U.S. Supreme Court Holds That Test for Whether Federal Courts Have Exclusive Jurisdiction Over Securities Exchange Act Claims Is Whether Suits “Arise Under” the Act
The Supreme Court held yesterday in Merrill Lynch v. Manning that the exclusive-jurisdiction provision of the Securities Exchange Act is governed by the same “arising-under” test used to determine the existence of federal-question jurisdiction.1 In other words, if a case arises under the Exchange Act for federal-question purposes, then the Exchange Act requires that the case be brought in federal court. The Exchange Act thus vests federal district courts with exclusive jurisdiction when the plaintiff pleads (i) a cause of action under the Act or an implementing regulation or (ii) a state-law claim that necessarily raises a disputed and substantial issue of the Act’s meaning. In Manning itself, the complaint pleaded solely state-law causes of action but referred to a breach of the Exchange Act or its implementing regulations. In that circumstance, the Court concluded, removal is appropriate only if resolving the statelaw claims requires addressing the meaning of the Exchange Act or its regulations.
Shareholders in Escala Group, Inc. sued Merrill Lynch, Pierce, Fenner & Smith Inc. and several other financial institutions engaged in equity trading. They alleged that the defendants had depressed the price of Escala stock through “naked” short selling, which is a sale of stock that the seller neither owns nor intends to borrow. Although the plaintiffs’ amended complaint alleged only New Jersey state-law causes of action, it repeatedly referenced the requirements of federal Regulation SHO, 17 C.F.R. § 242.200 et seq., which prohibits short-sellers from intentionally failing to deliver securities. There is no analogous provision in New Jersey law.
Defendants removed the case to the District of New Jersey. In addition to invoking the general federal-question statute, 28 U.S.C. § 1331, they invoked Section 27 of the Exchange Act, which grants district courts 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.”2 Defendants contended that plaintiffs’ suit was “brought to enforce” a “liability or duty” created by Regulation SHO.
The district court denied plaintiffs’ motion to remand the case to state court, but the Third Circuit reversed. The court of appeals held that there was no federal-question jurisdiction “[b]ecause the success of [p]laintiffs’ state-law causes of action does not ‘necessarily’ depend upon the contents of federal law.”3 In the court’s view, the Exchange Act’s exclusive-jurisdiction provision added nothing, because “such provisions cannot independently generate jurisdiction.”4 The Third Circuit’s ruling contributed to a circuit split over the meaning of Section 27 of the Exchange Act, and the Supreme Court granted review.
THE SUPREME COURT’S DECISION
In an 8-0 decision authored by Justice Kagan, the Supreme Court affirmed. It held that the scope of the Exchange Act’s exclusive-jurisdiction provision is governed by the same test that governs the scope of federal-question jurisdiction under Section 1331. The Exchange Act thus vests federal district courts with exclusive jurisdiction in two circumstances: (i) when the Act or an implementing regulation “creates the cause of action asserted” and (ii) when a state-law claim “necessarily raise[s]” an issue of the Act’s meaning that is “disputed and substantial” and that “a federal forum may entertain without disturbing any congressionally approved balance of federal and state power.”5
In so holding, the Court declined to adopt either party’s proposed reading. Merrill Lynch had argued that Section 27 is triggered whenever a complaint either explicitly or implicitly asserts that the defendant breached an Exchange Act duty.6 Manning, in contrast, had contended that Section 27 applies only when the Exchange Act or an implementing regulation itself creates the plaintiff’s cause of action.7 The Court rejected both approaches as inconsistent with the statutory text, prior precedent, and public policy—all of which, in the Court’s view, pointed toward using the familiar “arising-under” test as an administrable standard for Section 27.
Justice Thomas, joined by Justice Sotomayor, concurred only in the judgment. In Justice Thomas’s view, the arising-under standard lacks any basis in Section 27’s text, which instead “establishes a straightforward test: If a complaint alleges a claim that necessarily depends on a breach of a requirement created by the Act, [Section] 27 confers exclusive federal jurisdiction over that suit.”8 Justice Thomas concluded, however, that Manning’s suit did not necessarily depend on a breach of Regulation SHO.
The Court’s decision resolves the circuit split over the proper interpretation of Section 27, and it does so by adopting a narrower interpretation of Section 27 than had prevailed in the Fifth and Ninth Circuits. In those circuits, the Court’s decision will make it more difficult for defendants to remove to federal court cases in which the plaintiff nominally alleges only state-law claims, even if those claims appear to rest on breaches of the Exchange Act or its implementing regulations. Removal will be proper only when the plaintiff’s state-law claims require resolving the meaning of the Exchange Act or associated regulations. The Court’s decision also may have ramifications for the nine other federal statutes—including the Securities Act of 1933, 15 U.S.C. § 77v(a), and the Investment Company Act of 1940, 15 U.S.C. § 80a- 43—that use the same language as Section 27.9