This week, the Supreme Court issued a unanimous decision resolving a circuit split as to whether Section 27 of the Exchange Act provides exclusive federal jurisdiction over claims that, although asserted under state law, allege underlying conduct that would also have violated regulations adopted under the Exchange Act. In Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, No. 14-1132 (May 16, 2016), the Court held that it does not. Because the jurisdictional test established by Section 27 should be understood to cover “the same class of cases as ‘arise under’ the Exchange Act for purposes of [28 U.S.C.] §1331” (the general federal question statute), the Court held that the claim had to affirmatively seek relief under federal law, and not merely track federal law with a parallel state law claim, for federal court jurisdiction to come into play.

While many commentators jumped to the conclusion that this decision will be a boon to the plaintiffs’ bar, it actually resolves a narrow procedural issue and likely will have relatively limited impact. Most importantly, it will have no application in the vast majority of securities cases, which are brought as class actions (unlike the Manning case), because typical class actions still must be brought in federal court pursuant to the Securities Litigation Uniform Standards Act of 1998 (SLUSA).

Background

The Exchange Act regulations at issue in Manning (Regulation SHO) prohibit short sellers from (among other things) intentionally failing to deliver securities. See 17 CFR §§ 242.203–242.204 (2015). The litigation arose from allegations by particular former shareholders of Escala Group, Inc., who claimed that several financial institutions devalued Escala Group through “naked” short sales of its stock. The complaint referred explicitly to Regulation SHO, cited instances where the defendants had supposedly violated it previously, and “couched its description of the short selling at issue ... in terms suggesting that [defendants] had again violated that regulation, in addition to infringing New Jersey law.” However, all of legal claims asserted arose under New Jersey state law, not federal law.

The defendants predicated removal to federal court on two grounds:

  1. The general federal question statute, 28 U.S.C. § 1331, which grants district courts jurisdiction of “all civil actions arising under” federal law;
  2. Section 27 of the Exchange Act, which, in relevant part, grants district courts exclusive jurisdiction over “all suits in equity and actions at law brought to enforce any liability or duty created by [the Exchange Act] or the rules or regulations thereunder.”

In its decision, the Supreme Court agreed with the Third Circuit that the case should be remanded to state court. The Court held that the jurisdictional test established by Section 27 should be understood to cover the same class of cases as those covered by the general federal question statute, thereby rejecting the defendants’ argument that the language in Section 27 should be read more broadly. The Court “[took] as a given” the Third Circuit’s additional holding that Section 1331 was not a proper basis for removal, as the defendants had not sought Supreme Court review on that issue.

In support of its decision, the Court explained that its “construction fits with [the Court’s] practice of reading jurisdictional laws, so long as consistent with their language, to respect the traditional role of state courts in our federal system and to establish clear and administrable rules.” The Court consequently rejected the alternative approaches of the Second Circuit (which had construed Section 27 more narrowly1) and of the Fifth and Ninth Circuits (which had construed Section 27 more broadly2).

Potential Impact

The vast majority of securities cases are brought as class actions and are removable to federal court pursuant to SLUSA (assuming that they are “covered class actions” under that statute). As Justice Alito recognized at oral argument, in light of SLUSA, the Manning case is only relevant in the context of individual actions and claims by small groups of investors.

Moreover, even in those limited contexts, to avoid removal to federal court, plaintiffs must establish that their claims do not “arise under” federal law pursuant to Section 1331. The Court offered no new guidance as to the contours of that jurisdictional test, but rather accepted “as a given” the Third Circuit’s determination in that regard (because the defendants had not challenged that portion of the ruling). However, it is well-established that a claim pursuant to a state statute does not necessarily “arise under” an analogous federal statute just because the former statute parrots the language of the latter one; in contexts where SLUSA or similar statutes do not apply, a plaintiff may choose to sue pursuant to the state statute rather than its federal analogue. That risk is inherent in the independent sovereignty of state law.

Indeed, it was only the plaintiffs’ gratuitous references to federal regulations in their complaint that raised the issue in the first place of whether the lawsuit belonged in federal court under Section 27. Consequently, whatever decision the Court would have reached, a future plaintiff could have avoided the issue simply by “purg[ing] his complaint of any references to federal securities law” and “mak[ing] the complaint less informative” (as the Court recognized), which is a further reason why the impact of this decision should be relatively limited.