The Supreme Court of the United States recently evaluated the scope of jurisdiction granted to federal courts under Section 27 of the Securities Exchange Act (the “Exchange Act”). Section 27 provides district courts with exclusive jurisdiction of "all suits in equity and actions at law brought to enforce any liability or duty created by [the Exchange Act] or the rules and regulations thereunder." 15 U. S. C. §78aa(a). Similarly, Section 1331 provides district courts with jurisdiction over "all civil actions arising under" federal law. 28 U.S.C. §1331. In Merrill Lynch, Pierce, Fenner & Smith Inc., et al. v. Greg Manning, et al., the Supreme Court rejected Petitioners’ argument that any suit expressly or implicitly alleging a breach of duty under the Securities Act is “brought to enforce” that duty. See 2016 U.S. LEXIS 3049, at *11. The Supreme Court also rejected Respondents’ argument that a claim is “brought to enforce” an Exchange Act duty only if brought directly under the Exchange Act. Id. at *14. The Supreme Court, in viewing these opposing views as extreme, held that questions of federal jurisdiction under Section 27 must be evaluated pursuant to the “arising under” test for general federal jurisdiction under 28 U.S.C. §1331. See 2016 U.S. LEXIS 3049, at *5, 16.

Facts and Procedural Posture. Greg Manning and others (collectively as “Manning” or “Respondents”) held shares in Escala Group. Id. at *6 Manning claimed that Merrill Lynch and others (collectively as “Merrill Lynch” or Petitioners”) drove down the share price through “naked” short sales of the Escala stock. Id. The Securities and Exchange Commission promulgated Regulation SHO to prevent the market manipulation that may ensue from “naked” short selling of securities. Id. at **6-7. Manning brought claims against the petitioners under various New Jersey statutory provisions and common law theories for relief. Id. at *7. Although Manning brought no federal claims, he expressly referred to Regulation SHO and implied that Merrill Lynch violated the same. Id.

Manning commenced his action in New Jersey state court. Id. at *8. Petitioners later removed it to the federal district court arguing (1) the alleged violation satisfied the “arising under” standard of §1331 and (2) Section 27 was triggered because Manning’s suit was “brought to enforce” the Exchange Act. Id. Manning sought to remand the case back to state court arguing his claims were brought under state law and not implicated by either federal statute. Id. The district court denied his motion. Id. The Court of Appeals for the Third Circuit reversed the district court ruling and remanded the case back to state court. Id. at *9. The Third Circuit first determined that Section 1331 did not grant federal jurisdiction to Merrill Lynch because Manning’s claims were “brought under state law” and did not “necessarily raise[]” a federal issue. Id. The Third Circuit next decided that it lacked jurisdiction under Section 27 relying upon Pan American Petroleum Corp. v. Superior Court of Del. for New Castle Cty., 366 U. S. 656 (1961). See 2016 U.S. LEXIS 3049, at *9. There, the Supreme Court analyzed the same “brought to enforce” language under the Natural Gas Act (“NGA”) and determined there was no distinction between an action “brought to enforce” a duty created by federal law or a claim “arising under” federal law. Id. at *21 (citation omitted).

The Supreme Court’s Decision In Merrill Lynch. The Supreme Court’s review was limited to whether Section 27 required this matter to be heard in federal court. It did not. Section 27’s language is not so expansive as to require that any alleged violation of the Exchange Act be brought in federal court. Id. at *12-13. The Supreme Court reasoned that “§27 confers federal jurisdiction when an action is commenced in order to give effect to an Exchange Act requirement. That language, in emphasizing what the suit is designed to accomplish, stops short of embracing any complaint that happens to mention a duty established by the Exchange Act.” Id. The Court noted that granting federal jurisdiction would be superfluous if the suit could be decided upon state law issues without even reaching a federal question. Id. at *13. The Court also reasoned that Section 27 does not take on a narrow construction whereby parties must bring claims directly under Section 27 to trigger its “brought to enforce” language. Id. at **13-14. Such a restrictive reading would preclude federal courts from adjudicating claims actually hinging upon a federal issue, but brought under the guise of state law. Id. at **14-15. The Supreme Court adopted a balanced approach to these two competing views and decided the jurisdictional test under §1331 is best suited for actions brought directly under Section 27 and state law claims “brought to enforce” a federal duty. Id. at *15. Federal courts have jurisdiction to decide controversies predicated upon a federal question. Id. Federal courts may also exercise jurisdiction over a state court matter if it “necessarily raise[s] a stated federal issue, actually disputed and substantial, which a federal forum may entertain without disturbing any congressionally approved balance” of federal and state power. Id. at *16 (quoting Grable & Sons Metal Products, Inc. v. Darue Engineering & Mfg., 545 U. S. 308, 314 (2005)).

The Supreme Court’s previous interpretations of Section 27’s “brought to enforce” language run parallel with the jurisdictional analysis under §1331. See, e.g., Pan American Petroleum Corp. v. Superior Court of Del. for New Castle Cty., 366 U. S. 656 (1961); Matsushita Elec. Industrial Co. v. Epstein, 516 U. S. 367 (1996). In Pan American, the Court evaluated the grant of federal jurisdiction under Section 22 under the NGA, a provision similar to Section 27 of the Exchange Act. See 2016 U.S. LEXIS 3049, at *20 (citation omitted). Section 22 also enables federal jurisdiction when a claimant commences a suit “brought to enforce” a provision under the NGA. Id. The Supreme Court there established “that an action ‘brought to enforce’ a duty or liability created by a federal statute is nothing more (and nothing less) than an action ‘arising under’ that law.” Id. at *22.

In Matsushita, the Court determined whether the “state court…could approve a settlement releasing…potential Exchange Act claims that Section 27 would have committed to federal court.” Id. at *23 (citation omitted). The Supreme Court permitted the state court to do so and interpreted Section 27 on three occasions as granting exclusive federal jurisdiction of suits "arising under" the Exchange Act. Id. at **23-24.

The Supreme Court emphasized its reluctance to interpret jurisdictional statutes broadly because doing so may encroach upon the states’ right “to provide for the determination of controversies in their courts.” Id. at **25-26 (quoting Romero v. International Terminal Operating Co., 358 U. S. 354, 380 (1959). Construing Section 27 under the §1331 jurisdictional construct thus promotes the balance of power between state and federal governments. See 2016 U.S. LEXIS 3049, at *25.

Conclusion. The Supreme Court’s decision effectively defined the jurisdictional boundaries of Section 27. Exclusive jurisdiction under Section 27 applies only when the case “arises under” the Exchange Act, consistent with Section 1331. Thus, for cases to be determined in federal court, an action must present a cognizable federal issue requiring resolution. This ruling is consistent with two Supreme Court cases and advances federal policy of respecting “the independence of state governments”. See Romero, at 358 U. S. at 380. Further, even if a federal issue is raised, state courts will likely retain jurisdiction over a case if resolving the federal issue is unnecessary. For instance, in a hypothetical breach of contract dispute, the Supreme Court noted that a “plaintiff can get all the relief he seeks just by showing [a] breach of an agreement, without proving any violation of federal securities law.” See 2016 U.S. LEXIS 3049, at *13. Merrill Lynch thus demonstrates the limits to Section 27's grant of exclusive federal court jurisdiction. Merely alleging a violation of an SEC regulation is not enough to get a case involving a securities dispute removed to federal court. Only where the “state-law cause of action is ‘brought to enforce' a duty created by the Exchange Act because the claim's very success depends on giving effect to a federal requirement[,]” id. at *16, will the test for exclusive jurisdiction under Section 27 be met.