7th Circuit Makes It Harder for Plaintiffs to Keep Securities Class Actions in State Court

Pamela A. MacLean

The National Law Journal

The decision, issued on Jan. 5, stems from a disputed real estate investment trust merger and splits with a 9th Circuit interpretation of conflicting terms between the 1933 Act's anti-removal provisions and the Class Action Fairness Act's terms that allow removal of state class actions to federal court.

"The case is significant because it provides in-depth analysis of what the [7th Circuit] found was a conflict between the two statutes," said Christopher King, a partner in Sonnenschein Nath & Rosenthal's Chicago office, who is representing the defendants. "On a going forward basis, it will make it more difficult for plaintiffs to gin up 1933 Act claims in an effort to avoid federal jurisdiction," he said.

Ken Wexler, of Wexler Wallace in Chicago, disagreed. "It remains to be seen if it will be more difficult for plaintiffs." Under the 1933 Act, securities cases may be filed in either state or federal court, said Wexler, who represents plaintiff Jack P. Katz.

The 7th Circuit held that an anti-removal provision in Section 22 of the Securities Act of 1933 does not prevent removal when other requirements of the CAFA are met. The CAFA is more recent and thus generally allows removal, despite the 1933 Act bar, so long as terms of the CAFA are met. Katz v. Gerardi, 08-8031 (7th Cir.).

This breaks with a 2008 decision in the 9th Circuit that held that the more specific terms of the 1933 Act, applying to securities cases, can trump the generalized terms of the 2005 act applying to all civil actions, Luther v. Countrywide Home Loans Servicing, 533 F.3d 1031 (9th Cir. 2008).

The dispute in Katz arose from the 2007 merger of real estate investment trust Archstone with Tishman-Lehman Partnership. Investors were given the option of converting existing A-1 shares into cash or new Series O shares.

Jack P. Katz, a shareholder, sold the shares for cash but filed a securities action asserting that, under the 1933 Act, he had converted to the new Series O shares and then sold for cash, in effect making him a "buyer" of the Series O shares and invoking the anti-removal terms of the 1933 law. "What Katz calls the 'fundamental change doctrine' that turns a sale into a purchase is word play designed to overcome the actual text of the securities law," wrote Chief Judge Frank Easterbrook for the panel.

"Katz sold his units for cash; he did not buy any new security," Easterbrook wrote. "The 'new A-1 units' are figments of a lawyer's imagination. Using legally fictitious (and factually nonexistent) 'new A-1 units' to nullify a legislative decision that only buyers have rights under the 1933 act would be wholly unjustified," he wrote.

"This is an important case that will come up again and again because plaintiffs' lawyers will try to find ways to get in state court, and the 1933 Act is a good way to do that," said Jonathan Polkes, lead counsel for the defense and a partner at Weil Gotshal & Manges in New York.

Wexler called Easterbrook's comments "mean-spirited and untrue."

The 7th Circuit remanded the case to district court, but lawyers for Katz have notified the court that they will agree to transfer the case to a related action in federal court in Colorado, according to Steven Merouse, also at Sonnenschein and representing the defense. That was the original goal of the defense, to send the case to Colorado, where it is filed as a contract dispute and subject to arbitration, he said. Stender v. Gerardi, No. 07-cv-2503 (D. Colo).

The plaintiffs "have called uncle," he said.