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Brief Overview of Class Action Issues Under SLUSA (Securities Litigation Uniform Standards Act) For The Defense Lawyer

SLUSA (Securities Litigation Uniform Standards Act) was enacted by Congress in 1998 to affect sweeping changes to federal securities laws class actions. SLUSA addresses numerous federal securities laws class actions issues including pleading, class representation, discovery, liability, attorney fee awards, expenses and more. SLUSA also sought to pre-empt state law securities class action litigation, but the Circuit Courts disagreed on the breadth of that pre-emption.

In Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, __ U.S. ___, 126 S.Ct. 1503 (2006), the United States Supreme Court issued its opinion. This opinion addresses whether the Securities Litigation Uniform Standards Act (SLUSA) “only pre-empts state-law class-action claims brought by plaintiffs who have a private remedy under federal law,” as the Second Circuit held in Dabit v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 395 F.3d 25 (2005), or whether SLUSA “also pre-empts state-law class-action claims for which federal law provides no private remedy,” as the Seventh Circuit held in Kircher v. Putnam Funds Trust, 403 F.3d 478 (7th Cir. 2005). The Supreme Court agreed with the Seventh Circuit, holding that SLUSA’s pre-emption provision was intended to be read broadly, and pre-empted state-law class-action claims brought not only by purchasers and sellers of securities, but also by holders of securities. As so read, SLUSA pre-empted state-law claims alleging the fraudulent manipulation of stock prices.

As the Supreme Court observed,

Title I of the Securities Litigation Uniform Standards Act of 1998 (SLUSA) provides that “[n]o covered class action” based on state law and alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security” “may be maintained in any State or Federal court by any private party.” § 101(b), 112 Stat. 3227 (codified at 15 U.S.C. § 78bb(f)(1)(A)).

Merrill Lynch v. Dabit, 126 S.Ct. at 1506-07.

Dabit formerly worked as a broker for Merrill Lynch. He filed a class action in federal court on behalf of all current and former Merrill Lynch brokers who purchased certain stocks, either for themselves or for their clients. Dabit’s suit, however, was not based on federal securities laws but, rather, advanced Oklahoma state law claims. In essence, Dabit alleged that Merrill Lynch disseminated misleading research to its brokers in an effort to manipulate stock prices. The Supreme Court summarized Dabit’s lawsuit at page 1507 as follows:

The research analysts, under management’s direction, allegedly issued overly optimistic appraisals of the stocks’ value; the brokers allegedly relied on the analysts’ reports in advising their investor clients and in deciding whether or not to sell their own holdings; and the clients and brokers both continued to hold their stocks long beyond the point when, had the truth been known, they would have sold. The complaint further alleged that when the truth was actually revealed . . ., the stocks’ prices plummeted.

Dabit’s damage claims were based on two theories: first, that Merrill Lynch’s conduct caused class members to “hold onto overvalued securities; and second, that “the brokers lost commission fees when their clients, now aware that they had made poor investments, took their business elsewhere.” Id., at 1507.

Merrill Lynch moved to dismiss the complaint on the grounds that the lawsuit was preempted by SLUSA. (Merrill Lynch also argued that Dabit’s claims were not cognizable under Oklahoma state law. The District Court was “not impressed” with that argument, and it played no role in the Supreme Court’s decision.) The District Court agreed that SLUSA preempted Dabit’s claims to the extent that they sought damages for “wrongfully-induced purchases” of securities; however, to the extent Dabit sought damages for “wrongfully-induced holding” of securities, the claims were not preempted. Id., at 1507-08. Dabit therefore amended his complaint to exclude any reference to “purchases,” and to advance claims only on behalf of those brokers who “owned and continued to own” the securities at issue. Id., at 1508.

After the Judicial Panel on Multidistrict Litigation transferred the dozens of similar lawsuits against Merrill Lynch to the United States District Court for the Southern District of New York, Merrill Lynch again moved to dismiss Dabit’s complaint. The motion was granted, but the Second Circuit reversed. According to the Circuit Court, claims asserted on behalf of securities holders do not allege fraud “in connection with the purchase or sale” of securities under SLUSA. As the Supreme Court explained at page 1508,

Under the Second Circuit’s analysis, fraud is only “in connection with the purchase or sale” of securities, as used in SLUSA, if it is alleged by a purchaser or seller of securities. Thus, to the extent that the complaint in this action alleged that brokers were fraudulently induced, not to sell or purchase, but to retain or delay selling their securities, it fell outside SLUSA’s pre-emptive scope.

(The Second Circuit also held that Dabit’s “lost commission” claims were not preempted by SLUSA, but that aspect of the opinion was not before the Supreme Court. Merrill Lynch v. Dabit, at 1508 n.3.)

Dabit’s argued, and the Second Circuit agreed, that SLUSA affected preempted only “purchaser-seller” transactions, and that such a conclusion was compelled by the Supreme Court’s decision in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). In rejecting this argument, the Supreme Court explained that “Blue Chip Stamps relied chiefly, and candidly, on ‘policy considerations,’” and “purported to define the scope of a private right of action under Rule 10b-5-not to define the words ‘in connection with the purchase or sale.’” Merrill Lynch v. Dabit, at 1512 (citations omitted).

The Supreme Court also admitted, again candidly, that a narrow statutory construction of Rule 10b-5 “would not, as a matter of first impression, have been unreasonable,” but such a narrow reading was not given by the Court. Rather,

Under our precedents, it is enough that the fraud alleged “coincide” with a securities transaction-whether by the plaintiff or by someone else. . . . The requisite showing, in other words, is “deception ‘in connection with the purchase or sale of any security,’ not deception of an identifiable purchaser or seller.” . . . Notably, this broader interpretation of the statutory language comports with the longstanding views of the SEC. . . .

Merrill Lynch v. Dabit, at 1513 (citations omitted). From there, the Supreme Court opined that Congress was aware of the “broad construction” adopted by the Supreme Court in Rule 10b-5 cases, and presumably intended to graft a similarly broad construction onto SLUSA. Id.

The High Court found support for its construction in the purpose of SLUSA, as well:

A narrow reading of the statute would undercut the effectiveness of the 1995 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. SLUSA § 2(5), 112 Stat. 3227. As the Blue Chip Stamps Court observed, 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. . . .

126 S.Ct. at 1513-14 (italics added) (citations omitted).

In vacating the judgment of the Second Circuit, the Supreme Court concluded:

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 . . . .

Merrill Lynch v. Dabit, at 1515 (italics added) (citations omitted).

This recent opinion by the United States Supreme Court should prove useful to class action defendants, and will hopefully assist in stemming the tide of abusive lawsuits.