Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit

PETITIONER:Merrill Lynch, Pierce, Fenner & Smith, Inc.
LOCATION:U.S. Court of Appeals for the Ninth Circuit

DOCKET NO.: 04-1371
DECIDED BY: Roberts Court (2006-2009)
LOWER COURT: United States Court of Appeals for the Second Circuit

CITATION: 547 US 71 (2006)
GRANTED: Sep 27, 2005
ARGUED: Jan 18, 2006
DECIDED: Mar 21, 2006

David C. Frederick – argued the cause for Respondent
Jay B. Kasner – argued the cause for Petitioner
Thomas G. Hungar – argued the cause for Petitioner

Facts of the case

Shadi Dabit, formerly a stockbroker at Merrill Lynch, brought a class action suit against his former employer alleging that the company had defrauded brokers by deceptively inflating stock prices, causing the brokers to hold onto stocks they would otherwise have sold. Dabit’s class action was filed in the U.S. District Court based on federal diversity jurisdiction, but was based on Oklahoma state law.

In response to perceived abuses of the class-action vehicle in securities litigation, Congress had passed the Private Securities Litigation Reform Act of 1995, which placed restrictions on federal securities fraud class actions. When plaintiffs began avoiding the law by bringing the suits in state courts instead of federal courts, Congress passed the Securities Litigation Uniform Standards Act of 1998 (SLUSA), which pre-empts federal class action securities fraud claims brought under state law that allege misrepresentation “in connection with the purchase or sale of a covered security.”

Merrill Lynch argued that Dabit’s suit was pre-empted by SLUSA and therefore could not be brought under state law. Dabit countered that the suit alleged misrepresentation concerning only the holding of stocks, and therefore was beyond the scope of SLUSA. The District Court for the Southern District of New York ruled for Merrill Lynch, finding the language of SLUSA broad enough to include suits such as Dabit’s. The Second Circuit Court of Appeals reversed, holding that suits by holders of stocks are distinct from suits by sellers and purchasers and that SLUSA was meant to pre-empt only the latter.


Are class action securities fraud suits brought under state law pre-empted by the Securities Litigation Uniform Standards Act of 1998 if the suits allege that misleading statements or omissions induced brokers to hold, not sell or purchase, securities?

Media for Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit

Audio Transcription for Oral Argument – January 18, 2006 in Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit

Audio Transcription for Opinion Announcement – March 21, 2006 in Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit

John G. Roberts, Jr.:

Justice Stevens has the opinion in 04-1371, Merrill Lynch, Pierce, Fenner & Smith versus Dabit.

John Paul Stevens:

This case comes to us on a writ of certiorari to the Court of Appeals for the 2nd Circuit.

We granted review to resolve a conflict between the 2nd and 7th Circuits over the extent to which the Securities Litigation Uniform Standards Act of 1998 preempts plaintiffs from bringing certain class actions under state law.

The respondent in this case is a former Merrill Lynch broker who brought a class action under Oklahoma law, alleging that Merrill Lynch had breached state-law duties that it owed to its brokers by disseminating research, misleading research and thereby manipulating stock prices.

His complaint encompassed what are known as holder claims, claims that the brokers were injured because they continued to hold their stocks long beyond the point when, had the truth been known, they would have sold.

These holder claims are different from claims brought by purchasers or sellers alleging a particular transaction of purchase or sale was wrongfully induced.

The Federal District Court dismissed the case, concluding that it was preempted by the 1998 Act, which provides that no covered class action based upon state law and alleging a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security may be maintained in any state or federal court by any private party.

On appeal however, the 2nd Circuit reached a different conclusion, reasoning that holder claims are not, “in connection with the purchase or sale”, of a security within the meaning of the 1998 Act.

The Securities Exchange Act of 1934 and SEC Rule 10b-5 generally prohibit fraud in connection with the purchase or sale of a security.

Ever since 1946, federal courts have recognized a private federal cause of action for damages for violations of Rule 10b-5, but we have held that only purchasers or sellers may invoke that remedy.

Thus, respondent in this case does not have a federal remedy for his alleged injury.

On the other hand, in enforcement actions initiated by the SEC, we have broadly construed the “in connection with” phrase to encompass a variety of situations in which investors other than actual purchasers or sellers are the injured parties.

The 1998 Act that we construe today broadly preempts a large category of class actions that are based on state law and allege fraud in connection with the purchase or sale of a security.

The question for decision, then, is whether the act only preempts state law class actions for which federal law provides a remedy, as the 2nd Circuit held, or whether, as the 7th Circuit has held, it also preempts state-law class actions for which there is no federal remedy.

We conclude that the broad interpretation of the “in connection with” phrase that we have accepted in SEC enforcement actions is the meaning that Congress intended in the 1998 Act.

This conclusion is supported not only by the statute’s text, but also by the concerns that led to its enactment; namely, that Congress believed that lawyers who were bringing securities class actions in state court were invoking their state remedies to avoid the necessity of complying with an earlier federal statute that had tightened the requirements for bringing securities class actions under federal law.

Our conclusion is consistent with the presumption that Congress does not cavalierly preempt state law causes of action, because the 1998 Act does not actually preempt any cause of action, but rather merely denies plaintiffs the right to use the class-action device to vindicate a carefully defined category of claims.

Moreover, it is federal law rather than state law that has long provided the principle basis for asserting class-action securities-fraud acclaims.

Thus, this is by no means a case in which a federal statute has eliminated a historically entrenched state-law remedy.

Accordingly, we vacate the judgment of the Court of Appeals for the 2nd Circuit and remand for further proceedings consistent with our unanimous opinion.

Justice Alito did not participate in the consideration or decision of the case.