Amicus Curiae Brief — Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit

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INTEREST OF THE AMICUS CURIAE

The Chamber of Commerce of the United States of

America is the world’s largest business federation, represent-

ing a membership of nearly three million businesses and or-

ganizations of every size, ir every industry sector and geo-

graphical region of the country.' A central function of the

Chamber is to represent the interests of its members in im-

portant matters before the courts, Congress, and the Execu-

tive Branch. To that end, the Chamber has filed amicus

briefs in numerous cases addressing issues of vital concern to

the Nation’s business community.

The Chamber has a substantial interest in the issue pre-

sented in this case: the preemption of state-law securities

class actions brought on behalf of “holders” of securities.

Securities class action litigation imposes an enormous toll on

the national economy, affecting virtually every public corpo-

ration in America and costing American businesses billions

of dollars in settlements every year. A recent study con-

cluded that, over a five-year period, the average public cor-

poration faces a 10% probability of facing at least one securi-

ties class action lawsuit. Buckberg et al.. NERA, Recent

Trends in Securities Class Action Litigation: Are WorldCom

and Enron the New Standard? 2 (July 2005).

Congress has enacted legislation to rein in some of the

worst abuses of securities class action litigation, assuring that

class actions involving nationally traded securities are heard

in federal court and governed by federal standards. In this

case, however, the Second Circuit approved an attempt to

circumvent these standards through use of state law as the

' Pursuant to Rule 37.6, amicus states that this brief was not au-

thored in whole or in part by counsel for a party and that no person

or entity, other than the amicus curiae, its members, and its coun-

sel made a monetary contribution to its preparation and submis-

sion. The written consents of the parties to the filing of this brief

have been filed with the clerk.

foundation for a particularly abusive and speculative form of

litigation. The Chamber believes that the experience of its

members makes it well situated to address the harm that will

follow from the Second Circuit’s approach.

INTRODUCTION AND SUMMARY OF ARGUMENT

1. It has long been settled that private litigants may not

bring actions seeking damages for fraud under the Securities

and Exchange Commission’s Rule 10b-5, 17 C.F.R.

§ 240.10b—5, unless they were purchasers or sellers of securi-

ties. The question in this case is whether a person who was

not a purchaser or seller, but instead claims that he was in-

duced by fraud to “hold on” to his shares, may bring a na-

tional class action based upon state law. As petitioner dem-

onstrates in some detail in its brief, the plain language of the

Securities Litigation Uniform Standards Act of 1998 (the

“SLUSA”), Pub. L. No. 105-353, 112 Stat. 3227 (codified as

amended in various sections of 15 U.S.C.), says that the an-

swer to that question is no.

The unequivocal language of the SLUSA preempts virtu-

ally all class actions based upon state law that allege fraud

relating to nationally traded securities. The statute does not

say, as the Second Circuit believed, that only suits involving

purchasers and sellers are preempted. Instead, it broadly pro-

vides that no class action may be brought under state law by

any private party alleging fraud in connection with the pur-

chase or sale of a covered security. The alleged fraud here

surely was one “in connection” with such a purchase or sale

under the broad reading of the term that repeatedly has been

propounded by this Court: the whole point of the assertedly

fraudulent statements challenged by respondents was to in-

fluence trading in the affected securities. Respondents’ claim

therefore cannot be squared with the vaambiguous language

of the SLUSA.

2. The straightforward terms of the statute accordingly

are enough to dispose of this case. But to the extent that

there is any doubt on that score, the statutory background and

policy confirms that the SLUSA was meant ‘J preempt state-

law “holder” class actions. The SLUSA was the culmination

of a more extensive congressional effort to combat abusive

practices that infected the process of securities fraud litiga-

tion. Congress determined that meritless securities suits of-

ten succeeded in coercing settlements — a process that did

investors little good, but that imposed enormous costs on is-

suers, shareholders, and the national economy. Congress re-

sponded by enacting the Private Securities Litigation Reform

Act of 1995 (“the PSLRA”), Pub. L. No. 104-67, 109 Stat.

737 (codified as amended at 15 U.S.C. § 77a et seq.), which

broadly reformed the process of federal securities litigation

by curbing the practices that were most likely to produce ex-

tortionate settlements. When plaintiffs attempted to circum-

vent the PSLRA by bringing national class actions in state

court under state law, Congress enacted the SLUSA’s pre-

emption provisions.

Read against this background, the Second Circuit’s hold-

ing plainly will frustrate the unambiguous intent of the

SLUSA. The state-law holder claims that were validated by

the decision below present the very dangers of abuse that led

to enactment of the PSLRA, and that Congress sought to nail

into their coffins with the SLUSA. Indeed, such suits are es-

pecially susceptible to misuse as a vehicle to extract extor-

tionate settlements because they allege speculative injuries

that typically are proven through use of oral testimony. Con-

gress could not have intended to allow national class actions

asserting such claims to survive the SLUSA.

ARGUMENT

I. THE PLAIN LANGUAGE OF THE SLUSA PRE-

EMPTS “HOLDER” CLASS ACTIONS BASED

UPON STATE LAW

Petitioner shows in some detail how the Second Circuit's

decision is inconsistent with the plain language of the

SLUSA. Rather that repeat that argument, the bulk of this

brief will make a related point: the background and policy of

the SLUSA show that Congress meant the broad words of the

statute to be interpreted broadly. The SLUSA was intended

to prevert plaintiffs from circumventing the goals of the

PSLRA, which reformed the process of securities litigation in

an effort to combat serious and well-documented abuses that

were injuring investors, issuers, and the national economy as

a whole. The Second Circuit’s decision in this case, which

disregards the manifest congressional intent by allowing an

important category of such abusive claims to proceed, will

frustrate that goal.

Before addressing the congressional policy, however, it is

worth pausing to emphasize that the plain language of the

SLUSA does resolve this case. That language is clear and

unequivocal, providing that

{nJo covered class action based upon the statutory or

common law of any State or subdivision thereof

may be maintained in any State or Federal court by

any private party alleging—{A) a misrepresentation

or omission of a material fact in connection with the

purchase or sale of a covered security; or (B) that

the defendant used or employed any manipulative or

deceptive device or contrivance in connection with

the purchase or sale of a covered security.

15 U.S.C. § 78bb(f)(1); 15 U.S.C. § 77p(b). The statute does

not say, as the Second Circuit would have it, that only suits

by purchasers or sellers are preempted; instead, it declares

that no covered class action based on state law of any kind

may be maintained in any court by any private party alleging

fraud in connection with the purchase or sale of a security.”

? The breadth of the statutory language is suggested by SLUSA’s

definition of preempted “covered class action,” which is broader

than that of Rule 23 of the Federal Rules of Civil Procedure. See

15 U.S.C. § 77p(f(2); S. Rep. No. 105-182, at 8 (1998) (“[I]t re-

There is no doubt that the SLUSA’s “in connection with”

language, which was borrowed from Section 10(b) of the Se-

curities Act of 1934, 15 U.S.C. § 78)(b), is broad enough to

reach the conduct alleged in this case. It has long been rec-

ognized that, as the Second Circuit itself put it in its seminal

decision in SEC v. Texas Gulf Sulphur Co., 401 F.2d 833,

862 (2d Cir. 1968) (en banc), the “in connection with” re-

quirement is satisfied when a misrepresentation is made “in a

manner reasonably calculated to influence the investing pub-

lic.” And this Court has since repeatedly confirmed that, un-

der the “in connection with” language, “[i]t is enough that the

scheme to defraud and the sale of securities coincide.” SEC

v. Zandford, 535 U.S. 813, 822 (2002). See, e.g., Superin-

tendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 12-13

(1971) (“in connection with” includes deceptive practices

“touching” the sale of securities); Santa Fe Indus., Inc. v.

Green, 430 U.S. 462, 476 (1977) (same). Here, it can hardly

be denied that the conduct alleged by plaintiffs — dissemina-

tion of false analyst reports to the trading public — satisfies

this standard.

Nor is there room to impose extra-statutory limits on the

scope of the SLUSA’s language. The statute contains three

express, narrowly defined exceptions from preemption (see

15 U.S.C. § 78bb(f)(3)); suits by holders of securities, which

are of an entirely different character from those exceptions,

are not one of them. And the Second Circuit plainly erred in

its belief that, because only purchasers and sellers of securi-

ties have standing to bring private actions under the SEC’s

Rule 10b-5, 17 C.F.R. § 240.10b—5, the SLUSA likewise

preempts only class actions brought by purchasers and sell-

ers. The purchaser/seller limitation is based on the policy of

the Rule 10b—5 implied right of action and “does not stem

mains the Committee[’]s intent that the bill be interpreted broadly

to reach mass actions and all other procedural devices that might

be used to circumvent the class action definition.”

from a construction of the phrase ‘in connection with the

purchase or sale of any security.” Holmes v. Sec. Investor

Prot. Corp., 503 U.S. 258, 284 (1992) (O'Connor, J., concur-

ring in part and concurring in the judgment). See United

States v. O’Hagan, 521 U.S. 642, 651 (1998) (Section 10(b)

“does not confine its coverage to deception of a purchaser or

seller of securities”). That is why the purchaser/seller limita-

tion does not affect the SEC’s enforcement authority or the

United States’ prosecutorial authority under Section 10(b).

See, e.g., Zandford, supra; United States v. Naftalin, 441

U.S. 768, 774 n.6 (1979); Blue Chip Stamps v. Manor Drug

Stores, 421 U.S. 723, 751 n.14 (1975).

The SLUSA’s language thus is dispositive. The respon-

dents’ suit here is a “covered class action.” It is based upon

the “statutory or common law” of a state. It claims a “mis-

representation or omission of a material fact.” And — be-

cause those alleged misstatements plainly coincided with

(and supposedly were intended to induce) trading in secun-

ties — the misstatements were made “in connection with” the

purchase or sale of securities. That is enough to dispose of

this case.

fl. THE POLICY AND UNAMBIGUOUS CONGRES-

SIONAL INTENT UNDERLYING THE SLUSA

PREEMPTS “HOLDER” CLASS ACTIONS BASED

UPON STATE LAW

Respondents’ claim accordingly should not survive ap-

plication of the statutory language. But to the extent that

there is any doubt on that score, the statutory background and

policy confirm that the SLUSA was meant to preempt state-

law holder class actions. The SLUSA was intended to effec-

tuate the congressional intent to prevent certain abusive prac-

tices that had bedeviled securities litigation prior to enact-

ment of the PSLRA. And state-law holder suits, of the type

at issue here, present precisely the dangers of abuse that

Congress had in mind.

A. The Pressure To Settle Even Meritless Securities

Class Actions Imposes An Enormous Toll On

The National Economy

In determining Congress’s goal in enacting the SLUSA, it

is helpful to begin with the problems that prompted enact-

ment of legislation reforming securities litigation. As this

Court has long recognized, securities fraud litigation presents

“a danger of vexatiousness different in degree and in kind

from that which accompanies litigation in general.” Blue

Chip Stamps, 421 U.S. at 739. Such lawsuits contain unique

elements that encourage defendants to settle even insubstan-

tial claims — and that, as a consequence, encourage plaintiffs

to file them. This phenomenon is a function of the incentives

faced by both issuers and plaintiffs. See generally Coffee,

Understanding the Plaintiff's Attorney: The Implications of

Economic Theory for Private Enforcement of Law Through

Class and Derivative Actions, 86 COLUM. L. REV. 669

(1986). These incentives, in turn, stem from asymmetries in

the risks and rewards of litigation.

1. The direct costs of litigation — especially the process

of discovery — impose enormous burdens on defendants.

See, e.g., Kassis, The Private Securities Litigation Reform

Act of 1995: A Review of Its Key Provisions and an Assess-

ment of Its Effects at the Close of 2001, 26 SETON HALL

LeGIS. J. 119, 124 (2001) (describing the discovery process

as “financial blood letting”). Moreover, the lost productivity

and business disruption caused by the discovery process may

“dwarf the expense of attorneys’ fees.” Pritchard, Markets as

Monitors: A Proposal to Replace Class Actions with Ex-

changes as Securities Fraud Enforcers, 85 VA. L. REV. 925,

953 (1999); see also Blue Chip Stamps, 421 U.S. at 742-743

(describing “the threat of extensive discovery and disruption

of normal business activities” posed by securities class ac-

tions); S. Rep. No. 104—98, at 14 (1995), reprinted in 1995

U.S.C.C.A.N. 679, 693.

Wholly aside from the costs of litigation, the sheer size of

the damages demanded in national class actions makes it at-

tractive for defendants to forgo the adversarial process and

settle even meritless suits to avoid the prospect of ruinous

liability. The arithmetic is implacable: a 10% chance of fac-

ing a $300 million judgment makes a settlement of $29.9

million look attractive. Joint and several liability presents the

same quandary to peripheral actors, such as underwriters and

accountants, who might be named defendants because of

their deep pockets and thus be exposed to liability for a

grossly disproportionate share of the damages. See H.R.

Conf. Rep. No. 104-369, at 37-38 (1995); S. Rep. No. 104—

98, at 5, 9.

This is so regardless of the strength of the plaintiffs’

claims. An influential study found that the costs and risks of

litigation made the merits of securities suits largely irrelevant

to the decision to settle. Alexander, Do the Merits Matter? A

Study of Settlements in Securities Class Actions, 43 STAN. L.

REV. 497, 516-517 (1991).? Instead, the best predictors of

whether suit would be brought and the size of the ultimate

settlement were declines in stock price and the amount of the

defendant's insurance coverage. /d. at 550.* The hearings

> See also Garry 7 al., The Irrationality of Shareholder Class Ac-

tion Lawsuits: A Proposal for Reform, 49 S.D. L. REV. 275, 287

n.98 (2005) (citing additional studies); Bohn & Choi, Fraud in the

New-Issues Market: Empirical Evidence on Securities Class Ac-

tions, 144 U. PA. L. REV. 903, 979-980 (1996) (evaluating proxies

for merit of pre-PSLRA securities fraud class actions arising out of

IPOs, such as underwriter quality and insider sales, and concluding

that “most securities-fraud class actions are, in fact, frivoious”);

Grundfest, Why Disimply?, 108 HARV. L. REV. 727, 742-743

(1995) (reviewing a sample of settlements in which 23 percent of

the settlements were for less than $2 million, suggesting that the

suits held only a nuisance value).

* See also Thompson & Sale, Securities Fraud as Corporate Gov-

ernance: Reflections Upon Federalism, 56 VAND. L. REV. 859,

that preceded the enactment of the PSLRA were replete with

testimony and studies supporting the proposition that secun-

ties suits commonly followed a drop of 10 percent or more in

a security’s price and that most suits were settled within the

boundaries of the applicable insurance policy.°

894 (2003) (reporting that most complaints filed in 1999 were

based on stock market drop); Martin et al., Recent Trends IV:

What Explains Filings and Settlements in Shareholder Class Ac-

tions, 5 STAN. J. L. Bus. & FIN. 121, 153, 157 (1999); Winter,

Paying Lawyers, Empowering Prosecutors, and Protecting Man-

agers: Raising the Cost of Capital in America, 42 DUKE L.J. 945,

949-50 (1993) (reporting that in one industry, a class action was

filed to challenge every IPO where the stock traded below the IPO

price after 15 months). The rise in securities class action suits

against high-technology firms after the bursting of the stock mar-

ket bubble in 2001 mirrors a similar spike in suits following a

downturn in the Hambrecht and Quist High Technology Index in

1983. See Garry et al., supra, 49 S.D. L. REV. at 290.

* See, e.g., Private Litigation Under the Federal Securities Laws:

Hearings Before the Subcomm. on Sec. of the S. Comm. on Bank-

ing, Hous., & Urban Affairs (“1993 Senate Hearings”), 103d

Cong., Ist Sess. 10, 12 (1993) (statement of Edward R. McCraken,

President and CEO of Silicon Graphics, Inc.) (testifying that a law-

suit was filed several weeks after Silicon Graphics, Inc.’s 10 per-

cent drop in stock price that resulted from the company’s lower

than expected earnings); see also Staff Report on Private Securities

Litigation: Hearing Before the Subcomm. on Sec. of. the S. Comm.

on Banking, Hous., and Urban Affairs, 103d Cong., 2d Sess. 190

n.37 (1994) (discussing technology industry representatives’ re-

ports that strike suits would be filed whenever stock price de-

creased 10% or more). Numerous SEC Chairmen and Commis-

sioners echoed these concerns and have urged reform of securities

class actions. See Securities Litigation Reform Proposals: Hear-

ings an S. 240, S. 667, and H.R. 1058 Before the Subcomm. on Se-

curities of the S. Comm. on Banking, Housing, and Urban Affairs

(“Reform Act Senate Hearings”), 104th Cong., Ist Sess. 229

(1995) (then-Chairman Arthur Levitt); id at 239 (former Acting

Chairman Charles C. Cox); id. at 49-50 (former Commissioner J.

2. These insubstantial strike suits are of little benefit to

shareholders — even to shareholder plaintiffs. Every delayed

announcement of accurate firm information produces both

winners (who sold during the period of inflation) and losers

(who bought then and sold after disclosure of the truth). See

Posner, ECONOMIC ANALYSIS OF THE LAW 489 (Sth ed.

1998). “Over the long run, any reasonably diversified inves-

tor will be a buyer half the time and a seller half the time”

and will not benefit from “a legal rule that forces his winning

self to compensate his losing self over and over.” Easter-

brook & Fischel, THE ECONOMIC STRUCTURE OF CORPORATE

LAW 340 (1991); see also Thakor, et al., U.S. Chamber Insti-

tute for Legal Reform, The Economic Reality of Securities

Class Action Litigation | (2005), available at http://www.

instituteforlegalreform.com/pdfs/EconomicRealityNavigant.-

pdf (explaining that diversified institutional investors in par-

ticular are for this reason overcompensated as a result of liti-

gation). Even worse, such wealth transfers entail significant

transaction costs. To the extent that class members still own

shares in the issuer, “payments by the corporation to settle a

class action amount to transferring money from one pocket to

the other, with about half of it dropping on the floor for law-

yers to pick up.” Alexander, Rethinking Damages in Securi-

ties Class Actions, 48 STAN. L. REV. 1487, 1503 (1996); see

also Coffee, Causation by Presumption? Why the Supreme

Court Should Reject Phantom Losses and Reverse Broudo,

60 Bus. Law. 533, 542-543 (2005); Perino, Did the Private

Securities Litigation Reform Act Work?, 2003 U. ILL. L. REV.

913, 921-922; Easterbrook & Fischel, Optimal Damages in

Securities Cases, 52 U. CHI. L. REV. 611, 638-639 (1985).

Carter Bresse, Jr.); S. Rep. 104—98, at 21 (noting testimony of for-

mer Chairman David S. Ruder), id. at 16 (noting testimony of for-

mer Chairman Richard C. Breeden); Shad, Introduction to Securi-

ties Class Actions: Abuses and Remedies | (1996), Grundfest, su-

pra.

More profoundly, the costs of abusive litigation are felt

throughout the national economy. These costs are borne dis-

proportionately by the most innovative and entrepreneurial

companies, which are targeted because the volatility in their

share price attracts the attention of the plaintiffs’ bar.° And

abusive securities class action litigation has enormously de-

structive ripple effects. The risk of out-of-control liability

deters competent individuals from serving as independent

directors on corporate boards. S. Rep. No. 104~98, at 21.

Accounting firms, often named as deep-pocket defendants,

become less willing to perform auditing services (id. at 21-

22) — especially for “newer and smaller companies” that are

for that reason less likely to be able to obtain high-quality

professional services, as “business failure would generate

securities litigation against the professional, among others.”

Central Bank of Denver, N.A. v. First Interstate Bank of

Denver, N.A., 511 U.S. 164, 189 (1994), abrogated by 15

U.S.C. § 78t; H.R. Rep. No. 104—S0, at 20 (1995) (“Fear of

litigation keeps companies out of the capital markets,” and

“businesses suffer as auditors and directors decline engage-

ments and board positions”); Alexander, supra, 43 STAN. L.

REV. at 570-573. D&O insurers must increase premiums or

stop underwriting policies altogether. S. Rep. No. 104-98, at

21.

Furthermore, because any statement that later is proven

inaccurate or any prediction that fails to come true could

form the predicate for an allegation of fraud, the prospect of

liability chills corporate disclosures of information that could

be useful to investors, thus directly frustrating the disclosure

objectives of the federal securities laws. See id. at 15—16;

Easterbrook & Fischel, supra, at 339 (noting that because a

* See Reform Act Senate Hearings, supra, at 109 (testimony of

George Sollman on behalf of the American Electronics Associa-

tion) (estimating that about half of the top 100 companies in Sili-

con Valley have been subjected to a securities class action lawsuit

at least once).

firm that discloses information “inevitably takes the risk of

excessive optimism and excessive pessimism,” a “rule penal-

izing excesses in either direction would lead to silence” about

a company’s prospects). The risk of liability also muzzles

corporate managers’ communications with analysts, which

are “necessary to the preservation of a healthy market.”

Dirks v. SEC, 463 U.S. 646, 658-659 (1983); see also SEC,

Release No. 33-7881, 65 Fed. Reg. 51716, 51718 n.19

(2000) (“fear of legal liability” “chill{[s]” communications

with analysts). When SEC disclosure requirements do not

make silence an option, issuers may respond to the threat of

unconstrained liability with defensive disclosures that “bury

the shareholders in an avalanche of trivial information.” TSC

Indus. v. Northway, Inc., 426 U.S. 438, 448-449 (1976).

In addition to detracting from the quantity and quality of

information received by investors, securities class action

abuse reduces the overall competitiveness of United States

securities markets, as fear of potential liability deters foreign

companies from listing on domestic stock exchanges. Com-

mon Sense Legal Reform Act: Hearings on H.R. 10 Before

the Subcomm. on Telecommunications and Finance of the H.

Comm. on Commerce, 104th Cong., ist Sess. 221, 224

(1995) (statement of former SEC Chairman Richard C.

Breeden) (“Based on conversations with potential issuers of

securities all over the world, the fear of litigation inhibits for-

eign firms from participating in the U.S. market(s].”); see

also PricewaterhouseCoopers LLP, 2004 Securities Litiga-

tion Study 2 (Mar. 2005), available at http://www.10b5.com/

2004_study.pdf (reporting that a record 29 foreign issuers

were sued in domestic securities class actions in the 2004 fis-

cal year).

Ultimately, the decline in the efficiency and competitive-

ness of domestic capital markets and the concomitant in-

crease in the expense of corporate governance mechanisms

are absorbed by shareholders in the form of reduced earnings

or passed along to the general public in the form of higher

prices. Abusive securities class actions thus amount to a liti-

gation tax on capital formation and consumption that im-

pedes job creation, injures investors, and weakens the Na-

tion’s economy.

B. The PSLRA Adjusted Litigation Incentives And

Reoriented Securities Class Action Litigation To

Deter Fraud And Compensate Investors Who

Truly Were Injured

1. In the face of these abuses, Congress acted to broadly

reform the process of securities litigation. This movement

began with enactment of the PSLRA in 1995. That statute

took far-ranging steps to rein in meritless litigation and in-

crease issuers’ incentives to disclose information to inves-

tors:

¢ To ensure that investors rather than their lawyers

exercise primary contro] over litigation and elimi-

nate the race-to-the-courthouse mentality that dis-

couraged pre-filing investigation of complaints,

the PSLRA requires national publication of a no-

tice advising class members of the filing of a class

action and selection of a “lead plaintiff,” with a

presumption that the most suitable plaintiff is the

class member or group that has the largest finan-

cial stake in the litigation. 15 U.S.C. §§ 77z-

i(aX(3\(B), 78u-4(a)(3)(B). The presumption is

intended to “encourage institutional investors to

take a more active role in securities class action

lawsuits.” H.R. Rep. No. 104-50, at 34; see also

Weiss & Beckerman, Let the Money Do the Moni-

toring, 104 YALE L.J. 2053 (1995).

” Because, prior to the PSLRA, the first law firm to file a com-

plaint would be anointed lead counse!] and thus garner the lion’s

share of any contingency fee recovery, the resulting race to the

courthouse discouraged plaintiffs’ counsel from fully investigating

claims before filing suit. Law firms maintained a stable of profes-

e The PSLRA prohibits bonus payments to class

representatives (id. §§ 77z—1(a)(4), 78u~4(a)(4))

and limits investors to serving as a class represen-

tative no more than five times during any three-

year period. Id. §§ 77z-1(a)(3)(B)(vi), 78u-

4(a)(3)(B){vi).

e To better align the incentives of class counsel

with the class, the PSLRA limits attorneys’ fees to

a reasonable percentage of the damages and pre-

judgment interest actually paid to the class. /d.

§§ 77z-1(a)(6), 78u—4(a)(6).

generally Gulati, et al., Fraud by Hindsight, 98

Nw. U. L. REV. 773 (2004)), the PSLRA creates a

“safe harbor’ for projections of future perform-

ance that were not knowingly false. 15 U.S.C.

§§ 77z-2(c)(1)+(2), 78u-—5(c)(1)-(2).

e The PSLRA imposes a heightened pleading stan-

dard to prevent plaintiffs from suing first and at-

tempting to identify actionable fraud only after

expensive fishing-expedition discovery. Plaintiffs

sional plaintiffs — the “world’s unluckiest investors” (H.R. Conf.

Rep. No. 104-369, at 32 (1995)) — who would receive bonuses for

lending their names to class action complaints that were filed

within days or hours of any dramatic decline in share price. See

Reform Act Senate Hearings, supra, at 118 (statement of Sen. Pe-

ter Domenici) (more than 20% of securities class actions filed

within 48 hours of negative news), 1993 Senate Hearings, supra,

at 7-8 & Ex. | (letter from Melvyn I. Weiss to Sen. Donald W.

Riegle) (reporting that over three-year period, out of 229 Rule

10b-—5 actions filed by his firm, 157 filed within 10 days of major

adverse disclosure by defendant). Predictably, many of the com-

plaints were verbatim copies of those previously filed. See, ¢.g., In

re Philip Morris Sec. Litig., 872 F. Supp. 97, 98 (S.D.N.Y. 1995),

aff'd in part and rev'd in part, 75 F.3d 801 (2d Cir. 1996).

must identify each allegedly fraudulent statement

and explain why it is fraudulent, and must state

with particularity facts giving rise to a “strong in-

ference” that the defendant acted with “the re-

quired state of mind.” Id. § 78u-4(b)(2).

The PSLRA mandates imposition of sanctions for

violations of Rule 11 of the Federal Rules of Civil

Procedure, with the presumptive award being the

amount of defendants’ attorneys’ fees and costs

for defending the suit. Id. §§ 77z-1(c), 78u-4(c).

The PSLRA imposes a stay of discovery during

the pendency of a motion to dismiss, unless the

court finds that discovery is necessary to preserve

evidence or prevent undue prejudice. Id. §§ 77z-

l(b), 78u-4(b)(3). In combination with the

heightened pleading standards, the discovery stay

is intended to ensure that nonmeritorious com-

plaints do not impose enormous litigation costs on

defendants.

The PSLRA codified the “loss causation” re-

quirement; in addition to showing that fraud in-

duced the purchase a security, plaintiffs must

show that the fraud actually caused the security’s

price to be artificially inflated. 15 U.S.C. § 78u-

4(b)(4); see also id. § 771(b). Otherwise, private

securities actions “would become an insurance

plan for the cost of every security purchased in re-

liance upon a material misstatement or omission.”

Huddleston v. Herman & MacLean, 640 F.2d

534, 549 (Sth Cir. 1981), aff'd in part and rev'd in

part on other grounds, 459 U.S. 375 (1983). See

Dura Pharms., Inc. v. Broudo, 125 §S. Ct. 1627

(2005).

To help prevent the prospect of massive damage

awards coercing otherwise unjustified settlements,

the PSLRA replaced joint and several liability for

peripheral defendants with proportionate liability

if those defendants did not knowingly violate the

securities laws. Id. §§ 77z-2(c)(2), 78u-—4(g)(3),

78u—S(c)(2). To preclude a treble damage award

under the Racketeering Influenced and Corrupt

Organization Act of 1970, securities fraud was

eliminated as a predicate for a civi! racketeering

claim, and mail and wire fraud may not constitute

a predicate RICO offense if the underlying con-

duct would be actionable as securities fraud. 18

U.S.C. § 1964(c). And to increase the accuracy of

damage awards, the PSLRA provided that dam-

ages must be measured by the difference between

the price the plaintiff paid for the security and the

mean trading price of the security during the

ninety-day period after dissemination of correc-

tive information to the marketplace. 15 U.S.C. §

78u—4(e)(1).

e In addition to addressing the litigation incentives

of plaintiffs, defendants, and lawyers, the PSLRA

strengthened other enforcement mechanisms. For

example, it required firms auditing public compa-

nies to take certain measures to detect fraud and

to disclose any unlawful acts they uncover (15

U.S.C. § 78j-1); the statute vested the SEC with

the power to prosecute those who aid and abet

violations of the securities laws. Id. § 78t(f).

2. The PSLRA had a limited but significant success in

squeezing out abusive litigation while preserving the oppor-

tunity for plaintiffs to advance meritorious securities claims

under federal law, thus rationalizing the system of securities

litigation. The statute certainly did not close the courthouse

door to plaintiffs: with the exception of a bref decline in

litigation activity the year after the enactment of the PSLRA,

the mean number of securities issuers sued each year has in-

creased to 258, a 33% increase over the pre-PSLRA average.

See Securities Class Action Clearinghouse (“SCAC”), at

http://securities.stanford.edu/.

Moreover, the dollar magnitude of settlements has in-

creased. Eight post-PSLRA settlements have exceeded $500

million: the Enron and WorldCom litigations, while still

pending, already have produced settlements of $7.16 billion

and $6.128 billion, respectively; the Cendant litigation set-

tled for $3.525 billion; AOL Time-Warner settled for $2.5

billion; parts of the IPO Allocation Litigation against nu-

merous issuers settled for $1 billion; McKesson HBOC set-

tled for $960 million; Lucent Technologies settled for $673

million; and Raytheon Corporation settled for $535 million.

See SCAC Top Ten_List, at http://securities.stanford.edu/

top_ ten_list.html.

Even adjusting for inflation and excluding the World-

Com partial settlkement announced in May 2004, a record

$2.881 billion in settlements were reached last year. Simons

& Ryan, Post-Reform Act Securities Settlements: Updated

Through December 2004 1, available at http://securities.

stanford.edu/Settlements/RE VIEW __1995-2004/Settlements_

Through_12_2004.pdf. The total value of settlements has

exceeded the $2 billion mark for the last five years. I[bid.

This increase reflects not only a higher number of settle-

ments, but also an increase in the average settlement size.

While over 65% of settlements in 2004 were for less than

$10 million, seven exceeded $100 million and the “percent-

age of ‘mid-range’ settlements between $60 million and

$100 million” increased significantly. Jd. at 3. Although the

median settlement in the pre-Reform Act era was $3.5 mil-

lion, Bajaj et al., Securities Class Action Settlements, 43

SANTA CLARA L. REV. 1001, 1022-1923 (2003), the most

recent figures indicate that the median settlement value has

risen steadily, and reached $6.8 million in the first half of

2005. Buckberg, et al., supra, at 4. One study attributes

part of that increase to the increasing participation of institu-

tional investors as lead plaintiffs, which now occurs in 35%

of post-PSLRA cases. Simons & Ryan, supra, at 9.

On the other hand, the dismissal rate of federal securities

class actions also has risen. The percentage of securities

fraud cases that were involuntarily dismissed (including

through summary judgment) roughly doubled after enact-

ment of the PSLRA. See Buckberg, ef al., supra, at 3;

Painter et al., Private Securities Litigation Reform Act: A

Post-Enron Analysis 7-9 (2002) (gathering studies analyz-

ing data through 2001), available at http://www.fed-soc.org/

pdf/PSLRAFINALIL.PDF. While pretrial dismissals dis-

posed of 20.3% of securities cases filed between 1991 and

1995, that rate has increased to 39.3% of cases filed between

1996 and 2002. Buckberg, supra, at 3.

These contrasting sets of figures — more dismissals, but

higher settlement values for cases that are not dismissed —

suggest that the PSLRA has had some success. A higher

dismissal rate indicates that frivolous actions are more likely

to be dismissed, with surviving cases more likely to be those

involving more substantial claims. Pritchard, Should Con-

gress Repeal Securities Class Action Reform? 9 (Univ. of

Mich. John M. Olin Center Working Paper No. 03-003,

2003) (“If only strong claims lead to settlements, class ac-

tions are producing more cost-effective deterrence.”). See

Choi, The Evidence on Securities Class Actions, 57 VAND.

L. REV. 1465, 1477-1498 (2004) (canvassing the existing

literature and concluding that it provides evidence that

“frivolous suits existed prior to the PSLRA and that a shift

occurred in the post-PSLRA period toward more meritorious

claims”). Moreover, studies confirm that indicia of possible

fraud — such as restatements of accounting results and alle-

gations of insider trading — play a Jarger role in the filing

and settlement of securities fraud class actions after the en-

actment of the PSLRA than before. See Simons & Ryan,

supra, at 7; Pritchard, supra, at 1 yy

C. The SLUSA Was Enacted To Prevent Frustra-

tion Of The PSLRA’s Reforms

Prior to the enactment of the PSLRA, state securities

laws — the subject of the SLUSA — had played virtually no

role in class action litigation involving securities traded on

national exchanges. But that changed as plaintiffs and their

attorneys attempted to circumvent the PSLRA’s reforms.

The plaintiffs’ bar had brought “essentially no significant se-

curities class ?ction litigation” in state courts before the ef-

fective date of the PSLRA. H.R. Rep. No. 105-640, at 10

(1998). In the two years after the enactment of the PSLRA,

however, at least 104 state-law securities class actions were

filed. Rosen, The Statutory Safe Harbor for Forward-

Looking Statements After Two and a Half Years: Has It

Changed the Law? Has It Achieved What Congress In-

tended?, 76 WASH. U. L.Q. 645, 670 (1998). Congress heard

® We note, though, that the pressure on corporations to settle re-

gardless of the merits of the case remains high. The magnitude of

the pressure to settle even the most frivolous of cases is illustrated

by the fact that fewer than 1% of securities fraud class actions are

ultimately taken to trial. See Painter et al., supra, at 8. See

Pritchard & Sale, What Counts as Fraud? An Empirical Study of

Motions to Dismiss Under the Private Securities Litigation Reform

Act 4 (Univ. of Mich. John M. Olin Center for Law & Economics,

Working Paper 03-011, 2003); Black, et al., Outside Director Li-

ability 34 (Univ. of Mich. John M. Olin Center for Law & Eco-

nomics, Working Paper No. 250, 2003) (finding only one securi-

ties case that proceeded to trial). The pressure on defendants is so

great that, even when they do succeed in obtaining a dismissal with

prejudice in the trial court, the risk of losing on appeal may lead to

enormous settlements. For example, a securities class action de-

fendant recently agreed to settle for $300 million even after pre-

vailing in the trial court. See Weil, Win Lawsuit—and Pay $300

Million, Wall St. J., Aug. 2, 2004, at C3.

testimony that in California alone, about five times as many

State securities class actions were filed in the first six months

of 1996 than in the first six months of 1995, prior to the en-

actment of the PSLRA. H.R. Rep. No. 105-640, at 10

(1998); see also Radom, Balkanization of Securities Regula-

tion: The Case for Federal Preemption, 39-Fall Tex. J. Bus.

L. 295, 309-310 & nn. 97-98 (2003).

Predictably, the weaker cases, which would not pass mus-

ter in federal court after the PSLRA, were the ones filed in

State court. See Perino, Fraud and Federalism: Preempting

Private State Securities Fraud Causes of Action, 50 STAN. L.

REV. 273, 307-318 (1998); SEC, Office of General Counsel,

Report to the President and the Congress on the First Year of

Practice Under the Private Securities Litigation Reform Act

of 1995, Apr. 1997, at 84 (noting that increase in filings of

State securities class actions “may reflect a migration of

weaker cases to state court”). Moreover, savvy plaintiffs’

lawyers could magnify the coercive pressure to settle these

strike suits by engaging in state-court forum shopping. See

Chao, Securities Class Actions and Due Process, 1996

CoLumM. Bus. L. REv. 547, 550-551 (describing the resulting

“race to the bottom” settlement process in state courts); see

also Garry et al., supra, 49 S.D. L. REV. at 276 (2005) (not-

ing increase in filings in Mississippi).”

The obvious effect of the movement of securities class

actions to state court was to frustrate the PSLRA’s purposes

and to resurrect the abusive practices that Congress had

sought to discourage. To offer just one example, the balkani-

* Members of the plaintiffs’ bar attempted to obtain the passage of

state legislation that would have increased this substitution effect;

an ultimately defeated ballot initiative in California would have

transformed the state into a “Mecca” for securities class action liti-

gation. See Walker, Evaluating the Preemption Evidence: Have

the Proponents Met Their Burden?, 60 L. & CONTEMP. PROBS.

237, 241 (1997).

zation of securities law produced by the proliferation of state

securities litigation threatened to render the safe harbor pro-

vision of the PSLRA a dead letter. See S. Rep. 105-182, at

4. The SEC warned that “[c]ompanies have been reluctant to

provide significantly more forward-looking disclosures than

they had prior to the enactment of the safe-harbor” (SEC, su-

pra, at 3) because, in part, of “fear of state court liability,

where forward looking statements may not be protected by

the Federal safe harbor.” Jd. at 27. The data revealed that

allegations in complaints filed in state court were more than

twice as likely to be based on forward-looking statements

than were complaints filed in federal court. Id. at 77 (25% of

“stand-alone” state complaints (those filed without a parallel

federal suit) “are based solely on failed forecasts (as com-

pared to twelve percent at the federal level)”).

This evidence of the migration of securities class action

litigation to state court led Congress to enact the SLUSA.

The statute’s parallel provisions added to the Securities Act

of 1933 and the Exchange Act of 1934 provide that “[n]Jo

covered class action based upon the statutory or common law

of any State or subdivision thereof may be maintained in any

State or Federal court by any private party alleging,” “in

connection with the purchase or sale of a covered security,”

either “an untrue statement or omission of a material fact” or

“that the defendant used or employed any manipulative or

deceptive device or contrivance * * *.” 15 U.S.C. §§ 77p(b),

78bb(f)(1). Under the SLUSA, if such a class action is

brought in state court, it may be removed to federal district

court and thereafter dismissed. Id. §§ 77p(c), 78bb(f)(2).

There is no mystery about Congress’s goal in this legisla-

tion: the SLUSA’s preemption of state law was intended to

“prevent certain State private securities class action lawsuits

alleging fraud from being used to frustrate the objectives of

the [PSLRA].” Pub. L. No. 105-353, § 2(5), 112 Stat. 3227,

3227 (codified at 15 U.S.C. § 78a note). Representative Bli-

ley, the House Manager, remarked that “(t]he premise of this

legislation is simple: lawsuits alleging violations that involve

securities that are offered nationally belong in Federal

court.” 144 Cong. Rec. H10771 (daily ed. Oct. 13, 1998)

(emphasis added). See also H.R. Conf. Rep. No. 105-803, at

13 (1998) (“this legislation establishes uniform national rules

for securities class action litigation involving our national

capital markets”).

D. Excepting State-Court “Holder” Suits From

SLUSA Preemption Would Frustrate The Con-

gressional Purpose

Against this background, it is manifest that the Second

Circuit’s decision, which allows state-law holder suits to pro-

ceed, is inconsistent with the central purpose of the SLUSA.

Congress determined that the securities litigation process was

rife with abuses that were harming issuers and shareholders

alike, and reacted by promulgating the corrective rules of the

PSLRA. When plaintiffs’ counsel sought to circumvent

those rules by bringing national securities class actions under

state law — a species of suit that had virtually never before

been seen — Congress responded by providing broadly in the

SLUSA that class actions involving nationally traded securi-

ties should proceed only under federal law. For several rea-

sons, the decision below, which again allows plaintiffs’ law-

yers to avoid the PSLRA’s requirements by bringing a novel

type of national class action, cannot be squared with that in-

tent.

|. To begin with, holder suits present exactly the sorts of

dangers that led to enactment of the PSLRA in the first place.

Indeed, this Court imposed the purchaser/seller requirement

on the cause of action implied under Rule 10b—5 precisely

because holder actions are especially susceptible to use as an

abusive vehicle to extract extortionate settlements. The

Court examined this point at some length in Blue Chip

Stamps, explaining that, in contrast to purchasers and sellers,

“a putative plaintiff, who neither purchases nor sells securi-

ties but sues instead for intangible economic injury such as

the loss of a noncontractual opportunity to buy or sell, is

more likely to be seeking a largely conjectural and specula-

tive recovery in which the number of shares involved will

depend on the plaintiff's subjective analysis.” 421 US. at

734-735.

This means that a holder action “will turn largely on

which oral version of a series of occurrences the jury may

decide to credit, and therefore no matter how improbable the

allegations of the plaintiff, the case will be virtually impossi-

ble to dispose of other than by settlement.” Blue Chip

Stamps, 421 U.S. at 742. A holder suit also necessarily

“would throw open to the trier of fact many rather hazy is-

sues of historical fact the proof of which depended almost

entirely on oral testimony,” a circumstance where “dangers

of * * * abuse appear to exist * * * to a peculiarly high de-

gree.” Id. at 743. And this problem would be compounded

because “(t]he jury would not even have the benefit of

weighing the plaintiff's version against the defendant’s ver-

sion, since the elements to which the plaintiff would testify

would be in many cases totally unknown and unknowable to

the defendant.” /d. at 746.

And that is not the end of the abuse made possible by

holder actions. In the absence of a rule that permits only

purchasers and sellers to bring private securities suits,

bystanders to the securities marketing process could

await developments on the sidelines without risk,

claiming that inaccuracies in disclosure caused non-

selling in a falling market and that unduly pessimis-

tic predictions by the issuer followed by a rising

market caused them to allow restrospectively golden

Opportunities to pass.

Blue Chip Stamps, 421 U.S. at 747. Holder suits thus “would

appear to encourage the least appealing aspect of the use of

the discovery rules” (id. at 741) and would “‘lead to large

judgments, payable in the last analysis by innocent investors,

for the benefit of speculators and lawyers.’” Id. at 739 (quot-

ing Texas Gulf Sulphur, 401 F.2d at 867 (Friendly, J., con-

curring)); see also Dura, 125 S. Ct. at 1631-1632 (emphasiz-

ing that a decline in stock price “after the truth makes its way

into the market place * * * may reflect, not the earlier mis-

changed investor expectations, new industry-specific or firm-

specific facts, conditions, or other events, which taken sepa-

rately or together account for some or all of that lower

price”); Holmes, 503 U.S. at 272-273 (precluding recovery

on behalf of customers who had not themselves traded in

manipulated securities but whose brokers were rendered in-

solvent by doing so, because “[i}f the nonpurchasing custom-

ers were allowed to sue, the district court would first need to

determine the extent to which their inability to collect from

the broker-dealers was the result of the alleged conspiracy to

manipulate, as opposed to, say, the broker-dealers’ poor

business practices or their failures to anticipate developments

in the financial markets.”).

2. In addition, allowing holder claims to proceed would

be unlikely either to deter fraud or to benefit shareholders.

As a logical matter, holders of securities, viewed as a class,

cannot be injured. A holder claim assumes that fraud led the

class to keep a stock rather than sell it so as to take advantage

of an artificially inflated stock price. But if the fraud had not

occurred, the stock price would not have been inflated — es-

pecially if, as the holder claim implies, shareholders would

have sold their shares had accurate information been released

to the market — and so there would have been no profits from

the sale. See, e.g., Arent v. Distribution Scis., Inc., 975 F.2d

1370, 1374 (8th Cir. 1992) (“Plaintiffs were not harmed be-

cause they were unable to realize the true value of their stock

~ they were harmed because the true value of their stock was

zero.”); Crocker v. FDIC, 826 F.2d 347, 351 (Sth Cir. 1987)

(absent fraud, “there would have been no market for the

stock at the artificially high price,” and “[w]ithout such a

market, the [holder’s] envisioned ‘profit opportunity’ evapo-

rates into hardly more than an illusion”).

By the same token, “[t}he deterrent effect is weak” when

“the merits of claims” are “irrelevant to their initiation or set-

tlement values,” as promises to be the case with state-law

holder damages suits. Winter, supra, 42 DUKE LJ. at 952.

And truly meritorious claims, of course, can be brought in

federal court as traditional purchaser/seller suits; holder ac-

tions are premised on a drop in stock price, and the share

price can change only if there are purchasers and sellers who

could themselves pursue “fraud on the market” claims. See

Basic, Inc. v. Levinson, 485 U.S. 224, 245-247 (1988).

3. Viewed in this light, state-law holder suits present all

of the dangers that prompted enactment of the PSLRA. Such

suits, of course, will proceed outside of the PSLRA's rules:

they may, for example, allow for joint and several liability

and punitive damages; may premise liability on forward-

looking statements; will not make use of the discovery stay

and pleading standards that have curbed abusive discovery;

and will not apply the lead plaintiff rules that discourage the

“race to the courthouse door.” There is every reason to be-

lieve that state-law holder suits will, for this reason, become

the plaintiffs’ vehicle of choice. See Pet. 17 n.5 (gathering

24 such cases); see also H.R. Conf. Rep. No. 105-803, at 14—

15 (noting plaintiffs’ attorneys’ attempt to “circumvent the

[PSLRA’s] provisions by exploiting differences between

Federal and State laws by filing fmvolous and speculative

lawsuits in State court, where essentially none of the Reform

Act's procedural or substantive protections against abusive

suits are available”). After all, virtually any purchaser or

seller claim could, if gerrymandered as to the timing of the

class period and tweaked a bit in its allegations, be stated as a

holder suit.

As a consequence, there is little doubt that, under the

Second Circuit’s approach, holder suits will impose signifi-

cant costs on defendants through fishing-expedition discov-

ery and interruption of business, and will pose the danger of

enormous liability. Such suits accordingly will lead to sub-

stantial settlements, even when (as often will be the case)

they are wholly lacking in merit. They will discourage cor-

porate disclosures of information. They are unlikely to do

investors any good. And they will impose heavy costs on all

participants in the securities markets. Indeed, the only win-

ners in this system of blackmail suits and windfall settle-

ments will be the lawyers.

The Second Circuit's holding thus leads to a bizarre and

anomalous result. For more than fifty years, the federal

courts have precluded holder suits under Rule 10b—5 because

such actions are so easily abused. See Birnbaum v. Newport

Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S.

956 (1952). The PSLRA and the SLUSA were designed to

tighten the federal securities rules to further combat meritless

litigation. Yet the court of appeals read the SLUSA to have

excluded from the scope of the PSLRA’s substantive provi-

sions, alone among the favored weapons in the strike suit ar-

senal, this most abusive type of claim. It seems plain that

Congress could not have had any such intent.

4. Finally, we note that, wholly apart from private dam-

ages litigation, significant deterrents to fraud affecting hold-

ers of securities are in place. SEC regulations impose strin-

gent reporting obligations on corporations, subject to SEC

enforcement proceedings. Corporations must file quarterly

and annual financial statements, which executives now must

certify under threat of criminal penalty and disgorgement of

their compensation and stock trading profits. 15 U.S.C. §§

7241, 7243; 18 U.S.C. § 1349. Issuers also must file Form

8—-K reports on any of a host of material corporate events,

including agreements, acquisitions, disposition of assets, off-

balance sheet financial obligations, and changes in officers or

directors. SEC, Release No. 33-8400, 69 Fed. Reg. 15594

(2004).

The powers of the SEC and Department of Justice to en-

force these corporate disclosure obligations are substantial.

The Commission may obtain injunctive relief, cease-and-

desist orders, orders barring or suspending individuals from

serving as an officer or director of an issuer of securities, and

large civil penalties, including disgorgement of any gain. 15

U.S.C. §§ 78u, 78u-3. Under the Sarbanes-Oxley Act, the

SEC may earmark penalties and amounts disgorged “for the

benefit of the victims” of the violation. 15 U.S.C. § 7246(a).

A person who willfully and knowingly makes a false or

misleading statement of material fact may also be criminally

liable and is subject to imprisonment for 20 years and multi-

million dollar fines. Jd. § 78ff. The Securities Act authorizes

many similar remedies for misstatements made in connection

with the registration of securities, for which liability may be

established without proof of scienter. /d. §§ 77t, 77y.

The SEC does not shy away from invoking these powers.

During fiscal year 2004 alone, the SEC initiated 973 investi-

gations of possible violations of the securities laws and

brought 264 injunctive actions and 375 administrative pro-

ceedings against issuers and financial services providers — far

more than the 236 private securities actions filed in federal

court in 2004 (see SCAC, supra), and greatly in excess of the

number of state-law holder actions over the past several

years. The Commission obtained orders requiring the dis-

gorgement of $1.9 billion and the payment of $1.2 billion in

penalties.'® The Department of Justice’s Corporate Fraud

Task Force has charged over 900 defendants since it was

' SEC 2004 Annual Report app. C at 3, 21, available at

http://www.sec.gov/about/secpar/secpar04stats.pdf. Details on

recent settlements may be found on the SEC's website.

formed in July 2001, and has obtained over 500 guilty pleas

and convictions."

State prosecutors and blue-sky officials bring their own

overlapping civil and criminal enforcement actions. Among

State securities law enforcers, for example, the New York

Attorney General alone has reported substantially more than

a billion dollars in recent settlements with financial services

companies,

Financial services industry Self Regulating Organizations

(“SROs”) also enforce regulations that implement and sup-

plement the securities laws. In 2004, the National Associa-

tion of Securities Dealers barred 454 individuals from the

securities business, suspended 379 others, and expelled 22

firms.'? The New York Stock Exchange brought 195 cases

of rules violations against members that year.'*

Securities market participants are thus policed by an array

of federal and state government powers (both civil and

criminal), SRO sanctions, and, of course, civil liability under

the federal securities laws in actions conducted according to

'' See Second Year Report to the President: Corporate Fraud Task

Force 2.3 (2004), at http://www.usdoj.gov/dag/cftf/2ndyr_fraud

_report.pdf.

2 See http://www.oag.state.ny.us/press/2005/jul/jul20a_05.html

($125 million settlement in mutual fund market timing case); id. at

feb/Banc.pdf, at 35 ($375 million settlement in similar case); id. at

Columbia.pdf, at 25 ($140 million settlement); http://www.oag.

state.ny.us/investors/alliance_cap_mgmt_aod.pdf, at 22 ($250 mil-

lion settlement), id. at jcm/aod.pdf, at 9 ($100 million settlement),

http://www.oag. state .ny.us/press/2002/may/may21a02.htm! ($100

million settlement in analyst conflict of interest case).

"See http://www.nasd.com/web/idcplg?idcService=SSGETPAGE

&nodeld=749&ssSourceN odeld=6.

” -//www.nyse.com/regulation/howregworks/ 1022221394131.

html.

the standards prescribed by Congress. Together, these

checks effectively curb unlawful practices and compensate

injuries. Given the availability of these remedies, which deter

and punish misconduct and compensate those who truly are

its victims, there is no reason for this Court to permit state

holder actions to unravel the litigation reforms implemented

by Congress.

CONCLUSION

The judgment of the court of appeals should be reversed.

Respectfuliy submitted.

ROBIN S. CONRAD

AMAR D. SARWAL

National Chamber Litiga-

tion Center, Inc.

1615 H Street, NW

Washington, DC 20062

(202) 463-5337

CHARLES A. ROTHFELD

Counsel of Record

ANDREW J. PINCUS

Mayer, Brown, Rowe & ~

Maw LLP

1909 K Street, NW

Washington, DC 20006

(202) 263-3000

STEPHEN M. SHAPIRO

TIMOTHY S. BISHOP

Mayer, Brown, Rowe &

Maw LLP

71 South Wacker Drive

Chicago, IL 60606

(312) 782-0600

NOVEMBER 2005

n 0 = sae ae nena

SY Cats Ct St

pate Pyiiay

DEC 19 2005 |

OFFICE GF THE CLERK

IN THE

Supreme Court of the Anited States

MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.,

Petitioner,

Vv.

SHADI DABIT, ON BEHALF OF HIMSELF

AND ALL OTHERS SIMILARLY SITUATED,

Respondent.

On a Writ of Certiorari

to the United States Court of Appeals

for the Second Circuit :

BRIEF FOR PHILLIP GOLDSTEIN AND

BULLDOG INVESTORS AS AMICI CURIAE

IN SUPPORT OF RESPONDENT

ROBERT L. KING

Counsel of Record

Gateway One on the Mall

701 Market Street, Suite 350

St. Louis, Missouri 63101

December 19, 2005 (314) 621-4012

QUESTION PRESENTED

Whether SLUSA preempts claims brought by holders of

securities based upon misrepresentations, omissions, or

manipulation, notwithstanding SLUSA’s language limit-

ing preemption to claims “in connection with the purchase

or sale of a covered security,” and this Court’s interpreta-

tion of identical language to cover only claims brought by

purchasers or sellers in Blue Chip Stamps v. Manor Drug

Stores, 421 U.S. 723 (1975).

TABLE OF CONTENTS

Page

QUESTIONS PRESENTED... ececeeseeeeesseeessseeeeeeeeees i

TABLE OF AUTHORITIES ...0.0..........cccccssesssssesessseereeeneee lil

INTEREST OF AMICI CURIAE....00.... occ ccceeeetteeeeeeeeeeees l

SUMMARY OF ARGUMENT. ...00......cccecceeeeecesseeseeeeseeeeeeees 1

OT tr deiecntchininninnctedinctnnsindgtepiviihdiiibiaitihanpininniiions 4

I. SLUSA’S TEXT, ITS LEGISLATIVE HIS-

TORY AND RUDIMENTARY RULES OF

STATUTORY CONSTRUCTION POINT

TO THE CONCLUSION THAT SLUSA

DOES NOT PREEMPT HOLDER CLAIMG............. 4

A. The States have traditionally regu-

lated securities transactions, and for

more than sixty years federal securi-

ties law supplemented such state au-

thority which Congress explicitly pre-

served and protected ...............cccesseecceseeececeeeeeeees 4

B. Congress employed § 10(b)’s exten-

sively litigated “in connection with the

purchase or sale” language to define

SLUSA’s pre-emptive Scope ..............cccceeeeeeeeeeees 6

C. Holder claims were not part of the leg-

islative bargain that produced SLUSA

and are therefore not pre-empted by

SLUSA, as the Second Circuit cor-

I civetnisinecbtiitenastsienitninitbiclcteiisctinines 9

II. HOLDER CLAIMS HOLDER CLASS

ACTIONS PRESENT THEMSELVES IN

A VARIETY OF FACTUAL CONTEXTS

UNDER A VARIETY OF STATE LAW

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TABLE OF AUTHORITIES

Page

CASES

Birnbaum v. Newport Steel Corp., 193 F.2d 461

SIN, TUN ciideisns Aicsttiadepandhpdaicwksniehcplichiaesduinbisicmbessianaaios 12

Blue Chip Stamps v. Manor Drug Stores, 421 U.S.

: SIE NE ccndlastatiduncunianntidtenieniiemanemeintieniaiunbiaied 8, 12

Cipollone v. Liggett Group, Inc., 505 U.S. 504

( ERER RS, LOPE a at NS hs oe SE TOE ae RON 11

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

395 F.3d 25 (2d Cir. 2005) .............ccccccceeeceesserererees 8, 14

Department of Revenue of Oregon v. ACF Indus.,

i, Te ee i citartntacintinticisinicncinmcepietammmpanederinss 8

Disher v. Citigroup Global Markets, Inc., 419 F.3d

649 (7th Cir. 2005), petition for cert. pending, No.

05-776 (U.S. filed Dec. 15, 2005) .0............ccccceseeeeeeeeeees 14

Green v. Ameritrade, Inc., 279 F.3d 590 (8th Cir.

RE SRI LOE IN PS ALE RRS NPY 90 Ps FOO 8

Gustafson v. Alloyd Co., 513 U. _& f: eneeeae 8

Kircher v. Putnam Funds Trust, 403 F.3d 478 (7th

Cir.), petition for cert. pending, No. 05- 409 (U.S.

a i ietateala untied 6, 14

Leroy v. Great Western United Corp., 443 U.S. 173

TI richie inal ncectitte iad hina inisieniaahidasabnadial 5

Medtronic, Inc. v. Lohr, 518 U.S. 470 (1996) ................004. 11

Mutual Funds Inv. Litig., In re, 384 F. Supp. 2d 745

Ss Sas Si iciecedecctenpecieanduehigpeapitinsdtniitpinghcieinbabeiiads 2,14

Penn Dairies v. Milk Control Comm'n, 318 U.S. 261

PSEA SEP Oe eT ee coD peer Smee Oe ay we en NCR ll

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

292 F.3d 1334 (11th Cir. 2002) ...00.00.......ccccescceseeseeeeeee ees 8

Small v. Fritz Cos., 65 P.3d 1255 (Cal. 2003)............. 13, 14

Weinberger v. Kendrick, 698 F.2d 61 (2d Cir.

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Williams v. AFC Enters., Inc., 389 F.3d 1185 (11th

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STATUTES AND RULES

Private Securities Litigation Reform Act of 1995,

Pub. L. No. 104-67, 109 Stat. 737 ............cccseccceseessseeeeees 6

Securities Act of 1933, ch. 38, 48 Stat. 74, codified at

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15 U.S.C. § 77p (§ 16, 48 Stat. 74)... eeeeeeeeeeeeees 5

Securities Exchange Act of 1934, ch. 404, 48 Stat.

881, codified at 15 U.S.C. §§ 78a et seq. .........0:0ecccceecees 5

15 U.S.C. § 78a(2)oeessccccvsesscecsssen MEDIA PI A 9

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15 U.S.C. § 78bb (§ 28, 48 Stat. 881)... eee 5

BE DIELS. 6 PE i nsncicrincccssiideiociinitinhiniaiapeinideitesiusiail 8

Securities Litigation Uniform Standards Act of

1998, Pub. L. No. 105-353, 112 Stat. 3227...............000 2

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LEGISLATIVE MATERIALS

143 Cong. Rec. S$10477 (Oct. 7, 1997) ............cccccccceeeeeeeseees 10

144 Cong. Rec.:

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S. Rep. No. 105-182, 1998 WL 226714 (1998)..................... 9

Hearing on H.R. 7852 and H.R. 8720 Before the

House Comm. on Interstate and Foreign Com-

merce, 73d Cong., 2d Sess. (1934)................ccccseececceeeeseee 5

OTHER MATERIALS

Richard W. Painter, Responding to a False

Alarm: Federal Preemption of State Securities

Fraud Causes of Action, 84 Cornell L. Rev. 1

EE SS a re 4, 5, 6,7

INTEREST OF AMICI CURIAE'

Bulldog Investors, founded in 1993, is a group of pri-

vate investment funds that invest in registered closed-end

mutual funds and other publicly traded companies. Bull-

dog Investors is a leader in shareholder act:.'3sm as an

investment strategy.

Phillip Goldstein is a co-founder and a principal of

Bulldog Investors. He has served as a director of a num-

ber of closed-end funds and is currently a director of the

Mexico Equity & Income Fund, Brantley Capital Corpora-

tion, the Emerging Markets Telecommunications Fund

and the First Israel Fund. Mr. Goldstein is a widely-

quoted expert on value investing, shareholder rights, and

corporate governance.

SUMMARY OF ARGUMENT

Holder claims represent a residual but important class

of cases which arise exclusively under state law. The kind

of injury true holders typically sustain occurs through

acts of corporate misfeasance or malfeasance; such inju-

ries, being derivative in nature, are redressable under

state corporation law through shareholder derivative

suits. On occasion, however, securities holders are injured

directly and when they are, their only recourse is direct

action for damages under state law. Federal securities

laws provide no remedy to holders who are not injured

through their purchase or sale of a security. Similarly,

state corporation law offers holders no remedy in the form

of a derivative action when their injury is a direct one not

derivative of an injury to the corporation itself.

' This brief of amici curiae is submitted on behalf of Bulldog Investors

and Phillip Goldstein. The parties have consented to the filing of this

brief in letters filed with the Clerk. In accordance with Rule 37.6,

counse! states that this brief was authored by counsel and was not au-

thored in whole or in part by counsel for any party. No person or entity,

other than amici and their counsel submitting this brief on behalf of

amici, made a monetary contribution to the preparation or submission

of the brief.

Holders of a security are, on occasion, the investors

most severely injured by the kind of conduct the federal

securities laws proscribe. The mutual fund scandal

brought to light in 2003 is a perfect example of a situation

in which holders are injured to a much greater degree by

wrongdoing than are purchasers or sellers. As one of the

district judges presiding over pending litigation arising

out of that scandal wrote recently, denying holders the

right to sue “would have the supremely ironic effect in

this case of discriminating against victims who suffered

the greater injury.” In re Mutual Funds Inv. Litig., 384

F .Supp.2d 845, 854 n.6 (D. Md. 2005). The Securities Liti-

gation Uniform Standards Act of 1998 (SLUSA) does not

mandate—indeed, properly construed does not permit—

such a “supremely ironic effect.”

The present case also demonstrates the incongruity of

an interpretation of SLUSA which would deny holders

any remedy under either federal or state law. Customers

whom Merrill Lynch fraudulently induced to purchase

junk stocks may seek redress for their injuries under the

federal securities laws. Holders like Shadi Dabit, on the

other hand, whom Merrill Lynch fraudulently induced to

retain junk stocks have only those remedies that state law

may grant him. Holders like Mr. Dabit are no less worthy

victims than defrauded purchasers and their claims pre-

sent no difficulties of proof that do not also burden pur-

chaser plaintiffs. Yet if the Second Circuit's interpretation

of SLUSA is rejected and the Seventh Circuit's accepted,

defrauded purchasers will have their day in federal court,

while defrauded ho'ders will be shut out of all courts,

state and federal.

There is accordingly no legitimate reason to construe

the statutory language of SLUSA, which amends the 1934

Act, any differently than the identical language found in

section 10(b) of the same Act. To interpret the phrase nar-

rowly in section 10(b) (denying holders a federal cause of

action) but broadly in SLUSA (preempting holders’ state

law causes of action) would arbitrarily extinguish all

holder claims of every kind, state or federal. Such a result

is considerably broader than the effect SLUSA has on the

claims of purchasers and sellers. Even though SLUSA

preempts a purchaser's and seller’s state law claims, pur-

chasers and sellers may still assert their claims under

federal law; if they cannot plead such claims in compli-

ance with the requirements of PSLRA, then their claims

are presumably the kinds of “meritless strike suits” Con-

gress intended SLUSA to eliminate. Nothing in SLUSA’s

legislative history even remotely suggests that Congress

had holder claims in mind when it enacted SLUSA, much

less that Congress intended the wholesale obliteration of

all holder claims regardless of their merit.

There is no legitimate reason to construe the operative

language of SLUSA, which amends the Securities Ex-

change Act of 1934 Act, any differently than the identical

language found in section 10(b) of the same Act. To inter-

pret the phrase narrowly in section 10(b) (denying holders

a federal cause of action) but broadly in SLUSA (preempt-

ing holders’ state law causes of action) would arbitrarily

extinguish ail holder claims of every kind, state or federal.

Such a result is considerably broader than the effect

SLUSA has on the claims of purchasers and sellers. Even

though SLUSA preempts a purchaser's and seller’s state

law claims, purchasers and sellers may still assert their

claims under federal law; if they cannot plead such claims

in compliance with the requirements of PSLRA, then their

claims are presumably the kinds of “meritless strike

suits” Congress intended SLUSA to eliminate. Nothing in

SLUSA’s legislative history even remotely suggests that

Congress had holder claims in mind when it enacted

SLUSA, much less that Congress intended the wholesale

obliteration of all holder claims regardless of their merit.

The Second Circuit's conclusion that SLUSA does not

preempt claims alleging fraud or manipulation in connec-

tion with the retention of securities is consistent with the

historically limited reach of the federal securities law; is

consistent with SLUSA’s text, purpose and legislative his-

tory; is consistent with the applicable rules of statutory

construction; and is consistent with the decisions of the

overwhelming majority of federal courts to have ad-

dressed the issue. The decision below should accordingly

be affirmed.

ARGUMENT

I. SLUSA’S TEXT, ITS LEGISLATIVE HISTORY

AND RUDIMENTARY RULES OF STATUTORY

CONSTRUCTION POINT TO THE CONCLUSION

THAT SLUSA DOES NOT PREEMPT HOLDER

CLAIMS.

A. The States have traditionally regulated secu-

rities transactions, and for more than sixty

years federal securities law supplemented

such state authority which Congress explic-

itly preserved and protected.

Prior to 1933, every aspect of securities regulation lay

within the exclusive domain of the States. “Private rights

of action, at common law and in equity, for persons in-

jured in securities transactions preceded state statutes

regulating the sale of securities, and many of those reme-

dies still exist.” Richard W. Painter, Responding to a False

Alarm: Federal Preemption of State Securities Fraud

Causes of Action, 84 Cornell L. Rev. 1, 20 (1998) (hereinaf-

ter “Painter, Responding”). Shareholders were first per-

mitted to band together against corporate managers in

class actions under state law. Jd. at 21-22. In the early

twentieth century, States adopted Blue Sky laws govern-

ing securities transactions. Jd. at 21. Limitations on the

States’ interstate authority hindered the effectiveness of

state laws to combat securities abuses, however. “For ex-

ample, because state securities commissioners could not

extend their authority across state lines, state securities

laws could not control two major waves of securities

frauds, which took place from 1917 to 1920 and in the late

1920s.” Id. at 22-23.

In the aftermath of the 1929 stock market crash, Con-

gress undertook to supplement state law by regulating

interstate sales of securities through enactment of the Se-

curities Act of 1933 (“1933 Act”) and Securities Exchange

Act of 1934 (“1934 Act”). In both statutes, Congress ex-

pressly preserved state law. 1933 Act § 16, 48 Stat. 74, 84;

1934 Act § 28, 48 Stat. 881, 903. See Leroy v. Great West-

ern United Corp., 443 U.S. 173, 182 (1979) (savings clause

served “to protect, rather than to limit, state authority”).

This dual state and federal regime for the regulation of

securities transactions endured from 1933 until the mid-

1990's. Painter, Responding, 84 Cornell L. Rev. at 30-31.

The 1933 and 1934 Acts, which govern interstate sales

of securities are the two major exceptions to the general

rule that otherwise leaves matters of corporate law to the

States. Congress has never seriously considered adopting

a federal corporate law, and none of the legislation Con-

gress has since enacted has ever purported to change this

arrangement, including the reform measures of the

1990's. Painter, Responding, 84 Cornell L. Rev. at 15 (dis-

cussing failed legislative proposals to federalize broad

segments of corporate law).

Thus, for over sixty years federal securities law aug-

mented state law. Congress provided a private right of

action under the 1933 Act for claims reaching fraud “in

the offer of sale” of securities, with respect to which both

state and federal courts may exercise jurisdiction.

15 U.S.C. § 77e. Congress explicitly prohibited the re-

moval of 1933 Act cases from state to federal court.

15 U.S.C. § 77v. The 1934 Act provided additional reme-

dies and included § 10(b), “a catch-all clause to prevent

manipulative devices,” pursuant to which the federal

courts later found an implied right of action. Testimony of

Thomas G. Corcoran, Hearing on H.R. 7852 and H.R.

8720 before the House Committee on Interstate and For-

eign Commerce, 73d Cong., 2d Sess., 115 (1934) (discuss-

ing 9(c) which became § 10(b) of the 1934 Act). Congress

granted federal courts exclusive jurisdiction over 1934 Act

claims. As noted above, however, Congress explicitly pre-

served state law in both the 1933 and 1934 Acts.

B. Congress employed § 10(b)’s extensively liti-

gated “in connection with the purchase or

sale” language to define SLUSA’s pre-emptive

scope.

It is against the backdrop of more than sixty years of

dual state and federal regulation of securities transac-

tions that Congress enacted SLUSA. “[{I]n 1996 much of

the dual-registration regime was dismantled by a Repub-

lican controlled Congress committed to reducing the regu-

latory burden on business. Pursuant to the National Se-

curities Markets Improvement Act of 1996 (‘1996 Act’),

state blue sky laws requiring registration or merit qualifi-

cation no longer apply to ‘covered securities’ ....” Painter,

Responding, 84 Cornell L. Rev. at 29-30. The passage of

SLUSA in 1998 preempted areas of state law.

Even the Seventh Circuit agrees that the Congressional

findings in SLUSA and SLUSA’s legislative history make

unmistakably clear Congress’ purpose in enacting

SLUSA: to close a perceived “federal flight” loophole in

the Private Securities Litigation Reform Act of 1995

(PSLRA). Kircher v. Putnam Funds Trust, 403 F.3d 478,

482 (7th Cir. 2005) (“SLUSA is designed to prevent plain-

tiffs from migrating to state court in order to evade rules

for federal securities litigation in the Private Securities

Litigation Reform Act of 1995.”). Specifically, Congress

was concerned that securities class action lawyers and

their clients were evading the PSLRA’s procedural re-

forms by recasting traditionally federal purchaser or

seller claims as claims based upon state law and filing

them in state courts where the PSLRA does not apply. In

response, Congress enacted SLUSA to preempt such re-

packaged state law claims. SLUSA also makes any such

claims filed in state court removable to federal court.

SLUSA thus makes the remedies provided under federal

securities laws the sole remedies available to most securi-

ties purchasers and sellers who file their claims as class

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