In a recent case arising from the Facebook IPO, NASDAQ OMX Group v. UBS Securities, LLC, No. 13-Civ. 2657 (2d Cir. October 31, 2014), the Second Circuit determined that the federal courts had jurisdiction to enjoin an arbitration against NASDAQ, finding that the case implicated important federal issues regarding the regulation of an orderly securities market, even though the underlying claims were based solely upon state law. In a strong dissent, Judge Chester J. Straub argued that majority decision extended federal court jurisdiction “far beyond its permissible bounds,” and that the decision would likely lead to an unwarranted increase in federal litigation.
Claimant, a market maker trading Facebook securities, had commenced arbitration against NASDAQ relying on an arbitration provision in the parties’ services agreement, alleging that NASDAQ had failed to fulfill its obligations in connection with the Facebook IPO. Claimant asserted claims under New York state law for breach of contract, indemnification, breach of implied duties of good faith and fair dealing and gross negligence. In response, NASDAQ commenced a declaratory judgment action in federal court and obtained a preliminary injunction enjoining the arbitration on the ground that the claims were not within the scope of the arbitration clause. Appeal to the Second Circuit ensued.
As a jurisdictional matter, the Court was required to determine whether the claims at issue were among the “special and small” category of state law claims which give rise to federal jurisdiction under the standards articulated by the Supreme Court in Gunn v. Minton, 133 S. Ct. 1059 (2013). In that case, the Supreme Court set forth a four-part test, where federal jurisdiction over a state law claim is present if a federal issue is:
- necessarily raised;
- actually litigated;
- substantial; and
- capable of resolution in a federal court without disrupting the federal-state balance.
In a majority decision by Judge Reena Raggi, the Court concluded that all four of the Gunn factors were present. Although the claims for relief invoked state law of contract and torts, the Court found that the underlying basis for all the claims was NASDAQ’s obligation under the federal securities laws to provide for a fair and orderly securities market. The question of whether NASDAQ met its obligation under the federal securities laws was necessarily raised by the claims, according to the Court, and those federal issues would be actually litigated in the arbitration. The Second Circuit also determined that the federal issues were substantial and resolution of those issues in federal court would not disrupt the federal-state balance envisioned by Congress.
The Court next concluded that the issue of whether the parties were required to arbitrate should be decided by the court, not the arbitrator, because the arbitration provision did not “clearly and unmistakably” refer the question of arbitrability to the arbitrator. Finally, the Court determined that the claims asserted in the arbitration were not within the scope of the arbitration provision and affirmed the decision of the district court.
In his dissent, Judge Straub disagreed with the majority’s finding of federal jurisdiction. The dissent argued that the issues to be litigated concerned application of NASDAQ rules – and not application of the Exchange Act itself – to the Facebook IPO. According to the dissent, the NASDAQ rules are contractual in nature and the dispute regarding the application of those rules did not involve substantial issues of federal law under controlling precedent.
The dissent also expressed substantial concern that the majority’s reasoning would give rise to additional litigation in federal court. At this time, the extent to which the Second Circuit’s decision may give rise to federal jurisdiction over other state law claims that may be asserted in other matters, whether by private plaintiffs or state regulators, remains open.