On December 1, 2015, the Supreme Court heard argument in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning. In that case, the Court will resolve the split in the Circuits as to whether Section 27 of the Securities Exchange Act of 1934 ("the '34 Act") provides federal jurisdiction over claims that are asserted under state law but are based on violations of regulations adopted under the '34 Act.
Section 27 of the '34 Act states that federal courts "shall have exclusive jurisdiction of violations of [the '34 Act] . . . and of all suits . . . brought to enforce any liability or duty created by [the '34 Act]." In Manning, the Third Circuit found no federal question jurisdiction over the plaintiffs' suit and held the case should proceed in state court. The Second Circuit had previously adopted that view, while the Fifth and Ninth Circuits have held that Section 27 provides exclusive federal jurisdiction over this kind of case.
Plaintiffs in Manning alleged that defendants engaged in "naked short selling" of a specific stock, which caused plaintiffs' shares to decline in value. The claims were based on state law, but the operative complaint repeatedly cited the SEC's Regulation SHO, adopted in 2004 pursuant to the authority granted to the SEC by the '34 Act. Merrill Lynch removed the case to federal court, arguing that it is subject to exclusive federal jurisdiction under Section 27.
Neither party disputed that the complaint included violations of federal law. Plaintiffs argued that the violations of federal law were not elements of their claims, but rather were merely part of a larger manipulative scheme that violated state anti-fraud provisions. Plaintiffs therefore sought to have the case heard in state court, arguing that all of the causes of action were created by New Jersey law and not predicated on violations of federal law. The Third Circuit agreed.
At last week's oral argument, Respondents (Manning and others) argued that none of their causes of action sought to enforce any liability or duty created by the '34 Act because they were all claims created by New Jersey law, and sought recoveries specified by New Jersey law. They also argued that the complaint was not dependent on showing that Petitioner violated federal regulations, although the complaint did allege that such violations had occurred. Petitioner argued that the complaint was "artful[ly]" pleaded to try to keep the case out of federal court. Petitioner further argued that the plain meaning of Section 27 grants exclusive jurisdiction to the federal courts so that the federal securities laws could be uniformly interpreted and applied and such "artful pleading" should not defeat that purpose.
Respondents' original complaint cited Regulation SHO and asserted that defendants' actions violated that regulation. At oral argument counsel argued that Respondents' claims were based on market manipulation, for which Regulation SHO set a "floor" but for which they would need to show additional facts to prove their state law claims.
At argument, Justice Scalia expressed concern that the petitioner's approach would impose "quite an onerous task" on federal judges to "sift through the complaint to see if any of the claimed causes of action under State law mirror a cause of action that happens to exist under Federal law, without even the hint that they mention the Federal statute." Justice Ginsburg noted that there are "many instances in which there is a State claim, say a State claim for negligence, and the negligent conduct is alleged to be a violation of a Federal safety standard . . . You wouldn't say that that is a claim that has to be brought in Federal court."
The SEC's absence from the case also interested the Court. If the SEC and the federal government understood Section 27 to bar state actions under this kind of circumstances, Justice Breyer noted that they would be expected to intervene. Justice Breyer stated that if Congress had intended these kinds of cases to be heard only in federal court, the SEC's absence was "curious."
If the tone of the Court during argument accurately predicts the outcome of the case, a decision affirming the Third Circuit and allowing the case to proceed in state court is likely. Such a decision will mark a departure from a recent string of Supreme Court decisions that have been largely friendly toward defendants and hostile to plaintiffs and securities class actions.
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