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

Supreme Court brief2006

Ask Donna

What actually matters in this document.

Text

annual reports for years 1994, 1995, and 1996 all of which

contained the false and misleading financial information.

These annual reports, in turn, induced the shareholder to

continue to hold on to his or her stock. {n January 1997,

when the truth about the company is disclosed, the stock

precipitously drops in value, and the shareholder experi-

ences a corresponding loss as a result of his or her continu-

ing to hold the stock in reliance upon these false financial

representations. There can be no doubt that the share-

holder experienced a loss as result of his or her reliance

upon the fraudulent financial representations — the day

before the disclosure of the truth he or she had holdings

that were valued at $X and the day after the truth was

disclosed the holdings were diminished to $X-T (where T

equals the market adjusted value of the stock after taking

into account the impact of the truth).’

Such facts state a prima facie claim for common law

fraud. Misrepresentations, reliance, action taken in

reliance upon the misrepresentations, injury and damage

- a paradigm common law fraud claim. Moreover, by

definition it is an action that is not seeking damages

arising out of frauds made in connection with tie purchase

or sale of a security.

* The above fact pattern is similar to one that occurred with

Mercury Finance Company, a Wall Street darling stock that reported 48

quarters of ever increasing profits only to restate 3 years of financial

reporting to reflect that it had, in fact, been losing money throughout

those years. A holder action brought in that matter has been certified as

a class action and, in fact, is an example of how such an action can be

certified as a class and achieve procedural efficiencies for state courts

while providing justice for defrauded shareholders. See, Dloogatch v.

Brincat, 97CH8790, Circuit Court of Cook County, Illinois, Chancery

Division, July 31, 2003 Memorandum Opinion and Order, Appendix at

App. 1.

There is nothing novel or cutting edge about such a

claim. Simply stated, a “holder” claim is a straightforward

state law common law fraud or misrepresentation claim. It

is brought on behalf of a shareholder who has been de-

frauded into retaining (as opposed to purchasing or

selling) a security. It does not seek damages arising out of

frauds perpetrated in connection with the purchase or sale

of securities. Rather, the gravamen of the claim is that at

some point in time after the shareholder acquired the

securities in question, the shareholder was fraudulently

induced to continue to hold the subject securities until

such time as the truth became public. This is the para-

digm “holder” claim.

Moreover, contrary to what some counsel and courts

have assumed, a “holder” claim does not require proof of

whether a shareholder was induced to refrain from selling

his or her stock at some point in time. It is this phantom

element that has given some courts and commentators

pause. They posit that it will open up the possibility of

manufactured intentions to sell. As a threshold matter, the

possibility of manufactured testimony with respect to the

intent to sell is no basis to extinguish an entire cause of

action. Numerous civil disputes revolve around proof of a

person’s intent and in turn the proof is based upon oral

testimony regarding the witness’ intent. Countless defen-

dants accused of fraud have testified that they did not

intend to commit fraud only to be found liable for fraud.

Most important, however, is that proof of intention to

sell at some prior point in time, while certainly an option,

is not a required element of a “holder” claim. Rather, the

claim is a typical common law claim alleging that defen-

dant’s misrepresentations anc plaintiff’s reliance on same

induced plaintiff to take an affirmative act — that of

continuing to hold on to the subject securities, until the

truth was disclosed and as a result plaintiff was damaged

when the disclosure of the truth caused the stock to drop

in value.

Likewise, as this Court may have already seen in its

review of the most recent lower court decisions dealing

with “holder” claims, there is some confusion both within

the bar and the bench as to what is a “holder” claim.

Section 10(b) claimants purchased their securities and

then continued to hold them until the fraud was disclosed.

As a result, some cases, which are really purchaser fraud

actions, have been pled as “holder” claims on behalf of

shareholders who purchased their stock when the frauds

were occurring and thus could have brought timely federal

securities fraud actions.

NASCAT and AARP respectfully submit that such

class actions are preempted by SLUSA and we have no

problem with the proposition that SLUSA preempts state

law based class actions on behalf of persons who pur-

chased their securities within three years of the disclosure

of the fraud, whether the case is styled as a holder/

purchaser action or as a holder action. Such persons had

valid Section 10(b) claims and were precisely the sort of

state law class actions that Congress intended to prohibit

us preempt: State law class actions brought on

behalf of classes that include persons who had valid

purchaser or seller claims under Section 10(b) of the 1934

Act.

There is a “hybrid” action, when purchaser claimants

and holder claimants are lumped into one class of state

law fraud claimants, which should also be preempted

under SLUSA to the extent that plaintiffs insert or include

purchaser claims in the class. Where, however, a class

action is brought on behalf of investors who acquired their

securities before the commencement of the actionable

Section 10(b) fraud,’ and the action is strictly limited to

claims for damages arising from these investors being

fraudulently induced tc continue to hold on to their securi-

ties, such an action is not and should not be preempted

under SLUSA. See, e.g., Gordon v. Buntrock, 2000 WL

556763,*4 (N.D. Ill. April 28, 2000).

* The Second Circuit appears to hold that only “holder” claimants

who acquired their shares prior to the commencement of the scheme to

defraud can avoid the reach of SLUSA. In its view, if one bringing a

“holder” claim purchased the security in question at a time when the

frauds were alleged to have been occurring, even though it was over

three years prior to the discovery of the fraud, any such claims brought

as a class action should be preempted under SLUSA. NASCAT and

AARP respectfully submit that this is the only error in the Second

Circuit’s approach. As discussed in greater detail below, SLUSA was

intended to bar class action claims that could have been brought in

federal court from being brought in state courts. If a defrauded investor

has a potential Section 10(b) claim that is barred due to the three-year

statute of limitations, this should not preclude her from pursuing, on a

class basis, a separate and independent holder claim. The two claims

are entirely distinct; indeed, they have entirely different elements and

involve entirely different damages. In fact, it would work a severe

injustice if investors who were the victims of a fraud that spanned five

years were barred from seeking any recovery whatever merely because

the perpetrators of the fraud were able to cover their tracks for a period

beyond the three-year federal statute of limitations. Again, in the

absence of Congress’s clearly expressed intention that such claims

should be preempted, it is respectfully submitted that these claims are

not within the ambit of SLUSA.

II. History of Holder Claims

A. Pre 1933 and 1934 Acts

The states traditionally regulated securities fraud

through common law torts such as fraud and negligent

misrepresentation, stockholder derivative suits, and blue

sky legislation. See Joshua D. Ratner, Stockholders’

Holding Claim Class Actions Under State Law After the

Uniform Standards Act of 1998, 68 U. Chi. L. Rev. 1035,

1037 (2001) (hereinafter, “Ratner Stockholders’ Holding

Claims”). From early on, most states that considered the

issue recognized “holder claims” — i.e., claims based on

allegations that misrepresentations induced forbearance

from selling stock. See, e.g., David v. Belmont, 291 Mass.

450, 197 N.E. 83 (1935) (alleging fraud inducing retention

of stock shareholder would otherwise have sold); Fottler v.

Moseley, 179 Mass. 295, 60 N.E. 788 (1901) (holding

plaintiff stated claim for fraud against broker whose

misrepresentations induced him to refrain from selling

stock); Duffy v. Smith, 28 Vroom 679, 57 N.J.L. 679, 32 A.

371 (1895) (plaintiff fraudulently induced to buy stock

could recover for period of retaining stock in reliance on

same misrepresentation); Continental Insurance Co. v.

Mercadante, 222 A.D. 181, 183-84, 225 N.Y.S. 488, 490-91

(1927) (considering claim for “fraud in inducing, not

purchase of the bonds, but their retention after purchase,”

and holding that “plaintiffs cannot be denied redress

because their conduct was inaction, rather than action”).*

See also, Rothmiller v. Stein, 98 Sickels 581, 38 N.E. 718,

* It should also be noted that what might be perceived as inaction

(e.g., not selling the stock) is actually an affirmative act that has been

induced by the fraud — that act being the continued holding and

retention of the stock.

719 (N.Y. 1894) (rejecting argument that plaintiff failed to

state a claim based on allegations that he refrained from

selling his stock based on defendant’s misrepresentations);

Gutman v. Howard Savings Bank, 748 F. Supp. 254, 264

(D.N.J. 1990) (holding that inaction induced by defen-

dants’ representations can establish the element of reli-

ance in a common law securities fraud claim); see also

Small v. Fritz Companies, Inc., 30 Cal. 4th 167, 132 Cal.

Rptr. 2d 490, 65 P.3d 1255 (2003).

Congress enacted the first federal laws regulating

securities in the early 1930’s in response to the stock

market crash of 1929. See Ratner, Stockholders’ Holding

Claim, 68 Chi. L. Rev. at 1042. Congress passed the 1933

Act and the 1934 Act because the states had been ineffec-

tive in regulating nationally traded securities. Id. at 1042

(citing Richard W. Painter, Responding to a False Alarm:

Federal Preemption of State Securities Fraud Causes of

Action, 84 Cornell L. Rev. 1, 24-25 (1998) (hereinafter

Painter, Responding to a False Alarm) (noting that states

were ineffective as the sole regulators of nationally traded

securities because of state securities commissioners’

inability to extend their authority across state lines).

Despite Congress’ concerns, each Act explicitly allowed

concurrent securities regulation by the states. See Ratner,

Stockholders’ Ho‘ding Claim, (citing Painter, Responding

to a False Alarm, 84 Cornell L. Rev. at 24-25 (noting that

Section 18 of the 1933 Act did not affect the jurisdiction of

state securities commissions and bestowed concurrent

state and federal court jurisdiction and that while the

1934 Act gave federal courts exclusive jurisdiction over

claims under that statute, Section 28(a) specifically

protected blue sky laws from federal preemption). See also

15 U.S.C. § 77r (1933 Act’s provision granting concurrent

jurisdiction); 15 U.S.C. § 78bb(a) (1934 Act’s provision

granting concurrent jurisdiction).

Section 10(b) of the 1934 Act enabled the SEC to enact

rules and regulations regarding the use of manipulative

and deceptive devices in relation to the purchase or sale of

securities. 15 U.S.C. § 78j(b); see Basic Inc. v. Levinson,

485 U.S. 224, 230 (1988). Among other things, the 1934

Act included extensive disclosure requirements. Basic, 485

U.S. at 230. Under the authority granted by the 1934 Act,

in 1942 the SEC promulgated a regulation making it

unlawful for any person ... (a) [tlo employ any

device, scheme cr artifice to defraud, (b) [t]o

make any untrue statement of a material fact or

to omit to state a material fact necessary in order

to make the statements made, ... not mislead-

ing, or (c) [tlo engage in any act, practice or

course of business which operates or would oper-

ate as a fraud or deceit upon any person, in con-

nection with the purchase or sale of any security.

17 C.F-R. § 240.10b-5 (emphasis added).

Following the enactment of the 1933 and 1934 Acts, it

became apparent that private suits were important to

supplement gcsvernment enforcement actions. Ratner,

Stockholders’ ..olding Claims, 68 U. Chi. L. Rev. at 1043.

In response to this acknowledged need, the lower federal

courts found an implied (or inferred a) private right of

action to enforce Section 10(b) of the 1934 Act and SEC

Rule 10b-5, and this Court endorsed this view in 1988.

Ratner, Stockholders’ Holding Claim, 68 U. Chi. L. Rev. at

1043; Basic, 485 U.S. at 230-31. In Birnbaum v. Newport

Steel Corp., 193 F.2d 461, 463 (2d Cir. 1952), the Second

Circuit interpreted SEC Rule 10b-5 as aimed only at “a

fraud perpetrated upon the purchaser or seller’ of securi-

ties and as having no relation to breaches of fiduciary duty

by corporate insiders resulting in fraud upon those who

were not purchasers or sellers.” The Birnbaum court's

interpretation of Rule 10b-5 barred holder’s actions under

that rule.

In 1975, this Court agreed that Rule 10b-5 did not

permit holder actions. Blue Chip Stamps, 421 U.S. at 733,

749. This Court recognized, however, that completely

barring holders’ actions would result in injustice by deny-

ing relief to victims of fraud. The Court concluded that

because its decision was limited to actions under Rule 10b-

5, such injustice would not occur because defrauded

stockholders still have a remedy in state court. As this

Court stated:

A great majority of the many commentators on

the issue before us have taken the view that the

Birnbaum limitation on the plaintiff class in a

Rule 10b-5 action for damages is an arbitrary re-

striction which unreasonably prevents some de-

serving plaintiffs from recovering damages which

have in fact been caused by violations of Rule

10b-5. . .. We have no doubt that this is indeed a

disadvantage of the Birnbaum rule, and if it had

no countervailing advantages it would be unde-

sirable as a matter of policy. . . .

Blue Chip Stamps, 421 U.S. at 738-39. This Court further

observed:

Obviously this disadvantage is attenuated to the

extent that remedies are available to nonpur-

chasers and nonsellers under state law. Cf. § 28

of the 1934 Act, 15 U.S.C. § 78bb. See Iroquois

Industries, Inc. v. Syracuse China Corp., 417 F.2d

963, 969 (C.A.2 1969), cert. denied, 399 U.S. 909,

90 S.Ct. 2199, 26 L.Ed.2d 561 (1970). Thus, for

example, in Birnbaum itself, while the plaintiffs

found themselves without federal remedies, the

conduct alleged as the gravamen of the federal

complaint later provided the basis for recovery in

a cause of action based on state law. See 3 L.

Loss, Securities Regulation 1469 (2d ed. 1961).

And in the immediate case, respondent has filed

a state-court class action held in abeyance pend-

ing the outcome of this suit. Manor Drug Stores

v. Blue Chip Stamps, No. C-5652 (Superior

Court, County of Los Angeles, Cal.).

Id. at 739 n.9.

In short, as this Court recognized in Blue Chip

Stamps, while there may have been policy reasons for

limiting federal claims to purchasers and sellers, it would

be unjust to deprive wronged stockholders who are not

sellers or buyers a remedy; and that injustice is only

avoided if such stockholders can maintain a lawsuit or

retain a remedy in state court.

}

B. Post Blue Chip Stamps

Subsequent to Blue Chip Stamps “holder” claims slid

into what might be described as a dormant period due to

reasons unrelated to any federal law concerns. The leading

state Supreme Court issued a series of decisions that

created ambiguity as to whether a “holder” claim could be

brought as a “direct” claim or was, in fact, a “derivative”

claim. Cf Lipton v. News Intern., PLC, 514 A. 2d 1075,

1078 (Del. 1986) (adopting “special injury” test), with

Kramer v. Western Pacific Industries, Inc., 546 A. 2d 348

(Del. 1988) (applying “nature of the wrong” test). For the

most part, other state courts, following the Delaware

Supreme Court’s lead, incorporated this ambiguous line of

cases into their corporate laws. See, e.g., Loewen v. Galli-

gan, 130 Or. App. 222, 228-29, 882 P.2d 104, 111-12 (Or.

App. 1994).°

This ambiguity, however, was resolved by the Dela-

ware Supreme Court in a series of decisions starting with

_ Malone v. Brincat, 722 A. 2d 5 (Del. 1998). In that case, a

class action was brought on behalf of Mercury Finance

shareholders seeking to recover damages arising out of a

financial fraud that spanned more than three years. Id. at

7. The lower court had dismissed the action with prejudice

as being derivative. The Delaware Supreme Court re-

versed and remanded, holding that a valid claim for

damages arising out of fraudulent financial reporting

could be brought by shareholders as a “direct” claim in

their capacity as shareholders." Jd. at 14. Subsequently, in

Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A. 2d

1031, 1037 (Del. 2004) the Delaware Supreme Court

rejected the “special injury” test and thus cleared the way

for direct claims to be brought on behalf of shareholders

for frauds whose disclosure thereafter caused a diminution

in the value of their securities. In a similar fashion, the

* The confusion arose from an initial formulation that held that

any conduct that caused a diminution in value of the stock as to all

shareholders as a whole was deemed to be a derivative claim. Jd.

* Malone was a related case to the previously cited Dloogatch v.

Brincat in which a class of holder claimants was certified.

Supreme Court of California also recognized that holder

actions were valid and could be brought under California

law. See Small, 39 Cal. 4th at 176, 132 Cal. Rptr. 2d at

496, 65 P.3d at 1260 (2003).

Ill. State Courts Should Be Allowed To Freely

Develop The Law Regarding Holder Claims

And Whether Such Claims Can Be Brought As

Class Actions

Because the lower federal courts have declined to

exercise subject matter jurisdiction over such “holder“

claims since Blue Chip Stamps, resolving whether such

“holder” claims are valid under the common law is, quite

obviously, a question that has been and must be left to the

respective state courts. In those states where “holder”

claims have already been recognized, individual actions

should be allowed to proceed and, by definition, cannot

and will not be preempted by SLUSA. As a result, large

individual investors who have substantial “holder” dam-

ages (and, thus, can economically afford to bear the substan-

tial costs involved in pursuing such fraud claims) will have

appropriate state court forums to vindicate their “holder”

claims. Smaller investors who have been similarly harmed,

however, will not be able to vindicate their claims unless

they have the opportunity to pursue them as class actions.

Under their broad police powers and in the absence of

a clear intention by Congress to preempt such claims, the

states’ legitimate interest in determining whether and how

to protect both large individual “holder” claimants and

smaller claimants who may need to join together in a class

action should remain intact. Moreover, there is no reason

why the individual states should be precluded from deter-

mining whether “holder” claims, under the appropriate

circumstances, should proceed as class actions. To allow

SLUSA to preempt “holder” class actions, on the other

hand, would produce a perverse result. Large “holder”

claimants would be allowed to pursue their claims in state

court. Small “holder” claimants, to the extent that it would

not be economical to bring their claims on an individual

basis, would for all practical purposes be denied the

opportunity for any relief whatsoever if such class actions

were preempted under SLUSA.

Removal of state law based “holder” class actions

would extinguish any right to pursue a class action for

such claims because, under Blue Chip Stamps, holder

claimants do not have standing under Section 10(b) of the

1934 Act. In contrast, small purchaser claimants whose

state law claims can be brought as class actions under

Section 10(b) do not have their right to pursue a class

extinguished under SLUSA upon removal. They retain the

right to pursue a class action under Section 10(b) if one

has not already been brought. If a federal class action has

already been brought, then at least their claims have the

opportunity to be vindicated via a class action.

Thus, if SLUSA preempts their state law based class

action, only small “holder” claimants are left with no

opportunity to seek relief through the class action proce-

dure. Yet, nothing in the language of SLUSA or in its

legislative history indicates that Congress intended to

completely extinguish the ability of any claimants to bring

class actions, let alone “holder” claimants. Rather, Con-

gress wanted to make sure that the practice of bringing

state law based purchasers class actions to avoid the

application of the PSLRA to claims that could have been

brought under Section 10(b) would be governed by the

PSLRA if the defendant chose to remove the action to

federal court. On this record, there is just no basis to

justify the usurpation of what clearly is a state interest

and state prerogative — the protection of smaller holder

claimants who are defrauded and who, by definition, have

no federal class action remedies.

Clearly, if such a result is to be achieved it can only be

done pursuant to a clearly worded statute directed at this

precise issue and not by an obtuse, convoluted misreading

of the current statute as reflected in the Seventh Circuit’s

opinion in Kircher.

For this reason numerous courts have held that state

law claims of misrepresentations or omissions that induce

the plaintiff to retain stock can proceed in state court

consistent with SLUSA. See, e.g., Hardy v. Merrill Lynch,

Pierce, Fenner & Smith, Inc., 189 F.Supp. 2d 14, 18

(S.D.N.Y. 2001); Dacey v. Morgan Stanley Dean Witter &

Co., 263 F. Supp. 2d 706, 712 (S.D.N.Y. 2003); Gutierrez v.

Deloitte & Touche, L.L.P, 147 F.Supp. 2d 584, 595

(W.D.Tex. 2001); Lalondriz v. U.S.A. Networks Inc., 68

F. Supp. 2d 285, 286 (S.D.N.Y. 1999); Gordon v. Buntrock,

2000 WL 556763, *4 (N.D. Ill. April 28, 2000); see also

Hines v. ESC Strategic Funds, Inc., 1999 WL 1705503, *6

(M.D.Tenn. Sept. 17, 1999) (“Because Plaintiff has alleged

that the defendants’ breach of their fiduciary duties

resulted from their actions after she purchased her shares,

Plaintiff’s post-sale allegations are sufficient to withstand

a motion to dismiss” based on SLUSA). As set forth below,

there is good reason for this consensus.

IV. SLUSA Does Not Preempt State “Holder”

Claims

It is through the prism of both the long history of

judicial decisions interpreting the phrase “in connection

with the purchase or sale of any security” as part of Rule

10b-5 jurisprudence and the purpose of SLUSA by which

the phrase “in connection with the purchase or sale of a

covered security” in SLUSA should be viewed. Although

the starting point of statutory construction is the language

of the statute itself, Blue Chip Stamps, 421 U.S. at 756

(Powell, J., concurring), the phrase in question was not

written on a blank slate, but after decades of use and

interpretation by this Court and lower federal courts.

“(W]here Congress uses terms that have accumulated

settled meaning under either equity or the common law, a

court must infer, unless the statute otherwise dictates,

that Congress means to incorporate the established

meaning of these terms.” Riley v. Merrill Lynch, Pierce,

Fenner & Smith, Inc., 292 F.3d at 1342 (11th Cir. 2002).

A. Purpose of PSLRA and SLUSA

In 1995, in response to perceived abuses of the federal

securities laws through the filing of class actions of dubi-

ous or no merit, Congress passed the PSLRA. See Private

Securities Litigation Reform Act of 1995, H.R. Conf. Rep.

No. 104-369, *32 (Nov. 28, 1995), reprinted in 1995 U.S.

Code Cong. Admin. News 730 (“the abuse of the discovery

process [] impose[s] costs so burdensome that it is often

economical for the victimized party to settle”). See also

Greebel v. FTP Software, Inc., 194 F.3d 185, 191 (1st Cir.

1999) (PSLRA passed to curb abuse in private securities

lawsuits). In addition to enacting certain procedural

requirements concerning publication of the filing of an

action and appointment of lead plaintiff, the PSLRA

codified “loss causation” requirements, established a safe

harbor for forward-looking statements, and raised the

pleading requirement for the required state of mind. See

15 U.S.C. § 78u-4(b\(4) (codifying loss causation); 15

U.S.C. § 78u-5 (codifying safe harbor); 15 U.S.C. § 78u-

4(b)(2) (codifying scienter requirements). The response of

some defrauded investors was to file their purchaser cases

in state court, thereby avoiding some of the PSLRA’s more

onerous requirements. In 1998 Congress enacted SLUSA

in response to this perceived end run around the PSLRA.

“Driving enactment of SLUSA was Congress’ finding that

litigants eluded PSLRA’s reach with relative ease. Con-

fronted with more onerous procedural requirements and

dimmed prospects of success under the PSLRA, litigants

simply abandoned use of federal courts and filed suit in

state court under state securities laws.” Spielman uv.

Merrill Lynch, Pierce, Fenner & Smith, Inc., 332 F.3d 116,

123 (2d Cir. 2003). Thus SLUSA’s intended purpose was to

ensure that actions which were actionable under federal

securities laws would be brought in federal court and

subject to the PSLRA’s strict requirements.

B. Scope of Private Remedies Under Federal

Securities Laws

A private cause of action under Section 10(b) of the

1934 Act, prior to the PSLRA, was an implied cause of

action because private actions under Section 10(b) were

not specifically authorized in the 1934 Act. See Gustafson

v. Alloyd Co., 513 U.S. 561 (1995). As explained supra, this

‘changed in 1995 when the PSLRA codified certain ele-

ments of a cause of action under Section 10(b), including

loss causation and scienter.

Since the contours of a private action under Section

10(b) were shaped by judicial opinions without tbe benefit

of statutory guidance, the federal courts were left to decide

issues such as standing on their own. In the decades that

followed the 1930s and 1940s, the prevailing view on

standing under Section 10(b) became the Second Circuit’s

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

(2d Cir. 1952). Birnbaum held that a plaintiff had to

actually purchase or sell a security in order to satisfy the

“in connection with” requirement of SEC Rule 10b-5. Jd. at

463-64. In Blue Chip Stamps, this Court adopted the

Birnbaum rule, holding that the “in connection with”

requirement for a private action under Rule 10b-5 could

only be met by a plaintiff who had actually purchased or

sold the securities in question. Blue Chip Stamps, 421 U.S.

at 754-55.

Blue Chip Stamps was premised on a balancing of the

advantages and disadvantages of including non-

purchasers and non-sellers within the ambit of protection

under the implied cause of action under Section 10(b) of

the 1934 Act.’ The advantages of the restrictive Birnbaum

rule were that it would eliminate what the Court per-

ceived as speculative claims flooding the federal courts* —

” In Blue Chip Stamps this Court found this balancing proper since

private actions were a “judicial oak which ha[ve] grown from little more

than a legislative acorn,” and neither the 1934 Congress nor the SEC in

1942 anticipated the state of Rule 10b-5 in 1975. Jd. at 737.

* This was particularly true for “ - warted” purchaser claims where

the gravamen of the claim would ve that the frauds discouraged

(Continued on following page)

claims which would be harder to dispose of via pre-trial

procedures because the claim might ultimately hinge on

oral testimony concerning whether ti plaintiff would

have bought the stock. Jd. at 742. By adopting the Birn-

baum rule, this Court found that there would at least have

to be some objective evidence regarding the fact that a

purchase or sale took place. Id. at 747.° The disadvantage

of the Birnbaum rule were that potential meritorious

shareholder claims would be barred from the federal

courts. Id. at 738-39.

C. The Second Circuit’s Decision Is Correct

1. The Court Properly Considered Long-

standing Interpretations Of “In Connec-

tion With”

It was proper and correct for the court below to

consider the established meaning of “in connection with”

when construing the parameters of SLUSA.

In enacting SLUSA.. . Congress was not writing

on a blank slate; instead it was legislating in an

investors from purchasing a particular stock. This sort of claim could be

manufactured based upon oral testimony any time a stock precipitously

increased in value and would, quite obviously, present problems. In

contrast, a “holder” claim is subject to objective evidence — a holder

claimant actually owns the stock in question. The only issue that might

be subject to oral testimony is whether the investor relied on the

frauds. In cases not involving fraud on the market, investors must

establish their reliance and this normally is accomplished through oral

testimony.

* The same objective evidence exists for “holder” claimants - they

own the stock and whether they owned it during the fraud period can

also be objectively established.

area that had engendered tremendous amounts

of litigation and received substantial judicial at-

tention ... [Congress] was using language that,

at the time of SLUSA’s enactment, had acquired

settled, and widely-acknowledged, meaning in

the field of securities law, through years of judi-

cial construction in the context of § 10b-5 law-

suits.

Riley, 292 F.3d at 1342-43. It is valid to assume that

Congress, when it used the phrase “in connection with” in

SLUSA, was using its accepted meaning in the federal

securities laws. Dabit v. Merrill Lynch, Pierce, Fenner &

Smith, Inc., 395 F.3d 25, 36 (2d Cir. 2005); Riley, 292 F.3d

at 1343. The circuit courts that have adopted this ap-

proach simply followed this Court’s established precedent.

“When ... judicial interpretations have settled the mean-

ing of an existing statutory provision, repetition of the

same language in a new statute indicates, as a general

matter, the intent to incorporate its . . . judicial interpreta-

tions as well.” Bragdon v. Abbott, 524 U.S. 624, 645 (1998);

see also Lorillard v. Pons, 434 U.S. 575, 581 (1978) (Con-

gress can be presumed to have knowledge of interpreta-

tions of law incorporated into a new statute).

2. The Standing Rule of Blue Chip

Stamps Is Properly Applied to SLUSA’s

“In Connection With” Language

In this case, the Second Circuit aptly stated:

If the “in connection with” phrase is read to reach

the same conduct under SLUSA as it does under

§ 10(b) and Rule 10b-5, then SLUSA will preempt

precisely those state class actions which could

be brought as federal actions subject to the

heightened requirements of the PSLRA. If it

were otherwise, actions might be preempted for

meeting all of SLUSA’s requirements, including

the “in connection with” term, but not be capable

of being brought under federal law for failure to

meet the parallel requirement of Rule 10b-5, a

result that the legislative history does not sug-

gest Congress intended to produce in enacting

SLUSA.

Dabit, 395 F.3d at 36. The Dabit court was absolutely

correct in finding SLUSA was merely meant to preempt

federal actions masquerading as state actions, and not

meant to preempt state actions which never could be

brought as federal actions.

The Dabit court correctly applied the Blue Chip

Stamps standing rule. The Second Circuit reviewed the

claims of two distinct class action plaintiffs, Shadi Dabit, a

former Merrill Lynch broker; and IJG Investments Lim-

ited Partnership and Irlys Guy (collectively, “IJG”). Id. at

28-29. In the cases of both Dabit and IJG, the Second

Circuit carefully examined each of the plaintiffs’ claims for

any allegation that was “in connection with” or “coincided

with” a security transaction, and where it found that the

allegation included a transaction that fell within the Blue

Chip Stamps rule, that claim was dismissed as preempted

under SLUSA.

3. SLUSA Does Not Completely Preempt

All State Class Actions Which Might

Involve Publicly Traded Securities

This Court has held that “in deciding if federal law

preempts state law ... we start with the assumption that

the historic police powers of the States were not to be

superseded by the Federal Act unless that was the clear

and manifest purpose of Congress.” City of Milwaukee v.

States of Illinois and Michigan, 451 U.S. 304, 316 (1981).

The express language of SLUSA does not provide that all

state actions involving publicly traded securities are

preempted. In fact, it states just the opposite namely, that

it is intended to “prevent certain State private securities

class action lawsuits alleging fraud from being used to

frustrate the objectives” of the PSLRA, Securities Litiga-

tion Uniform Standards Act of 1998, Pub. L. No. 105-353,

112 Stat. 3227 (emphasis added). Because the objectives of

the PSLRA concerned only federal securities lawsuits

permitted under the Blue Chip Stamps rule, other state

private actions which historically were excluded from the

ambit of Section 10(b) could not possibly have been the

target. Further, there is nothing in the legislative history

of SLUSA to indicate that was Congress’ intent.

The conference report states the purpose of SLUSA is

“to prevent plaintiffs from seeking to evade the protections

that Federal law provides against abusive litigation by

filing suit in State, rather than in Federal, court.” Securi-

ties Litigation Uniform Standards Act of 1998, H.R. Conf.

Rep. No. 105-803, at 13, 1998 WL 703964 (Oct. 9, 1998).

The protection federal law provided against supposedly

abusive litigation were the procedural and pleading

requirements imposed by the PSLRA, which only applied

to lawsuits which could be filed in federal court in the first

instance. Thus there is no support either in the text of the

statute or the legislative history of SLUSA for a finding

that it preempts every possible state class action involving

publicly traded securities, including those which could

never have been filed in a federal court.

V. The Seventh Circuit’s Decision In Kircher Is

Premised On Faulty Assumptions

In Kircher, the Seventh Circuit misinterpreted Blue

Chip Stamps and SLUSA and it therefore reached the

incorrect decision when it held that “holders” claims

satisfied the “in connection with” requirement of SLUSA

and were preempted. Kircher contained a lengthy discus-

sion of Blue Chip Stamps and how the decision reflected a

policy decision to limit private causes of action to actual

purchasers or sellers. 405 F.3d at 482-83. However,

Kircher went awry when it stated:

It would be more than a little strange if the Su-

preme Court’s decision to block private litigation

by non-traders became the opening by which that

very litigation could be pursued under state law,

despite the judgment of Congress (reflected in

SLUSA) that securities class actions must pro-

ceed under federal securities law or not at all.

Id. at 484. This holding reflects a misunderstanding of

both SLUSA and Blue Chip Stamps. As explained supra,

SLUSA was passed to ensure that actions which are

subject to the federal securities laws are filed in federal

court, subject to the rigors of the PSLRA, and not under

parallel state provisions. It was not meant to ensure that,

as Kircher stated “securities class actions must proceed

under federal securities laws or not at all.” Moreover,

while the Blue Chip Stamps court did block private litiga-

tion by non-traders, it did so only in federal court under

the federal securities laws, and only because, inter alia,

those non-traders could pursue remedies under state law.

Blue Chip Stamps, 421 U.S. at 739 n.9. It would be “more

than a little strange” not to allow these purely state cases

to be pursued in state court, especially when it was the

judgment of Congress simply not to allow federal cases to

be filed in state court. There is no evidence Congress

meant to preempt claims which never could have been

filed in federal court in the first place.

CONCLUSION

Accordingly, NASCAT and AARP respectfully request

this Court affirm the decision of the Second Circuit in this

matter.

Respectfully submitted,

STEWART M. WELTMAN*

COHEN, MILSTEIN, HAUSFELD &

TOLL, P.L.L.C.

39 South LaSalle Street,

Suite 1100

Chicago, IL 60603

(312) 357-0370

KEVIN P. Roppy

WILENTZ, GOLDMAN & SPITZER, PA

90 Woodbridge Center Drive,

Suite 900

Woodbridge, NJ 07095-0958

(732) 636-8000

DEBORAH ZUCKERMAN

AARP FOUNDATION

601 E Street, NW

Washington, D.C. 20049

(202) 434-2060

BRIAN P. MURRAY

LAWRENCE D. McCABE

MURRAY, FRANK & SAILER LLP

275 Madison Avenue, Suite 801

New York, NY 10016

(212) 682-1818

CAROL V. GILDEN

MELINDA J. MORALES

MUCH, SHELIST, FREED, DENENBERG

AMENT & RUBENSTEIN, PC

191 North Wacker Drive,

Suite 1800

Chicago, IL 6060€

(312) 521-2000

e 1 for Amici Curi

National Association of

Shareholder and Consumer

Attorneys and AARP

*Counsel of Record

December 16, 2005

App. 1

IN THE CIRCUIT COURT OF COOK COUNTY,

ILLINOIS COUNTY DEPARTMENT

CROFT, MERCURY FINANCE

COMPANY, and KPMG PEAT

MARWICK,

Defendants.

- CHANCERY DIVISION

MICHAEL DLOOGATCH, on __—+)

behalf of himself and all others )

similarly situated, )

ws )

Plaintiff, ) No. 97 CH 8790

Vv. Judge

JOHN N. BRINCAT, JOHN N. ?) Patrick E. McGann

BRINCAT, JR., WILLIAMC. )

) Cal. 6

)

MEMORANDUM OPINION AND ORDER

Plaintiff Michael Dloogatch, on behalf of himself and

all others similarly situated, moves, pursuant to Section 2-

801 of the Dllinois Code of Civil Procedure, 735 ILLS 5/2-

801, to certify a class of “people who owned the common

stock of Mercury Finance Company on or before February

23, 1994 and held their stock through and including

January 29, 1997.” Defendant KPMG Peat Marwick

(“KPMG”) objects to class certification with respect to each

of Section 2-801's requirements.

I. FACTS

Plaintiff Michael Dloogatch (“Plaintiff” or “Dloogatch”)

has entered into a class-wide settlement agreement with

Mercury Finance Company (“Mercury”) and the individual

defendants. KPMG, who acted as Mercury's accounting

App. 2

firm and independent auditor of its financial statements,

is the only remaining defendant in this cause. In the

complaint, plaintiff seeks recovery against KPMG for

negligence, negligent misrepresentation and common law

fraud, claiming that during the period from February 23,

1994 through January 29, 1997, KPMG issued to the class

members, all of whom were shareholders in Mercury, false

and misleading auditor’s letters certifying the accuracy of

Mercury’s financial statements that falsely portrayed

Mercury's revenues, earnings and financial condition.

Plaintiff seeks to certify a class of holders of Mercury

stock that owned Mercury stock on the last day before the

fraud began, February 23, 1994, and who held their stock

during the three-year period when the fraud was revealed

on January 29, 1997. On January 29, 1997, Mercury

announced that previously reported net income for the

fiscal years 1993 through 1996 would be restated due to

the discovery of accounting irregularities. According to the

plaintiff, those false and misleading financial statements

and auditor’s letters misled the holders into believing that

Mercury was a going concern with a bright future, only to

experience substantial losses when the truth about Mer-

cury’s poor financial condition was disclosed on January

29, 1997. The plaintiff claims that he and the remaining

members of the proposed class would not have held onto

the stock, if not for the false reported earnings and audi-

tor’s letters.

Plaintiff has defined the class as:

All persons who purchased common stock of Mer-

cury Finance Company prior to February 23,

1994 and held such stock through and including

January 29, 1997. Excluded are KPMG and any

entity which KPMG has a controlling interest or

App. 3

which is a parent or subsidiary of or is controlled

by KPMG, and the officers, directors, employees,

affiliates, legal representatives, heirs, successors

and assigns of KPMG.

II. DISCUSSION

Section 2-801 of the Illinois Code of Civil Procedure,

735 ILCS 5/2-801, provides for the maintenance of a class

action in Illinois. Under this section, the court must find

that: (1) the class is so numerous that joinder of all mem-

bers is impracticable; (2) there are questions of fact or law

common to the class, which common questions predomi-

nate over any questions affecting only individual mem-

bers; (3) the representative parties will fairly and

adequately protect the interest of the class; and (4) the

class action is an appropriate method for the fair and

efficient adjudication of the controversy.

In deciding whether to certify a class, a court may

consider “any matters of fact or law properly presented by

the record, including the pleadings, depositions, affidavits,

answers to interrogatories and any evidence that may

have been adduced at the hearings.” Charles Hester

Enterprises, Inc. v. Illinois Founders Insurance Co., 137 Il.

App. 3d 84, 100 (5th Dist. 1985). This decision is left to the

sound discretion of the trial judge and will be disturbed

only upon a finding of a clear abuse of discretion or the

application of impermissible legal criteria. Slimack v.

County Life Insurance Co., 227 Ill. App 3d 287, 292. (5th

Dist. 1992).

App. 4

1. Numerosity

The numerosity portion of the Illinois statute is

identical to the language found in Rule 23 of the Federal

Rule of Civil Procedure. Thus, decisions of the federal

courts on this issue are instructive. Wood River Area

Development Corp. v. Germania Federal Savings and

Loan, 198 Ill. App. 3d 445, 450 (5th Dist. 1990).

Although the easiest factor to find, the issue as to

whether the proposed class is large enough to make

joinder of all members impracticable is not subject to

arithmetic certainty and depends on the facts and circum-

stances of each case. In Wood River, the Appellate Court

noted that courts, either federal or state, have not estab-

lished a “magic number” which guarantees certification.

The court did, however, point with authority to a quote

from Miller, An Overview of Federal Class Actions: Past,

Present and Future, Federal Judicial Center, at 22 (1977),

which stated:

If the class has more than forty people in it, nu-

merosity is satisfied; if the class has less than

twenty-five people in it, numerosity is probably

lacking; if the class has between twenty-five and

forty, there is no automatic rule and other factors

ated hed become relevant,

In Wood River, where there was twenty-one potential class

members, reduced to eighteen after three opted out, the

Court held that because the size was relatively small,

additional reasons for the use of the class action procedural

device was appropriate. These additional factors are: (1) the

class members geographical distribution; (2) the ability to

identify and locate the class members; (3) the degree of

knowledge and sophistication of the class members and

App. 5

their need for protection; (4) the amount of claims of the

individual class members; and (5) the nature of the cause

of action. Wood River, 198 Ill. App. 3d at 451.

Dloogatch asserts that he has met this numerosity

requirement, using as an example that over 1000 class

members have filed valid claims for their share of the

settlement of claims against the other defendants in this

matter. KPMG claims that Dloogatch cannot meet the

numerosity requirement because there is a strong reason

to believe that many of the class members who sought

compensation against other defendants have since re-

leased any claims they had against KPMG. Specifically,

KPMG argues that since two classes of purchasers of

Mercury securities have released their claims against

KPMG in a federal case, all putative members of the

holder class who also purchased Mercury securities during

the class period and have not opted out of the purchaser

class, have released their claims and cannot be members

of the holder class. KPMG points out that 53 of 61 institu-

tional investors had purchased stock during the class

period, and have thus, released their claims against

KPMG. KPMG also argues that at least 14 individual

plaintiffs have asserted individual claims against KPMG

and are in a position to assert their rights without relying

on the class action device. The Plaintiff denies the effect of

the releases.

Here, KPMG is correct that certain potential class

members may have released their claims against certain

holders but its argument ignores the fact that at least

some holders were not also purchasers during the class

period. The releases executed as part of the previous

settlement, Exhibit 5 to Defendant’s Memorandum, appvar

to affect only those persons who purchased Mercury stock

App. 6

on and after April 10, 1995 and up to and including Janu-

ary 29, 1997. The document also absolves KPMG of liabil-

ity for any and all services they performed for Mercury

during that time period. On its face, the settlement

agreement appears to exclude any putative member of the

“holder class” who purchased additional shares of Mercury

stock during the applicable period. It does not impact on

those investors, who purchased the stock prior to February

1994 and held the stock until January, 1996. The exact

number of individuals in either category is not left to

speculation. Mercury was an actively traded security.

More than thirty thousand notices were mailed in connec-

tion with a previous settlement. A number of institutional

investors did not settle their claims. In addition, the

defendant’s expert, Mr. Cox’ statistics suggest a significant

amount of ownership retention in his analysis of Mercury's

trading volume at the time of the financial reports.

In addition, the Plaintiff's suggestion that there are at

least one hundred thirty members of the proposed class is

persuasive. The defendant’s arguments and illustrations

are not sufficient to defeat the plaintiff’s assertion that

those holders meet the numerosity requirement, because

the numerosity requirement generally requires only about

forty class members. If the Plaintiff’s class is as small as

the defendant suggests, the issues relating to the pre-

dominance of common questions of reliance may not be as

cumbersome as suggested. Therefore, the plaintiff has met

the numerosity requirement.

App. 7

2. Common Questions of Law or Fact.

Prior to the enactment of Illinois’ class action statute,

common law required that a party seeking to be a repre-

sentative in a class suit have a community of interest in

the subject matter and the remedy. Harrison Sheet Steel

Co. v. Lyons, 15 Ill. 2d 532, 537 (1959). This standard

precluded a party opposed to the class from interposing an

objection by asserting hypothetical versions of a minor

character to prevent use of the class suit procedure. Lyons,

15 Ml. 2d at 538.

Shortly after Section 2-801 was enacted, then codified

as SHA Ch. 110 § 57.2, the Supreme Court issued its

decision in Steinberg v. Chicago Medical School, 69 Ill. 2d

320 (1977). The plaintiff, Robert Steinberg, had applied for

admission and paid the required fee to the defendant

medical school based upon its promise to make acceptance

decisions upon the criteria stated in its catalog. This

booklet emphasized academic achievement and potential

as the primary factors considered for admission. He

alleged that unbeknownst to him and others similarly

situated a candidate’s chance of acceptance increased in

direct proportion to the contribution or pledge of contribu-

tion to the school’s endowment fund. After finding the

former “community of interest” standard lacked structure,

the Court set forth the simple test of finding common

questions of law or fact. It also recognized that slight

deviations of claims by some portion of the class will not in

and of itself serve to defeat certification. Steinberg, 69 Il.

2d at 338.

As recognized by Steinberg, the standard now set out

by the legislature requires the court to perform a two-step

analysis. First, the court must ask whether there are

App. 8

common questions of law or fact. The language is in the

disjunctive; therefore, the commonality can be in fact or

law. If there are common questions of law or fact, the trial

court must determine whether the common questions

predominate over questions involving individual members.

In this case, Dloogatch asserts that the common

question of law or fact is whether KPMG is liable for its

conduct in auditing Mercury and disseminating the audit

opinion letters, and also claims that it is appropriate to

prove the class’ actual reliance through circumstantial

evidence sufficient to create an inference of reliance. This

is a reasonable position as corporate financial statements

are distributed to shareholders with an invitation they be

read and relied upon.

The Supreme Court of California has recently noted

the importance of the need for integrity in our financial

markets. The financial hardships reported in our daily

papers caused by shoddy or unethical business practices

shielded by inadequate or corrupt oversight by outside

auditors affect every resident of this country either di-

rectly by a loss of wealth or indirectly by increased costs

imposed because risk cannot be accurately gauged. see

Small v. Fritz Companies, 30 Cal. 4th 167 (2003). Thus,

the role of KPMG in preparing the audit letters and other

financial reports which the Plaintiff alleges caused his loss

is a critical issue in this litigation.

KPMG argues that the highly individualized question

of reliance is the predominant issue in this case. KPMG

additionally objects that plaintiff’s class-wide theory of

damages do not present predominant common issues

because case law rejects plaintiff’s benefit of the bargain

App. 9

theory of damages because holders cannot claim the

benefit of any bargain.

The Court accepts for the purpose of this motion that

the audit and financial reports prepared by KPMG and

distributed to shareholders by Mercury, served to a very

great extent, to set the market price of the stock. It also

must be assumed that the stock price was artificially

inflated by the fraudulent financial statements. The Court

acknowledges KPMG’s strong denial of any wrongdoing.

As noted, the statements were distributed to furnish

information to the shareholders and others either making

or advising on investment decisions. The gravamen of

fraud and negligent misrepresentation is reliance on the

falsehood. That means the injured party must do some-

thing as a result. That can be either action or, as alleged in

this case, inaction. Wright v. Chicago Title Insurance Co.,

196 Ill. App. 3d 920, 926 (1990). KPMG posits that if the

requirement of actual reliance were relaxed, individuals

who never read the reports or relied solely on the market

in making decisions to buy, sell or hold securities would

have a claim. This would unjustifiably expose KPMG to

potential liability for unsubstantiated claims and be

inconsistent with the rule set down in Oliveira v. Amoco

Oil, 201 Ill. 2d 134 (2002).

The danger of non-meritorious suits in securities cases

has been recognized by the United States Congress with

the enactment of the Private Litigation Securities Act of

1995 (109 Stat. 737). The United States Supreme Court

also noted sensitivity to the issue of fraudulent claims in

barring “Holders Actions” under federal securities laws

Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723,

739-740, 743-747 (1975). In a stated effort to reduce the

potential of such suits, one state court now requires that a

App. 10

Plaintiff making a state claim for fraud on a theory of

“Holding” stock must allege with particularity “how, when,

where to whom and by what means the representations

were tendered as well as details concerning the abandoned

decision to sell the security in question. Small v. Fritz

Companies, Inc., 30 Cal. 4th 167, 184 (2003). Claims for

negligent misrepresentation must allege that if the true

financial status were known, a sale would have occurred,

how much stock would have been sold, and when the sale

would have occurred. Id. The focus in each claim, the

Court noted, was on the decision making process of the

alleged injured party.

Plaintiff Dloogatch has asserted claims of common law

fraud, negligence and negligent misrepresentation against

KPMG. In order to state a claim for common law fraud or

negligent misrepresentation, the plaintiff and all of the

individual class members must prove justifiable reliance

upon the truth of the misrepresentations. Chicago v.

Michigan Beach Housing Coop., 297 Il. App. 3d 317, 323

(1st Dist. 1998); Good v. Zenith Electronics Co. 751 F.

Supp. 1320, 1323 (N.D. 1990) (applying Dlinois law); In re

First Merchants Acceptance Corporation Securities Litiga-

tion, 1998 WL 781118 at 12 (N.D. Ill.) (applying Illinois

law). Similar to’ Fritz Companies, the focus in these claims

must be on the decision making process of the Plaintiffs.

Other courts considering such claims have rejected

them as too speculative Chanoff v. United States Surgical

Corp., 857 F. Supp. 1011 (D. Conn. 1994) or required

personal contact between the defendant and plaintiff as

well as extrinsic proof. Guthman v. Howard Savings Bank,

748 F. Supp. 254 (D. N.J. 1990).

App. 11

The plaintiff seeks to assert an inference of reliance,

although he claims that he is not relying on the fraud on

the market theory. The fraud on the market theory, used

in securities fraud cases brought under Rule 10b-5 of the

Securities Exchange Act of 1934, allows for a rebuttable

presumption of reliance that a person purchasing stock

relied on the integrity of the price as set by the market

and that a misleading statement or omission by defen-

dants resulted in a lower stock price. Good, 751 F. Supp. at

1323, citing Basic Inc. v. Levinson, 485 U.S. 224 (1988).

This presumption has been used to satisfy the plaintiff’s

requirement to plead and prove transaction causation.

Plaintiffs most likely cannot rely on the fraud on the

market theory because several courts have held that while

the theory applies to securities fraud litigation, the theory

does not apply to state common law actions for fraud and

negligent misrepresentation. Good, 751 F. Supp. at 1323;

Katz v. Comdisco, 117 F.R.D. 403, 412 (ND. Ill. 1987).

Moreover, the Illinois Supreme Court has recently rejected

the theory’s application to a claim under the Illinois

Consumer Fraud Act. Oliveira v. Amoco Oil Co., 201 Tl. 2d

134 (2002). The Court required such plaintiffs to show the

injury was proximately caused by the acts of consumer

fraud. It is important to note that the Supreme Court’s

decision expressed a concern that the use of the fraud on

the market theory would allow individuals who did not

hear or believe the admittedly false advertising to recover

unjustly.

Dloogatch’s position is a variation of a theory found in

the earlier cases authorizing a “holder’s claim” in securi-

ties litigation. In Continental Insurance Company v.

Mercandante, 225 N.Y.S. 488 (S. Ct. App. Div. 1927), the

court was called upon to determine if a claim for fraud

App. 12

could be stated where the plaintiff insurance companies

did not allege that the defendant’s fraud did not cause the

plaintiffs to change their decision to sell the securities.

Rather, the wrong occurred when the misrepresentation

“transmuted their indecision whether to sell or keep into a

damaging decision to retain.” The court noted that the

plaintiffs had acted in a manner suggested by the mis-

statements, retain the security as a valuable investment.

This the court held showed, at the pleading stage, prima

facie legal causation. The court reasoned the question was

not whether the deceived party would have lost had the

fraud not been practiced, but whether there was a reason-

able probability that the fraud actually accomplished the

result it was intended to bring about. Here, the allegations

in the complaint set forth a series of deliberate acts done

by KPMG which were intended to influence investor

decisions related to purchase, sale, or retention of stock in

Mercury Finance Company.

Subsequent to the Mercandante decision, the Con-

gress enacted the depression era securities laws. The

rights of investors under these statutes were the focus of

fraud litigation over the ensuing four decades. While state

fraud claims were prosecuted, they were usually pendant

to the predominant action under section 10b of the Securi-

ties Exchange Act of 1934. The law that developed under

that scheme required a plaintiff to establish loss causation

as well as transaction causation in order to successfully

prosecute the action. AUSA Life Insurance Company v.

Ernst and Young, 206 F3d. 202, 209 (2nd Cir. 2000). Loss

causation is causation as defined in the traditional proxi-

mate cause sense. Id. Transaction causation on the other

hand has been analogized to reliance because it means the

violations in question caused the [injured party] to engage

App. 13

in the transaction in question. Id. However, in a securities

fraud case these two theories coalesce if the plaintiff can

establish that the transaction would not have occurred but

for the misrepresentation and that the misrepresentation

created the disparity between the price and the “invest-

ment quality” of the security at the time of the transac-

tion. Castellano v. Young & Rubicam, Inc., 257 F.3d. 171,

187 (2nd Cir. 2001).

It necessarily follows, that if the Mercantante rule

were accepted by this Court, a fact finder would be allowed

to conclude that KPMG’s alleged wrongdoing caused the

market to react in reliance on their reports. Such a deci-

sion would run afoul of the Supreme Court’s admonition

against use of the market theory to establish causation.

As the plaintiff argues, it is true that the Illinois

Supreme Court in Steinberg stated that having “one count

based on fraud does not prohibit a class action.” Steinberg,

69 Ill. 2d at 340. In understanding the import of that

statement and the Court’s reference to Korn v. Franchard

Corp., 456 F.2d 1206 (2nd Cir. 1972) (Claim for violation of

securities law in sale of a limited partnership interest), the

facts in Steinberg are instructive as is an analysis of

Illinois law evolving after Korn.

In Steinberg, it was clear that the Court had found

the defendant medical school had an equitable duty of

disclosure to the applicants. The Court also noted the

conflict in then existing Illinois case law as to this issue

and finally suggested the trial court had certain options,

such as subclasses or following the suggestions in Korn. It

is also important to remember that in Steinberg, there

were breach of contract and consumer fraud counts where

reliance on the falsehood is not an element.

App. 14

of reliance will not prevent certification. This is especially

true where a common core of facts exist or other claims are

joined and where reliance is neither presumed nor an

element of the claim. See Arenson v. Whitehall Convales-

cent and Nursing Home, Inc., (164 F.R.D. 659 ND Il. 1996)

(overcharging patients for medication alleged to be fraud,

consumer fraud, and RICO violation); Eisenberg v.

Gagnon, 766 F. 2d 770 (3rd Cir. 1985) (common offering of

sale of worthless tax shelters); Green v. Wolf v. Wolf Corpo-

ration, 406 F.2d 291 (2nd Cir. 1968) (sale of stock based on

three prospectuses containing similar false representa-

tions); In re Activision Securities Litigation, 621 F. Supp.

415 (ND Cal. 1985) (sale of stock based on false prospec-

tus, court allowed certification of state fraud claim joined

with 10b-5 action certified without objection by defen-

dant). The other cases cited by the Plaintiff also involve

claims of fraud in the sale of securities or insurance based

upon false sales material uniformly distributed.

The courts of Illinois have not adopted any of the

suggestions found in Korn. The Plaintiff has not cited to

one case where the traditiona)] elements of a fraud claim

has been relaxed by a court. Indeed, as noted, the Su-

preme Court recently reinforced the necessary require-

ment of pleading and proving proximate cause in these

cases. See Oliveira, 201 Ill. 2d at 155.

Hence, this Court concludes there are significant

individual questions related to the issue of reliance. This

Court, however, must examine whether the individual

questions of reliance in the instant case will predominate

over the common questions of law or facts in the instant case.

In undertaking this analysis, the Court is mindful of the

important role the class action has played in protecting

App. 15

individual investors from securities fraud. In order to

make his claim, the Plaintiff must prove that KPMG

knowingly made a false statement concerning the financial

status of Mercury Financial. That the statement was made

with the intent that investors rely upon it, that reliance

occurred because the injured party had a right to rely on

the falsehood. Finally, that damage was proximately

caused by the reliatce. Siegel v Levy Organization Devel-

opment Company, Inc., 153 Ill. 2d 534, 542-543 (1992). The

determination of KPMG’s role in auditing the financial

records of Mercury will determine whether it knowingly

made a false statement with the intent that investors rely

on it. This would create a core set of facts upon which, if

necessary, individual class members can present claims of

reliance. The resolution of these issues, in this Court’s

judgment, predominates over all others. The determina-

tion of this core issue would relieve this Court and those

small investors of the cost of multiple investigations and

trials over that portion of the case. KPMG would avoid the

multiple defense costs necessitated by multiple filings.

Moreover, if the class is as small as suggested by KPMG,

the later portion of the proceedings will be not burdensome

at all. Common sets of interrogatories and other discovery

tools can be devised. An administrative process designed

to separate valid claims from those without merit can be

employed. Thus necessitating trials in only the former

cases.

This Court acknowledges that several federal and

foreign state courts have denied class certification as to

the state law claims on the basis that individual issues of

reliance would predominate over any common question of

fraud and negligent misrepresentation. Katz, 117 F.R.D. at

412; Good, 751 F.Supp. at 1323; Gaffin v. Teledyne, 611

App. 16

A.2d 467, 474 (Del. 1992) (questions as to the element of

justifiable reliance will inevitably predominate over

common questions of law or fact). The notice provision of

the Code of Civil Procedure (735 ILCS 5/ 2-803), unlike

that of Rule 23 of the Federal Rules of Civil Procedure

places no restriction on requiring certain information from

putative class members to make a claim or become a

member of the class. Information concerning decisions to

hold the security and the basis of those decisions can be

required and reviewed for sufficiency. If facially defective,

they can be summarily rejected. If the proper claim is

made, KPMG can pose the agreed upon interrogatories,

engage in limited document production and depose the

claimant, as well as, insist on an individual hearing to

contest the claim. That trial however will be limited solely

to the issues of reliance and damages. This procedure

would not be unlike those employed in other mass tort

cases. It is not unusual for courts to conduct a single trial

in crash-related or toxic mass torts on limited issues. Once

liability is established, individual trials are conducted on

issues related to causation and damages. Conte, Newberg,

Newberg on Class Actions Chapter 17 generally and

Section 17.28 (4th Edition, Thomson/West 2002).

On the other hand if the responding class is too large,

the court can decertify the class and allow the claimants to

proceed individually with a binding finding of KPMG’s

wrongdoing as the benefit of class membership.

In addition, while Dloogatch’s expert, Dr. Lewellen

has asserted a benefit of the bargain calculation of dam-

ages, calculating the damages owed to all of the holders as

the difference between the value of Mercury stock on the

day before the fraud was revealed and the price after the

fraud was revealed. KPMG argues that any theory of

—

App. 17

damages which applies equally to all shareholders is a

shareholder derivative claim, and must be pleaded as

such. Moreover, KPMG asserts that this is not a benefit of

the bargain case, because all class members purchased

their Mercury stock before any fraud occurred and the

need to subtract any gains from the alleged fraud presents

a predominant individual issue that undermines any effort

to calculate damages on a class-wide basis.

Plaintiff is correct that this Court need not determine

the proper measure of damages at this instant, however, in

Illinois the benefit of the bargain approach generally

assesses the difference between the actual value of the

property purchased and the value of the property had the

representations been true. Gerill Co. v. Jack L. Hargrove

Builders, 128 011. 2d 179, 196 (1989); Giammanco v. Giam-

manco, 253 Ill. App. 3d 750, 759 (2d Dist. 1993). In this

case, it is unclear how the benefit of the bargain approach

would be appropriate in determining the damages of

individuals who purchased the stock before any fraud

occurred and held this stock throughout the fraud. The

price paid for the security was the value set by the market

thus they received full value for their money. They held

the stock for the entire period of the fraud and suffered

damage once the truth was revealed. No claimant can

receive any benefit from the inflated price as they would

be profiting from a fraud. Thus it appears the benefit of

the bargain approach would have no application. Moreover

some class members may have sold the stock precipitously

and received an artificially depressed price. The defen-

dant’s suggestion that any loss incurred must be offset by

any gain received for stock sold during the fraud has

significant equitable appeal. Finally, the Court in Small v.

Fritz Company, supra. discussed many approaches to the

App. 18

determination of damages which this Court finds of

interest. Nevertheless, this Court need not determine the

proper measure of damages, but notes benefit of the

bargain damages appears to be an inappropriate measure.

The final point on this issue is whether the claims are

personal! or derivative. In order to make such a determina-

tion, the Court must determine the nature of the harm

and the relief available upon success of the suit. In order

to state a direct claim under Delaware law, the plaintiff

must establish that the injury was one that is different

than that suffered by the other shareholders or involves

the contractual rights of the shareholder that are inde-

pendent of the corporation’s rights. Kramer v. Western

Pacific Industries. Inc., 546 A. 2d 348, 351 (Del. 1988).

This determination is made from a review of the actual

claims in the complaint, not its captions or stated inten-

tions. Id. P. 352. Here, the Plaintiff’s [sic] allege an injury

that is separate from any injury to the corporation. The

injury is not related to corporate affairs or to their rights

as shareholders. Their injury is personal to each of them.

As the Defendant so eloquently argued each shareholder’s

loss or damage is unique to him or her. There is no com-

monality. Their rights do not derive from those of the

corporation. Their injury, if any, derives from their right to

purchase securities in a free, open and honest market.

This right was violated, they allege, by the intentional acts

of KPMG. The Defendant vigorously denies the allegations

and so the issue is joined.

3. Adequate Representation

This requirement has due process implications. In

order to determine adequacy of representation, the trial

App. 19

judge must examine two issues: (1) will representation by

the proposed class representative protect the members of

the class who must be afforded due process; and (2) does

the attorney have the skill, qualifications and experience

to conduct the proposed litigation? Steinberg, 69 Ill. 2d at

339.

A. Adequate Representation by Proposed Repre-

sentative }

Unlike the requirement in Rule 23 of the Federal

Rules of Civil Procedure that the claim of the proposed

sy representative be typical of those of the class, Illinois

has adopted a more liberal approach. Carrao v. Health

Care Service Corp., 118 Ill. App. 3d 417 (1st Dist. 1983). In

Illinois, the class representative must fairly, adequately

and efficiently represent absent class members. Gordon v.

Boden, 224 Ill. App. 3d 195, 203 (1st Dist. 1991).

This has been defined as showing the interest of the

proposed class representatives are not antagonistic to

those of the absent class members. Thus, issues such as

slight variations in the claim, Purcell Wardrope Chtd. v.

Hertz Corp., 175 Ill. App. 3d 1069, 1078 (1st Dist. 1975), or

individualized affirmative defenses, Wenhold v. AT & T,

142 Ill. App. 3d 612, 619 (1st Dist. 1986) will not defeat

certification. However, in cases where there is evidence of

antagonism or collusion, Hansberg v. Lee, 311 U.S. 32

(1940), between the proposed representative and absent

class members or a close connection with the lawyer

representing the proposed class, Barliant v. Follett Corpo-

ration, 74 Ill. 2d 266 (1978), class certification should be

scrutinized.

App. 20

In this case, KPMG argues that Dloogatch will not

adequately represent the interests of the class because he

is subject to a defense that he cannot prove that he relied

on any fraudulent statement because he did not sell the

stock even after the alleged fraud was revealed in January

1997 and if Dloogatch intends to rely on its alternative

theory of damages, opportunity cost, he is a poor represen-

tative. These individualized affirmative defenses, which

can be explained by deposition testimony, are not suffi-

cient to undermine Mr. Dloogatch’s ability to adequately

represent the class.

B. Adequacy of Representation by Counsel

KPMG does not assert that counsel will not ade-

quately represent the potential class. Moreover, this Court

has read pleadings submitted by counsel and has deter-

mined that counsel will adequately represent the class.

For these reasons, the adequate representation prong

is met.

3. Appropriate Method for Fair and Efficient

Adjudication

In its earliest explanation of this prong, the Supreme

Court noted that once a determination was made that a

question of law or fact common to the class predominates,

the statute is satisfied. Steinberg v. Chicago Medical

School, 69 Tl. 2d 320, 340-341 (1977). The court noted that

once the dominant issue was resolved, the trial judge could

employ various procedures to resolve issues that affect

some, but not all of the class members. This could include

breaking the class into identifiable subgroups or even

ordering individual trials.

App. 21

Later cases developed a two-pronged test to determine

whether this requirement was met. Satisfaction of either

test proves the statutory requirement. The test is whether:

(1) the class action procedure can best secure the econom-

ics of time, effort and promote uniformity; or (2) accom-

plish the other ends of equity and justice that class actions

seek to obtain. Furthermore, a controlling factor in many

cases is that the class action is the only practical means

for class members to receive redress, particularly where

claims are small. Gordon, 224 Ill. App. 3d at 204-205.

This case is an appropriate method for the fair and

efficient adjudication of the individual class issues. While

the class action vehicle is not the only practical method for

the class members to receive redress. As KPMG pointed

out, numerous individual holder actions have been filed

against it. There are, as noted, efficiencies to be gained

from proceeding as a class action. The investigation into

the relationship between KPMG and Mercury will be

costly and time consuming. It will require extensive

document production, multiple depositions and the use of

expert witnesses. Individual investors probably do not

have the ability or resources to undertake such a task. The

class action vehicle was designed for this type of case.

Hence, the Court concludes the Plaintiff has estab-

lished the requirements for Class Certification.

Ill. ORDER

A. This Court certifies as a class of Plaintiffs:

All persons who purchased common stock of

Mercury Finance Company prior to Febru-

ary 23, 1994 and held such stock through

and including January 29, 1997. Excluded

App. 22

are KPMG and any entity which KPMG has

a controlling interest or which is a parent or

subsidiary of or is controlled by KPMG, and

the officers, directors, employees, affiliates,

legal representatives, heirs, successors and

assigns of KPMG.

B. The matter is set for case management con-

ference to discuss, among other issues, the form

and content of the notice to the certified class on

8/18, 2003, at 11:30 A.M.

— JUDGE

DATED: ENTERED: PATRICK McGANN -— 1510

Judge 1510

Li,

No. 04-1371

IN THE

Supreme Court of the An

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

Petitioner, —

SHADI DABIT, on behalf of himself and all

others similarly situated,

Respondent.

On Writ oF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT

BrigF OF New York, CALIFORNIA, CONNECTICUT, HAWAn,

ILLInots, lowa, MIcHIGAN, MINNESOTA, MIssIssiPPt,

Montana, New Jersey, New Mexico, Oun10o, OKLAHOMA,

OREGON, SOUTH CAROLINA, VERMONT, WASHINGTON,

WISCONSIN AS AMICI CuRIAE IN SUPPORT OF RESPONDENT

CaITLIN J. HALLIGAN* Eviot SpItzer

Solicitor General Attorney General of the

Mariya S. TREISMAN State of New York

Assistant Solicitor General 120 Broadway

New York, NY 10271

* Counsel of Record (212) 416-8016

Attorneys for Amici Curiae

(Additional Attorneys Listed on Signature Page)

—_—_—X—X—X—X“—_—__*_*"" —_———

198511 g

COUNSEL PRESS

(800) 274-3321 + (800) 359-6859

QUESTION PRESENTED

Whether SLUSA preempts state-law claims brought by

holders of securities based upon misrepresentations,

omissions, or manipulation.

TABLE OF CONTENTS

QUESTION PRESENTED ..........0scccecees

BAR GP CAMNEMSED fi cessevsicccccvcvees

TABLE OF CITED AUTHORITIES ............

INTERESTS OF AMICI CURIAE ...... FET ck

SUMMARY OF ARGUMENT .................

PP TOPS TTT TERE PEC TIPE r oT

SLUSA incorporates the well-settled

purchaser/seller limitation on private actions

for securities fraud and therefore does not

preempt state-law holder claims. .........

A. Because States have had a longstanding

role in protecting against securities

fraud, there is a presumption against

finding that SLUSA preempts holder

S. .nddabeodedneeddensepansues

B. In enacting SLUSA’s preemption

provision, Congress used a phrase with

a settled meaning that is limited in scope

to actions brought by purchasers or

sellers of a covered security. .........

Page

iii

Contents

Page

Il. Construing SLUSA to allow state-law

remedies for holder claims strikes an

appropriate balance between protecting

investors from fraud and furthering

Congress’s purpose of promoting consistent

and efficient markets. ........ccccceeee: 15

CEE Knew eccg paededdbcenvadecebece 19

TABLE OF CITED AUTHORITIES

Page

CASES

Abada v. Charles Schwab & Co.,

127 F. Supp. 2d 1101 (S.D. Cal. 2000) ........ 14

Amchem Products v. Windsor,

kt MP. Se rec rents ar 16

Blue Chip Stamps v. Manor Drug Stores,

GSE WA TEP ESPN bcc ccketvewdevesvennen passim

Bragdon v. Abbott,

re as RED. 6+ 5'p'b 4-60.60 060500 denen 10

Central Bank v. First Interstate Bank,

PER WR POGOe ob ekceee teed dar codeens 8, 12

Cipollone v. Liggett Group, Inc.,

Fa CA. DOP ENOEES oo cskbveveddebacctaetes 3

Continental Ins. Co. v. Mercadante, 222 A.D. 181,

Bee Psa GD EREETD 6 cariviivodess ceewees 4

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

Fee We oe GG NOE ec dbsecdésectatucas 11,17

David v. Belmont,

291 Mass. 450, 197 N.E. 83 (1935) ........... 4

Duffy v. Smith,

Be A, S58 ed GED bc ovcasctecsseccounnens 1,4

Cited Authorities

Page

Ernst & Ernst v. Hochfelder,

ES Ee 8

Fottler v. Moseley,

179 Mass. 295, 60 N.E. 788 (1901) ........... 4

Franchise Tax Board v. Construction

Laborers Vacation Trust,

hie Ae hes oes we ates ct bs 6

Gordon v. Buntrock,

No. 00 CV 303 (JFH), 2000 U.S. Dist. LEXIS

5977, 2000 WL 556763 (N.D. Ill. Apr. 28, 2000)

ee A Be ee a a ls tabs 14

Green v. Ameritrade, Inc.,

279 F.3d 590 (8th Cir. 2002) ................ 14

Gutierrez v. Deloitte & Touche, L.L.P.,

147 F. Supp. 2d 584 (W.D. Tex. 2001) ......... 14

iutman v. Howard Savings Bank,

748 F. Supp. 254 (D.N.J. 1990) .............. 18

Hines v. ESC Strategic Funds, Inc.,

No. 3:99-0530 (AAT), 1999 U.S. Dist. LEXIS

15790, 1999 WL 1705503 (M.D. Tenn. Sept. 17,

iia tnd ee nennadnwdeeteee es et 15

Holmes v. Securities Investor Protection Corp.,

i + aden edntebhedeeetaceces 9, 11

Cited Authorities

Page

In re WorldCom, Inc. Securities Litigation,

336 F. Supp. 2d 310 (S.D.N.Y. 2004) ...... ... 15

In re WorldCom, Inc. Securities Litigation,

382 F. Supp. 2d 549 (S.D.N.Y. 2005) .......... 15

Kircher v. Putnam Funds Trust,

403 F.3d 478 (7th Cir. 2005) ................ il

Lampf, Pleva, Lipkind, Prupis & Petigrow

v. Gilbertson,

ft € ee ee 8, 12

Medtronic, Inc. v. Lohr,

Dt a wcnueceesdeveseeaes o¢ 3, 6, 17

National Labor Relations Bd. v. Amax Coal Co..,

.: & | ee eer ree 10

New York State Conference of Blue Cross &

Blue Shield Plans v. Travelers Insurance Co.,

0 Bs Sh ere 3

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

292 F.3d 1334 (llth Cir. 2002) .............. 14

Rogers v. Cisco Systems,

268 F. Supp. 2d 1305 (N.D. Fla. 2003) ........ 18

Santa Fe Industries v. Green,

Ses SED Feb uete cocwecedbictcess 15

vil

Cited Authorities

Page

SEC v. Zandford,

SPIED, s ses ebdckceddteeciedens il

Seideman v. Sheboygan Loan & Trust Co.,

198 Wis. 97, 223 N.W. 430 (1929) ........... 4

Shaw v. Charles Schwab & Co.,

128 F. Supp. 2d 1270 (C.D. Cal. 2001) ........ 14

Silkwood v. Kerr-McGee Corp.,

PE ED Wovccccéddvedecescesées 6

Small v. Fritz Companies,

30 Cal. 4th 167, 65 P.3d 1255 (2003) ...... 4,15, 18

Sprietsma v. Mercury Marine,

Dh) PT dtieninndckncdaedenesenes 17

United States v. O'Hagan,

ED cndamancbbadcsevesebawen 11

Ward v. Atlantic Security Bank,

777 So. 2d 1144 (Fla. Dist. Ct. App. 2001) ..... 4

STATUTES

Private Securities Litigation Reform Act of 1995,

Pub. L. No. 104-67, 109 Stat. 737 ............ 5

Securities Act of 1933, Pub. L. No. 73-22,

SL OE han cheddadéewsstn ds decéuntecten 5

vill

Cited Authorities

Page

Securities Exchange Act of 1934,

Pub. L. No. 73-291, 48 Stat. 881 ............. 5

Securities Litigation Uniform Standards Act of 1998,

Pub. L. No. 105-353, 112 Stat. 3227 .......... |

SP AE. caches dncececceasesesdeciobes 5

a CUED 6-cectnedsdacceuendscesseee 7

SO OPED ASetccsicceoccudeseanevs 5

"EP ae FED obs cceddvctectedeseteteaés 5

Ss OS EEE ccc ccentcdeccocsosacn 7

1S U.S.C. § FERRET IMB) «nn cc cwrccccccscccees 7

2, 5 Ferner rys Pre 7

fe CRT Tre er 8

SP GED Secsvccceviseewecssevcéé 5

REGULATIONS

BF CI GBS co cccccccccccccssecveces 8

Cc ited Authorities

CONGRESSIONAL DOCUMENTS & RECORD

H.R. Conf. Rep. No. 104-369 (1997) ............

H.R. Conf. Rep. No. 105-803 (1998) ............

Implementation of the Private Securities Litigation

Reform Act of 1995: Hearing Before the Subcomm.

on Finance and Hazardous Materials of the

H. Comm. on Commerce, 105th Cong. (1997) ...

S. Rep. No. 105-182 (1998) ..............0000-

Securities Litigation Abuses: Hearing Before the

Subcomm. on Securities of the S. Comm. on

Banking, Housing, and Urban Affairs, 105th

SE EER Dh avhuccdvincndiontssabitcacse

Securities Litigation Uniform Standards Act of 1997

~ S. 1260: Hearing Before the Subcomm. on

Securities of the S. Comm. on Banking, Housing,

and Urban Affairs, 105th Cong. (1997) ........

Securities Litigation Uniform Standards Act:

Hearing Before the Subcomm. on Finance and

Hazardous Materials of the H. Comm. on

Commerce, 105th Cong. (1998) ..............

Page

Cited Authorities

Page

Securities Litigation Uniform Standards Act of 1997

- S. 1260: Hearing Before the Subcomm. on

Securities of the S. Comm. on Banking, Housing,

and Urban Affairs, 105th Cong. (1998) ........ 6, 10

143 Cong. Rec. $10,477 (1997) ..........00055. 12

144 Cong. Rec. H6,058 (1998) ................. 17

144 Cong. Rec. H10,775 (1998) ..........00005. 10

144 Cong. Rec. H11,020 (1998) ................ 17

MISCELLANEOUS AUTHORITIES

James D. Cox, et al., Securities Regulation (1997)

da bedWebdd'semenlanneddenseseedudesios 4,5

Richard W. Painter, Responding to a False Alarm:

Federal Preemption of State Securities Fraud

Causes of Action, 84 Cornell L. Rev. 1 (1998) .. 3-4

Louis Loss & Joel Seligman, Securities Regulation

SE EL Cb koéedeuabibdg ts tortbads obdbé 5

INTERESTS OF AMICI CURIAE

Amici States urge the Court to affirm the decision of the

United States Court of Appeals for the Second Circuit in Dabit

v. Merrill Lynch, Pierce, Fenner & Smith, Inc., holding that the

Securities Litigation Uniform Standards Act of 1998

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

preempt state-law class-action claims brought solely on behalf

of persons who were fraudulently induced to hold or retain

securities.

Amici States have a legitimate and compelling interest in

preserving a business climate free from fraud and deceptive

practices, and have used their police powers to achieve this goal

for more than a century. In general, state-law private rights of

action have been an important means of compensating victims

of securities fraud and compelling compliance with securities

laws. More specifically, state law has long provided remedies

to investors fraudulently induced to hold or retain a security,

see, e.g., Duffy v. Smith, 32 A. 371 (N.J. 1895), and, since 1975,

state law has provided the only remedy for such investors,

see Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723

(1975).

SLUSA displaces this historic exercise of the States’ police

power, thereby disrupting the balance of state and federal power

that has long operated in the securities arena. For this reason,

this Court’s precedent dictates, and Amici States strongly agree,

that the scope of SLUSA’s preemption must be strictly limited

to those causes of action that Congress explicitly intended to

preempt: actions “in connection with the purchase or sale of a

... Security,” a phrase which has previously been defined by

this Court in Blue Chip Stamps to exclude private actions

brought by nonpurchasers or nonsellers. Thus, SLUSA cannot

be construed as displacing state-law causes of action for holder

claims. To hold otherwise would eliminate remedies long

available to injured investors, and strip States of essential

authority to protect their citizens from fraud in securities

transactions.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.