy considerations supported its interpretation. Omitting holder claims from SLUSA's coverage—the very form of vexatious litigation targeted in Blue Chip Stamps—would be contrary to its purpose of preventing state law claims from frustrating the ends of the PSLRA. As holder claims were typically based on the same facts as purchaser-seller actions, if they were not preempted, wasteful litigation based on identical facts could proceed in parallel proceedings in federal and state courts. The existence of explicit exemptions in the statute (none applicable in this case) also discouraged the Court from itself finding further exemptions through implication. Finally, prior to the post-PSLRA exodus of securities claims to state courts, state law securities fraud claims were rare; the presumption against preemption that a "historically entrenched state-law remedy" enjoys was not present here.
Case citation
Case citation is the system used in many countries to identify the decisions in past court cases, either in special series of books called reporters or law reports, or in a 'neutral' form which will identify a decision wherever it was reported...
(2006), was a case decided by the Supreme Court of the United States
Supreme Court of the United States
The Supreme Court of the United States is the highest court in the United States. It has ultimate appellate jurisdiction over all state and federal courts, and original jurisdiction over a small range of cases...
involving the extent to which state law securities fraud
Securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a practice that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in losses, in violation of the securities laws....
class action
Class action
In law, a class action, a class suit, or a representative action is a form of lawsuit in which a large group of people collectively bring a claim to court and/or in which a class of defendants is being sued...
claims were preempted
Federal preemption
Federal preemption refers to the invalidation of US state law when it conflicts with Federal law.-Constitutional basis:According to the Supremacy Clause of the United States Constitution,...
by the Securities Litigation Uniform Standards Act
Securities Litigation Uniform Standards Act
The Securities Litigation Uniform Standards Act of 1998 is a federal legislative act in the United States regarding private class action lawsuits for securities fraud...
of 1998 (SLUSA). The Court unanimously ruled that SLUSA barred state law "holder" claims, which are based on losses caused when a shareholder retains stock due to fraud instead of selling it, even though federal securities laws only provided a private cause of action
Cause of action
In the law, a cause of action is a set of facts sufficient to justify a right to sue to obtain money, property, or the enforcement of a right against another party. The term also refers to the legal theory upon which a plaintiff brings suit...
to those suffering losses caused by the purchase or sale of stock. The Court's decision resolved a split among the circuits
United States federal judicial district
For purposes of the federal judicial system, Congress has divided the United States into judicial districts. There are 94 federal judicial districts, including at least one district in each state, the District of Columbia and Puerto Rico...
and closed a significant loophole in the coverage of SLUSA, which it based on the broad language used in the Act and the policies behind it.
Facts
In 2002, the investment banking firm Merrill LynchMerrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...
became the target of an investigation by the Attorney General of New York, based on the suspicion that the firm's loyalty to its investment banking clients had caused it to render biased investment advice. Though Merrill Lynch settled that dispute, the investigation spurred a number of private securities fraud
Securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a practice that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in losses, in violation of the securities laws....
class action
Class action
In law, a class action, a class suit, or a representative action is a form of lawsuit in which a large group of people collectively bring a claim to court and/or in which a class of defendants is being sued...
lawsuits, including one filed by Shadi Dabit, a former Merrill Lynch stock broker
Stock broker
A stock broker or stockbroker is a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms on behalf of investors...
, in the U.S. District Court for the Western District of Oklahoma.
Class action allegations
Dabit claimed that Merrill Lynch had manipulated stockStock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
prices by disseminating misleading research, and consequently using its misinformed brokers to artificially inflate the value of its investment banking clients' stock. In this alleged scheme, the research analysts issued unrealistically optimistic reports upon which the brokers relied in advising their clients and in deciding whether to hold on to their own stock, and that both the clients and brokers held on to their stock long past the point at which they would have sold if they had accurate information. By the time the truth was revealed around the time of the Attorney General's investigation, the price of the stocks had plummeted, causing the stockholders to lose value and the brokers to lose commission
Commission (remuneration)
The payment of commission as remuneration for services rendered or products sold is a common way to reward sales people. Payments often will be calculated on the basis of a percentage of the goods sold...
when their misinformed clients took their business elsewhere. Dabit's complaint
Complaint
In legal terminology, a complaint is a formal legal document that sets out the facts and legal reasons that the filing party or parties In legal terminology, a complaint is a formal legal document that sets out the facts and legal reasons (see: cause of action) that the filing party or parties In...
claimed damages on behalf of himself and all class members against Merrill Lynch under Oklahoma
Oklahoma
Oklahoma is a state located in the South Central region of the United States of America. With an estimated 3,751,351 residents as of the 2010 census and a land area of 68,667 square miles , Oklahoma is the 28th most populous and 20th-largest state...
state law for breach of fiduciary duty.
First motion to dismiss
Merrill Lynch moved to dismiss the class action, arguing that it was preempted by the Securities Litigation Uniform Standards Act, which bars class action lawsuits from bringing state law claims for fraud "in connection with the purchase or sale" of securities. The District Court agreed that SLUSA preempted Dabit's claims based on the purchase of stock, and dismissed with leave to amend so he could separate out the "holder" claims, based on the retention of stock. By the time Dabit filed his amended complaint, dozens of similar class actions had been filed around the country. The Judicial Panel on Multidistrict LitigationJudicial Panel on Multidistrict Litigation
The United States Judicial Panel on Multidistrict Litigation is a special body within the United States federal court system which manages multidistrict litigation. It was established by Congress in 1968 under 28 U.S.C...
then transferred all of the cases, included Dabit's, to the Southern District of New York for pre-trial consolidation.
Second motion to dismiss and the Second Circuit's decision
Merrill Lynch again moved for dismissal, which was granted by Senior Judge Milton PollackMilton Pollack
Milton Pollack was a longtime federal judge in New York City.Pollack was born in New York and obtained his bachelors and law degrees from Columbia University and Columbia Law School....
, on the grounds that the claims were "squarely within SLUSA's ambit." However, this decision was reversed on appeal by the Second Circuit Court of Appeals
United States Court of Appeals for the Second Circuit
The United States Court of Appeals for the Second Circuit is one of the thirteen United States Courts of Appeals...
, one of the ruling judges being Sonia Sotomayor. The court ruled that the holder claims did not satisfy the SLUSA requirement that the fraud claims be brought "in connection with the purchase or sale" of securities. Though recognizing the typically broad interpretation that language has been given, the Second Circuit believed Congress
United States Congress
The United States Congress is the bicameral legislature of the federal government of the United States, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C....
meant to incorporate the Supreme Court's limitation from Blue Chip Stamps v. Manor Drug Stores
Blue Chip Stamps v. Manor Drug Stores
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 , was a decision by the United States Supreme Court, which ruled that only those suffering direct loss from the purchase or sale of stock had standing to sue under federal securities law....
, 421 U.S. 723 (1975), which ruled that only those suffering direct loss from the purchase or sale of stock had standing to sue under federal securities law. To the extent that Dabit's amended complaint alleged that Merrill Lynch had fraudulently induced the stockholders to retain their stock and not to purchase or sell it, the Second Circuit determined that his class action fell outside SLUSA's preemptive scope. The case was nonetheless remanded for dismissal with leave to amend again, because the amended complaint still did not necessarily exclude purchaser claims.
Judgment
The Supreme Court vacated the Second Circuit's decision. Justice John Paul StevensJohn Paul Stevens
John Paul Stevens served as an Associate Justice of the Supreme Court of the United States from December 19, 1975 until his retirement on June 29, 2010. At the time of his retirement, he was the oldest member of the Court and the third-longest serving justice in the Court's history...
delivered the Court's opinion, which was joined by the other seven Justices participating in the case.
Background of SLUSA
The Court began its analysis by summarizing the legal history preceding the enactment of SLUSA. In 1942, the Securities Exchange Commission promulgated SEC Rule 10b-5SEC Rule 10b-5
SEC Rule 10b-5, codified at 17 C.F.R. § 240.10b-5, is one of the most important rules promulgated by the U.S. Securities and Exchange Commission, pursuant to its authority granted under § 10 of the Securities Exchange Act of 1934...
, which broadly prohibits any "deceptive device" or fraud "in connection with the purchase or sale of securities." Courts recognized a private cause of action under Rule 10b-5 since 1946 despite the lack of explicit language to this effect. However, the majority of courts limited this to plaintiffs asserting purchaser or seller claims, rather than holder claims. The Supreme Court adopted this limitation in Blue Chip Stamps
Blue Chip Stamps v. Manor Drug Stores
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 , was a decision by the United States Supreme Court, which ruled that only those suffering direct loss from the purchase or sale of stock had standing to sue under federal securities law....
, despite the broad language in 10b-5 and despite the lack of a similar limitation upon government enforcement of the Rule. The Court found a policy for this limit in the "vexatiousness" that Rule 10b-5 litigation represented, which provided for substantial settlements in even weak cases due to the interference a pending lawsuit caused with normal business.
The Court believed that similar policy considerations prompted Congress in 1995 to pass the Private Securities Litigation Reform Act
Private Securities Litigation Reform Act
The United States Private Securities Litigation Reform Act of 1995, Pub. L. 104-67, 109 Stat. 737 implemented several substantive changes affecting certain cases brought under the federal securities laws, including changes related to pleading, discovery, liability, class representation, and...
, on the belief that, as a House Report
United States House of Representatives
The United States House of Representatives is one of the two Houses of the United States Congress, the bicameral legislature which also includes the Senate.The composition and powers of the House are established in Article One of the Constitution...
asserted, the class action device was being used to injure "the entire U. S. economy" by filing mere nuisance lawsuits, targeting deep-pocket defendants, making burdensome discovery requests, and through "manipulation by class action lawyers of the clients whom they purport to represent." The PSLRA imposed new restrictions such as damage caps and heightened pleading requirements on securities plaintiffs, and consequently prompted many to seek state court venues to avoid the new strictures. To prevent these state class actions from frustrating the purposes of the PSLRA, Congress then enacted SLUSA in 1998.
Interpretation of SLUSA text and policy
Dabit argued that the SLUSA language "in connection with the purchase or sale" should be read narrowly, so as to only apply to the purchaser-seller actions that Blue Chip Stamps required for private actions under Rule 10b-5. However, the Court pointed out that Blue Chip Stamps expressly relied upon "policy considerations" in crafting that limitation, not the text of the Rule, and that the decision was only defining the judicially-crafted private right of action, not the words "in connection with the purchase or sale" of securities. The Court asserted that it had always given broad meaning to the words themselves, as in the context of SEC enforcement actions, and that it is presumed that Congress was aware of this when it enacted SLUSA.The Court also found that policy considerations supported its interpretation. Omitting holder claims from SLUSA's coverage—the very form of vexatious litigation targeted in Blue Chip Stamps—would be contrary to its purpose of preventing state law claims from frustrating the ends of the PSLRA. As holder claims were typically based on the same facts as purchaser-seller actions, if they were not preempted, wasteful litigation based on identical facts could proceed in parallel proceedings in federal and state courts. The existence of explicit exemptions in the statute (none applicable in this case) also discouraged the Court from itself finding further exemptions through implication. Finally, prior to the post-PSLRA exodus of securities claims to state courts, state law securities fraud claims were rare; the presumption against preemption that a "historically entrenched state-law remedy" enjoys was not present here.
See also
External links
- [ Full text of the Supreme Court's decision]