When I merrily undertook to write a blurb on today’s Supreme Court opinion in Merrill Lynch v. Dabit (547 U.S. ___ (2006)), I had only read the opinion once. What I failed to realize was that the opinion would become more complex with each thoughtful read, such that I would ultimately end up in my office at 11:58 on a Tuesday night trying to write a blurb about a case with a holding not necessarily about holding that can honestly be summarized in about 19 words. But let us set that aside for a moment in favor of a short summary of Merrill Lynch v. Dabit ...

Shadi Dabit was a former Merrill Lynch broker. He sued Merrill Lynch on behalf of himself and all other former or current brokers who purchased certain securities in 1999 and 2000 (while employed by Merrill) on the fraudulent recommendations of Merrill Lynch’s investment banking research analysts. Dabit maintained that the Merrill Lynch analysts, under the direction of Merrill’s management, issued overly optimistic analyst reports on certain stocks to enhance the prices of these stocks, which were issued by favored or potential investment banking clients. Dabit maintained that he and other Merrill brokers relied on the analysts’ fraudulent reports in buying and holding stocks that were not actually of the financial quality represented by the analysts. As a result, Dabit’s clients lost money when the true financial worth of the stocks hit the market, and Dabit lost business commissions when those clients terminated their relationships with him. Dabit sued Merrill Lynch, alleging that Merrill breached the fiduciary duty and covenant of good faith and fair dealing owed to its brokers by disseminating misleading research and manipulating stock prices thereby. Dabit sued only on state law claims.

District Court and Second Circuit Opinions

The late Judge Milton Pollack in the Southern District of New York dismissed Dabit’s class action lawsuit in a brief, unpublished opinion, based on the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). SLUSA provides that no “covered class action” based on state law and alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security” can be maintained in any state or federal court by any private party. Apparently Judge Pollack viewed Dabit’s state law fiduciary duty and contract claims as federal securities fraud claims in state law sheep’s clothing. On appeal, the Second Circuit Court of Appeals gave us an interesting 26 page opinion, authored by Judge Sonia Sotomayor (who was joined on the panel by Judge Wesley and Judge Oakes (remember that Oakes penned the plurality opinion in AUSA Life Insurance Co. v. Ernst & Young, 206 F.3d 202 (2000), in which he dealt interestingly with loss causation in the state and federal securities laws context)), that basically said that if a plaintiff was bringing only a state-law-based claim that did not involve the plaintiff as a purchaser or seller within the reach of the language of Section 10(b), the claim would not be pre-empted by SLUSA. If, for example, plaintiff Dabit could show that he lost commissions due to his employer’s actions *and* he could show such without including allegations that would support a securities fraud claim, his state law claims would not be pre-empted.

Today’s Supreme Court Opinion

On appeal, the Supreme Court vacated and remanded. The Court begins its seventeen page opinion as follows:

In this case the Second Circuit held that SLUSA only pre-empts state-law class-action claims brought by plaintiffs who have a private remedy under federal law. . . . A few months later, the Seventh Circuit ruled to the contrary, holding that the statute also pre-empts state-law class-action claims for which federal law provides no private remedy. . . . The background, the text, and the purpose of SLUSA’s pre-emption provision all support the broader interpretation adopted by the Seventh Circuit.

Merrill Lynch v. Dabit, 547 U.S. __ (2006), slip op. at 1 (Mar. 21, 2006).

The Supreme Court concludes that “SLUSA pre-empts state-law holder class-action claims of the kind alleged in Dabit’s complaint.” Slip op. at 14.

Three things can be gleaned from today’s Supreme Court opinion in Merrill Lynch v. Dabit:

1. SLUSA pre-empts any state-law class-action claim that either alleges “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security” or alleges “that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.”

2. The Supreme Court’s decision in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), was a standing decision as opposed to a decision defining Rule 10b-5’s “in connection with the purchase or sale of a security” language. Slip op. at 11-12.

3. The Supreme Court sanctions a very broad reading of the Rule’s “in connection with” language:

[W] hen this Court has sought to give meaning to the phrase in the context of § 10(b) and Rule 10b-5, it has espoused a broad interpretation. . . . [O]ne might have concluded that an alleged fraud is ‘in connection with’ a purchase or sale of securities only when the plaintiff himself was defrauded into purchasing or selling particular securities. . . . But this Court . . . has rejected that view. Under our precedents, it is enough that the fraud alleged ‘coincide’ with a securities transaction—whether by the plaintiff or by someone else. The requisite showing, in other words, is “deception ‘in connection with the purchase or sale of any security,’ not deception of an identifiable purchaser or seller.”

Slip op. at 12-13 (internal citations omitted).

These Things Give Me Pause

1. The Court observes that “respondent and his amici have identified only one pre-SLUSA case involving a state-law class action asserting holder claims.” But I have some vague recollection of the notion that litigation classes should have common issues of law and fact. If we are trying to chase securities fraud using a class action, isn’t it going to be easier to just use a common federal statute (ala Section 10(b)) as opposed to using the parallel state law (which we then need to justify under our class certification rules)) which also fits within some state’s (not sure whose) choice-of-law paradigm? My sense is that the Supreme Court’s observation of what respondent did not find in terms of state law class actions is more related to the fact that it is *easier* to certify a class and litigate for a class on a common federal statute (ala Section 10(b)) as opposed to a state law claim. Perhaps my procedure brethren will tell me if I am missing something or if Justice Stevens is the one missing something with the above language that he penned.

2. With one fell swoop, the Supreme Court wipes out the practical value of many state blue sky laws and general consumer fraud laws and such. I understand and agree with the “occupying the field” argument in principle, but, geesh, today is a very different consumer fraud litigation day than was yesterday! If I am understanding correctly, the Supreme Court is now telling me that if the state of Nowicki wanted to adopt a Lying to Retail Customers’ Faces En Masse Act that penalized any retail salesperson (which would include brokers) who blatantly lied, face to face, to a class of retail customers (about an age-spot eradication cream, for example, ala the Carter-Wallace case) by (a) forbidding them from working in retail sales for two years and (b) making them pay treble damages to the victims, the state legislature of Nowicki could not adopt a class-action provision within that act.

3. The Supreme Court tells us that SLUSA “does not deny any individual plaintiff, or indeed any group of fewer than 50 plaintiffs, the right to enforce any state-law cause of action that may exist.” Slip op. at 15. I see that as an invitation for the smart plaintiffs’ lawyers to pull 10 or so of the “best” plaintiffs into one state-law-based suit in order to stay outside of SLUSA’s class action reach. Phrased differently, is there going to be an end-run around this opinion by plaintiffs’ lawyers taking the 10 biggest claims they can find and mashing them into one non-class action? If so, it seems to me that the small investor – with the $22,000 claim as opposed to the $400,000 claim – is going to get left out in the cold. . . unless the federal district courts recognize that class action holder claims can be brought under Section 10(b) because Blue Chip Stamps technically does not preclude them. . . . And this is where things get fuzzy. . . .

This Much I Do Not Know

I cannot tell you definitively what today’s Merrill Lynch opinion does or does not do (or clarifies or does not clarify) with respect to Blue Chip Stamps and holders. Allow me to explain:

The Blue Chip Stamps case involved plaintiffs who were offered the chance to buy securities as part of an antitrust settlement. The plaintiffs were fraudulently induced to pass up the chance to buy these securities as part of the settlement, such that the Blue Chip plaintiffs were never investors in the securities at issue (never bought, never sold). The plaintiffs brought suit when it became clear that they were defrauded into not purchasing the securities they were entitled to buy under the antitrust settlement. For policy reasons, the Supreme Court in Blue Chip held that the plaintiffs - “potential purchasers of shares” – did not have standing to bring suit under Section 10(b) of the Securities Exchange Act of 1934. If those plaintiffs were afforded standing, the Supreme Court feared that they would be opening the barn door to frivolous litigation by people who might have bought or sold stock absent the fraud but who never actually did either (they never ultimately took action).

Up until today, I have maintained that the Blue Chip Stamps logic does not extend to fraudulently-induced “holders” who ultimately had to sell into a bottomed-out market. The Supreme Court was not trying to address those plaintiffs in the Blue Chip Stamps opinion, and the below language from the Blue Chip opinion bolstered my view:

When Congress wished to provide a remedy to those who neither purchase nor sell securities, it had little trouble in doing so expressly. . . . While the damages suffered by purchasers and sellers pursuing a s 10(b) cause of action may on occasion be difficult to ascertain, in the main such purchasers and sellers at least seek to base recovery on a demonstrable number of shares traded. In contrast, a putative plaintiff, who neither purchases nor sells securities but sues instead for intangible economic injury such as loss of a noncontractual opportunity to buy or sell, is more likely to be seeking a largely conjectural and speculative recovery in which the number of shares involved will depend on the plaintiff's subjective hypothesis.

421 U.S. 723, at 734-735.

(In the above language, the Court uses conjunctive language (“neither. . . nor”), which I take to exclude those who hold and then later sell in a depressed market. In addition, the damages concern articulated in the lower half of the above-quoted seems irrelevant with respect to a holder who can show that he had 18 shares of Widget Corp. that he called his broker (on his cell phone, so there are records) to sell, and the broker said “no, you should hold. Jack Grubman says this stock is going to $200!!!”)

But the way the Court in today’s Merrill Lynch opinion refers to its Blue Chip opinion gives me pause. For example, on page 16 of today’s slip op., the Court says “[t]he holder class action that respondent tried to plead. . . is distinguishable from a typical Rule 10b-5 class action in only one respect: It is brought by holders instead of purchasers or sellers.” Slip op. at 16. Also,

Respondent does not dispute that both the class and the securities at issue in this case are ‘covered’ within the meaning of the statute, or that the complaint alleges misrepresentation and omissions of material facts. The only disputed issue is whether the alleged wrongdoing was “in connection with the purchase or sale” of securities. Respondent urges that the operative language must be read narrowly to encompass (and therefore pre-empt) only those actions in which the purchaser-seller requirement of Blue Chip Stamps is met. . . . But insofar as the argument assumes that the rule adopted in Blue Chip Stamps stems from the text of Rule 10b-5 – specifically, the “in connection with” language, it must be rejected. Unlike the Birnbaum court which relied on Rule 10b-5’s text in crafting its purchaser-seller limitation, this Court in Blue Chip Stamps relied chiefly, and candidly, on “policy considerations” in adopting that limitation.

Slip op. at 11-12.

Was the Supreme Court essentially acknowledging in today’s Merrill Lynch opinion that the holding from Blue Chip Stamps absolutely does translate in the negative to the holder-ultimately-seller context? Must I completely abandon my long-held minority belief about what Blue Chip Stamps narrowly stands for? I do not know – I think I need to read today’s Merrill Lynch opinion another few times. In the meanwhile, at least I am giving you something to chew on.

(Let me say for the record, however, that my reading of the language in Blue Chip Stamps is a sensible one, hinging on reasonable matters of proof, as opposed to needlessly broad concerns about bootless litigation. So even if I am forced to let it go, I might well be tempted to maintain that I was right about how holders should be treated under Section 10(b) and the Supreme Court was and is wrong. See Elizabeth A. Nowicki, A Response to Professor John Coffee: Analyst Liability Under Section 10(b) of the Securities Exchange Act of 1934, 72 Cin. L. Rev. 1305 (2004).)

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