It turns out that sometimes you can tell what the justices are thinking by the questions they ask. As was predicted by some observers following oral argument in the Dabit case, the U.S. Supreme Court has held that the Securities Litigation Uniform Standards Act (“SLUSA”) pre-empts state-law class actions brought on behalf of persons who were induced to hold (but not purchase or sell) securities. The 8-0 decision authored by Justice Stevens resolves a circuit split between the Second Circuit and the Seventh Circuit on the issue.
SLUSA preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The primary goal of SLUSA was to prevent plaintiffs from using state law claims to avoid the heightened pleading standards imposed on federal securities class actions. The issue before the Supreme Court in Dabit was the meaning of SLUSA’s “in connection with” requirement.
Dabit is a former Merrill Lynch broker who filed a class action in federal court claiming, under Oklahoma state law, that Merrill Lynch breached its fiduciary duty to its brokers by disseminating misleading analyst research. Dabit asserted that this practice caused the brokers to hold onto overvalued securities too long and lose commission fees when their clients took their business elsewhere. The Second Circuit found that Dabit’s claims were not pre-empted by SLUSA to the extent that he “alleged that brokers were fraudulently induced, not to sell or purchase, but to retain or delay selling their securities.”
The Supreme Court previously had held that only purchasers and sellers of securities have standing to bring a private securities fraud action pursuant to Rule 10b-5. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). In Dabit, however, the Court clarified that its earlier decision to limit the potential plaintiffs in Rule 10b-5 cases was based on policy considerations, not on an attempt to define the phrase “in connection with the purchase or sale.” Indeed, the Court has generally “espoused a broad interpretation” of that phrase, holding that “it is enough that the fraud alleged ‘coincide’ with a securities transaction – whether by the plaintiff or by someone else.”
The Court found that this broad interpretation must have been known to Congress when it drafted SLUSA and used the “in connection with” language. Given that “class actions brought by holders pose a special risk of vexatious litigation,” it would be “odd, to say the least, if SLUSA exempted that particularly troublesome subset of class actions from its pre-emptive sweep.” Moreover, allowing state class actions brought by holders “would give rise to wasteful, duplicative litigation” if parallel state court (holders) and federal court (purchasers) class actions were brought based on the same facts.
Holding: Judgment vacated and case remanded for further proceedings consistent with opinion.
Quote of note: “The holder class action that respondent tried to plead, and that the Second Circuit envisioned, is distinguishable from a typical Rule 10b–5 class action in only one respect: It is brought by holders instead of purchasers or sellers. For purposes of SLUSA pre-emption, that distinction is irrelevant; the identity of the plaintiffs does not determine whether the complaint alleges fraud ‘in connection with the purchase or sale’ of securities. 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 as the phrase is defined in Zandford, 535 U. S., at 820, 822, and O’Hagan, 521 U. S., at 651.”