Opinion
01 CIV. 3013 (DLC)
October 9, 2001
John M. Dillon, Stephen Moore, Caruso Dillon, P.C. for Plaintiff
Edward J. Yodowitz, Jay B. Kasner, Jill Rennert, Skadden, Arps, Slate, Meagher Flom LLP for Defendant
OPINION ORDER
This motion to remand requires a determination of whether representations concerning transaction fees for purchasing securities are representations made "in connection with" the securities. Plaintiff Michael Spielman ("Spielman"), on behalf of himself and other similarly situated individuals, originally filed this action for breach of contract and other related state law claims in New York Supreme Court in February 2001. Defendant Merrill Lynch, Pierce, Fenner Smith Inc. ("Merrill Lynch") removed the action in April 2001, as preempted by the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), 15 U.S.C. § 78bb(f). For the reasons discussed below, plaintiff's motion to remand is granted.
BACKGROUND
The facts alleged in the Complaint include the following.
Merrill Lynch, a Delaware corporation with its principal place of business in New York, offers to clients a brokerage account known as the Cash Management Account ("CMA"). Spielman alleges that, according to Merrill Lynch marketing materials, the CMA allows clients, with certain exceptions, to buy eligible securities without having to pay a transaction fee. One type of security offered to CMA accountholders are "Holding Company Depository Receipts" ("HOLDRS"). Each HOLDRS investment consists of shares of common stock issued by twenty identified companies from specified industry sectors.
The plaintiff, a New York resident who became a CMA accountholder in February 1999, alleges that Merrill Lynch misled its CMA accountholders with a series of confusing statements.
While Merrill Lynch represented that CMA clients are simply charged a flat annual fee of one percent of the total assets under management rather than transaction fees, it also represented that "[u]nder certain circumstances, other fees and expenses will apply," yet also that "[t]he expenses associated with trading Utilities HOLDRS are expected to be less than trading each of the underlying securities separately." Spielman alleges that it was reasonable to conclude from Merrill Lynch's representations that a CMA accountholder could purchase HOLDRS receipts without having to a pay a transaction fee. Merrill Lynch, however, charged him a two percent transaction fee for each of his purchases of HOLDRS made at various times throughout 2000.
Merrill Lynch argues that the transaction fee is actually an underwriting fee.
The plaintiff brings six state causes of action: breach of contract, breach of implied covenant of good faith and fair dealing, fraud, negligent misrepresentation, breach of fiduciary duty, and violation of Section 349 of the New York State General Business Law.
DISCUSSION
This motion implicates several of our nation's securities statutes. One of these is the Private Securities Litigation Reform Act of 1995 ("PSLRA"), Pub.L. 104-67, 109 Stat. 737 (1995), which Congress passed to "provide uniform standards for class actions and other suits alleging fraud in the securities market." Lander v. Hartford Life Annuity Ins. Co., 251 F.3d 101, 107 (2d Cir. 2001). The PSLRA is designed to prevent strike suits — meritless class actions and other suits alleging fraud in the sale of securities. Id. According to Congress, it was enacted to "`protect investors and maintain confidence in our capital markets' by `discourag[ing] frivolous litigation.'" Id. at 109 (quoting H.R. Conf. Rep. 104-369 (1995)). The PSLRA established, among other things, heightened nationwide pleading requirements for class actions alleging fraud in the sale of national securities and a mandatory stay of discovery pending resolution of motions to dismiss. Id.
To avoid these constraints, many class action plaintiffs began bringing suit in state rather than federal court. Id. Congress responded by enacting SLUSA in 1998. SLUSA made federal court the "exclusive venue for class actions alleging fraud in the sale of certain covered securities" and mandated that these class actions be "governed exclusively by federal law." Id. at 108. The definition of a "covered" security is borrowed from the National Securities Markets Improvement Act of 1996 and includes any "security issued by an investment company that is registered, or that has filed a registration statement, under the Investment Company Act of 1940." Id. at 109 (quoting 15 U.S.C. § 77r(b)(2)). SLUSA itself provides that:
No 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 . . . .15 U.S.C. § 78bb(f)(1).
Under SLUSA, federal court is also the exclusive venue for suits alleging the "use or employ[ment] [of] 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)(B).
SLUSA authorizes the removal of suits that meet the criteria of Section 78bb(f)(1):
Any covered class action brought in any State court involving a covered security, as set forth in paragraph (1), shall be removable to the Federal district court for the district in which the action is pending, and shall be subject to paragraph (1).15 U.S.C. § 78bb(f)(2). Thus, in order to remove an action to federal court under SLUSA, the removing party must show that (1) the suit is a "covered" class action, (2) the claims in the action are based on state law, (3) the claims allege that one or more "covered" securities have been purchased or sold, and (4) that the defendant misrepresented or omitted a material fact "in connection with" the purchase or sale of such security. See Shaev v. Claflin, No. C 01-0009, 2001 WL 548567, at *4 (N.D.Cal. May 17, 2001); Shaw v. Charles Schwab Co., Inc., 128 F. Supp.
2d 1270, 1272 (C.D.Cal. 2001). A "covered" class action includes a lawsuit in which one or more named parties seek to recover damages on a representative basis on behalf of themselves and other unnamed parties similarly situated, and questions of law or fact common to those persons or members of the prospective class predominate over any questions affecting only individual persons or members . . . .15 U.S.C. § 78bb(f)(5)(B)(i)(II).
The parties do not dispute that HOLDRS are securities covered by the Standards Act or that the first three of the four requirements for removal exist. Rather, the parties contest whether the representations at the core of this action, namely,
Merrill Lynch's representations about transaction fees, are made "in connection with" the purchase of HOLDRS. If they are made in connection with covered securities, this action was properly removed. If not, then it must be remanded.
SLUSA does not define the phrase "in connection with the purchase or sale" of a covered security. Because this phrase tracks language in Section 10(b) of the Securities Exchange Act of 1934 ("Section 10(b)"), this Court will, as other courts have, rely upon the law arising under Section 10(b) to interpret SLUSA's requirement that the misrepresentation or omission be "in connection with" a purchase or sale of a security. See Shaev, 2001 WL 548567, at *4; Gordon v. Buntrock, No. 00 CV 303, 2000 WL 556763, at *3 (N.D.Ill. April 28, 2000). But see Shaw, 128 F. Supp. 2d at 1274. For example, courts have relied upon the law interpreting Section 10(b) to hold that SLUSA does not apply to misrepresentations or omissions that occur in connection with holding a security, see Gutierrez v. Deloitte Touche, L.L.P., 147 F. Supp.2d 584, 595 (W.D.Tex. 2001), and to hold that the scienter pleading requirements under PSLRA and Section 10(b) apply equally to SLUSA, see Simon v. Internet Wire, Inc., No. CV0013195, 2001 WL 688542, at *2 (C.D.Cal. Apr. 3, 2001); Green v. Ameritrade, Inc., 120 F. Supp.2d 795, 798 (D.Neb. 2000); Burns v. Prudential Sec., 116 F. Supp.2d 917, 922-23 (N.D.Ohio. 2000).
The decision to rely on the law arising under Section 10(b) rests on the conclusion that Congress's choice of identical statutory language should yield an identical interpretation. It is "familiar law that `[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.'" In re Chateaugay Corp., 89 F.3d 942, 947 (2d Cir. 1996) (quoting NLRB v. Amax Coal Co., 453 U.S. 322, 329 (1981)).
Caselaw interpreting the federal securities statutes thus provides the "background context against which we gauge congressional action." Lander, 251 F.3d at 113. Section 10(b) requires that the fraud forbidden by that statute be in connection with the sale of a security. See Brunjes v. Hoyt (In re Carter-Wallace, Inc. Sec. Litig.), 150 F.3d 153, 156 (2d Cir. 1998); Steiner v. Ames Dep't Stores, Inc. (In re Ames Dep't Stores Inc. Stock Litig.), 991 F.2d 953, 961-62 (2d Cir. 1993). In alleging this element of a cause of action, "it is not sufficient [merely] to allege that a defendant has committed a proscribed act in a transaction of which the pledge of a security is a part." Chem. Bank v. Arthur Andersen Co., 726 F.2d 930, 943 (2d Cir. 1984). Nonetheless, this element "must be read flexibly, not technically and restrictively" so that the statute will cover both typical and novel forms of fraud. Superintendent of Ins. v. Bankers Life Cas. Co., 404 U.S. 6, 10 n. 7, 12 (1971). To satisfy this requirement, a plaintiff need only demonstrate "an injury as a result of deceptive practices `touching' its purchase or sale of securities." Steiner, 991 F.2d at 964 (quoting Superintendent of Ins., 404 U.S. at 12-13). Nevertheless, "the incidental involvement of securities [does] not implicate the anti-fraud provisions of the federal securities laws." Pross v. Katz, 784 F.2d 455, 459 (2d Cir. 1986); see also Anatian v. Coutts Bank (Switzerland) Ltd., 193 F.3d 85, 88 (2d Cir. 1999). The fraud must be "integral to the purchase and sale of the securities in question." Pross, 784 F.2d at 459.
In the usual case, the requisite connection between a fraud and a purchase or sale is present "when the fraud alleged is that the plaintiff bought or sold a security in reliance on misrepresentations as to its value." Steiner, 991 F.2d at 967 (emphasis supplied). As Judge Friendly explained, the purpose of Section 10(b) "is to protect persons who are deceived in securities transactions — to make sure that buyers of securities get what they think they are getting." Chem. Bank, 726 F.2d at 943 (emphasis supplied). The Second Circuit has construed the requirement broadly, "holding that Congress, in using the phrase `intended only that the device employed . . . be of a sort that would cause reasonable investors to rely thereon, and, in connection therewith, so relying, cause them to purchase or sell a corporation's securities.'" Brunjes, 150 F.3d at 156 (quoting Sec. Exch. Comm'n v. Texas Gulf Sulphur Co., 401 F.2d 833, 860 (2d Cir. 1968)); see also Press v. Chem. Inv. Serv. Corp., 166 F.3d 529, 537 (2d Cir. 1999). Consistent with these principles courts have stated that the requirement is satisfied where a plaintiff alleges a misrepresentation "concerning the value of the securities . . . sold or the consideration . . . received in return." Saxe v. E.F. Hutton Co., Inc., 789 F.2d 105, 108 (2d Cir. 1986); see also Chem. Bank, 726 F.2d at 943; Hoffman v. TD Waterhouse Inv. Serv., 148 F. Supp.2d 289, 290 (S.D.N.Y. 2001).
Applying these principles, courts have found an alleged misrepresentation or omission to be "in connection with" the purchase or sale of securities when it concerned the prompt access to the proceeds of a Treasury bill transaction, Press, 166 F.3d at 537, but not when it involved misrepresentations as to the authority to extend credit, Anatian, 193 F.3d at 88; the execution of trades after previously confirming a plaintiff's order to cancel the trades, Hoffman, 148 F. Supp.2d at 291; or an investment advisor's misrepresentations regarding his credentials when the advice rendered did not relate to the investment quality of the securities at issue, Laub v. Faessel, 981 F. Supp. 870, 873 (S.D.N.Y. 1997).
The defendant relies on Marbury Management, Inc. v. Kohn, 629 F.2d 705 (2d Cir. 1980) and A.T. Brod Co. v. Perlow, 375 F.2d 393 (2d Cir. 1967), for the proposition that Section 10(b)'s "in connection with" requirement is satisfied even when the alleged misrepresentation does not relate to the value of the securities sold or the consideration received. Both of these cases, however, are consistent with the Second Circuit's reading of "in connection with" as limiting Section 10(b) to misrepresentations concerning value or consideration. In A.T. Brod, the Second Circuit found that an investor's promise to buy securities violated Section 10(b) when the investor intended to pay the broker for the securities only if the market value had increased on the date payment was due. A.T. Brod, 375 F.2d at 397. The investor's promise to pay was connected to the broker's purchase and subsequent sale of the securities because it "related to the value of the consideration." Hoffman, 148 F. Supp. 2d at 291. The promise "`tricked [the broker] into parting with something . . . for a consideration known to the buyer not to be what it purports to be'" — namely, a promise to pay the full amount when due. Sec. Exch. Comm'n v. Drysdale Sec. Corp., 785 F.2d 38, 42 (2d Cir. 1986) (quoting Chem. Bank, 726 F.2d at 943); see also Weiss v. Wittcoff, 966 F.2d 109, 112 (2d Cir. 1992).
In Marbury, the alleged fraud concerned the risk involved in purchasing securities on the advice of a trainee at a brokerage firm who led investors to believe he was a licensed stockbroker. Acting on the trainee's advice about particular securities, the plaintiffs purchased securities they may otherwise have deemed too risky. Marbury, 629 F.2d at 708. The trainee's misrepresentation of his qualifications was "in connection with" the investors' purchase or sale of securities because it "related to the value of the shares — specifically, the reliability of the trainee's valuation" of the stocks purchased by the plaintiffs. Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 97 (2d Cir. 2001). In other words, although the misrepresentation in Marbury Management
did not go to the intrinsic investment characteristics of the stock, it did go to the investment quality of the stock purchases because, had the plaintiffs known that their "broker" was an inexperienced trainee, they asserted they would not have accepted his recommendations, especially given their initial reservations.
Mfr. Hanover Trust Co. v. Drysdale Sec. Corp., 801 F.2d 13, 22 (2d Cir. 1986) (emphasis in original).
The present case presents an issue similar to one that the Second Circuit and this Court declined to reach in Feinman v. Dean Witter Reynolds, Inc., No. 94 CIV. 7798, 1995 WL 562177, at *3 (S.D.N.Y. Sept. 21, 1995), aff'd, 84 F.3d 539, 541 n. 1 (2d Cir. 1996). In Feinman, the plaintiffs alleged that brokerage firms charged hidden commissions by mislabeling the amount as transaction fees. It was unnecessary to reach the issue of whether the representations regarding the fees were "in connection with" the underlying securities since the Section 10(b) claims were dismissed on other grounds. The only other case that appears to have considered a similar claim is Shaw v. Charles Schwab Co., Inc., 128 F. Supp.2d 1270 (C.D.Cal. 2001), where the plaintiff claimed that the brokerage firm misrepresented the commission structure. Declining to read SLUSA's requirements as broadly as those of Section 10(b), the District Court held that the alleged misrepresentations were not "intrinsically related" to the securities but were instead related to the "vehicle" for delivery of the securities, and remanded the action to state court. Id. at 1274. The misrepresentations alleged here are not integral to the purchase of HOLDRS. Although Spielman has alleged that Merrill Lynch made statements regarding the fees that CMA accountholders would be charged when purchasing Utilities HOLDRS securities, these statements did not concern the value of those securities, or the consideration received in return for trading the securities. While the transaction fees charged by Merrill Lynch affect the cost of trading, this cost is part of Merrill Lynch's bargain with its accountholders and is not sufficiently connected to the underlying securities to meet the requirement that the misrepresentation about those fees be "in connection with" the purchase or sale of covered securities. Accordingly, the case is remanded.
CONCLUSION
The plaintiff's motion to remand is granted and the case is returned to New York Supreme Court. The Court declines to decide the defendant's motion to dismiss.
SO ORDERED: