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Washington-In the wake of a Supreme Court decision last week on state court securities class actions, plaintiffs’ lawyers are unlikely to rally around brokers like Shadi Dabit or small investors with securities fraud claims unless they sustained very large losses that justify bringing individual lawsuits, said securities experts and others. The high court, in its first case under the federal Securities Litigation Uniform Standards Act (SLUSA), unanimously ruled that the act pre-empts state-law class actions brought by people claiming that they suffered losses when they were fraudulently induced to hold or retain-not to purchase or sell-securities. Merrill Lynch v. Dabit, No. 04-1371. Because federal law does not recognize so-called holder claims, the Dabit decision closed both federal and state courthouse doors to the vast majority of those types of class actions. “What it really means in effect is if you’re a big investor and have a major case, SLUSA doesn’t apply if you’re a holder because you [will have the resources] to file an individual lawsuit in state court,” said securities law scholar Norman Poser of Brooklyn Law School. “If you’re a small investor who can only get any kind of satisfaction through a class action, you can’t sue anywhere. It shows, I think, the present court’s real lack of any kind of sympathy for the small investor.” It shows, instead, the high court’s careful adherence to congressional intent in enacting SLUSA in 1998 and its parent statute, the Private Securities Litigation Reform Act of 1995, said securities litigator John Reding, a partner in the San Francisco office of Paul, Hastings, Janofsky & Walker, who considers the ruling good for business. “This court continues to interpret these statutes with a careful eye on what Congress intended and Dabit reinforces, loud and clear, that Congress intended to deter or prohibit the filing of abusive and baseless class actions,” said Reding. “This holding along with the last couple of decisions in this area have, if anything, made it easier to predict where this court is going to go in this area,” he added. “I think this is an area where the court has circled its wagons and said this is a national issue.” But the high court’s very strong statement in Dabit about the “magnitude of the federal interest” in protecting market integrity and efficiency may come back to haunt corporate America as other federal regulatory issues proceed to the Supreme Court, cautioned securities law scholar Larry Ribstein of the University of Illinois College of Law. Plugging loophole Shadi Dabit is a lawyer and a former Merrill Lynch broker who brought a class action on behalf of himself and all other brokers who, while employed by Merrill Lynch Co. Inc., bought certain stocks for themselves and their clients between Dec. 1, 1999 and Dec. 31, 2000. Their claim, based on Oklahoma state law, was that Merrill Lynch breached its fiduciary duty to its brokers by disseminating misleading analyst research and thereby manipulating stock prices. They and their clients, they claimed, held onto their overvalued stocks well beyond the point when, had the truth been known about what Merrill Lynch was doing, they would have sold. They claimed losses when the truth about the research analysts’ practices was revealed-around the time that New York’s attorney general began an investigation of the investment firm. The high court, in an opinion by Justice John Paul Stevens, endorsed arguments by Merrill Lynch, represented by Jay Kasner of New York’s Skadden, Arps, Slate, Meagher & Flom, and the Bush administration, that these types of class actions fall under SLUSA’s pre-emptive arm. Congress enacted SLUSA, wrote Stevens, to stem the shift of class actions from federal to state courts-a shift that began after Congress made it more difficult for securities fraud plaintiffs to prevail in federal courts under the Private Securities Litigation Reform Act (PSLRA). Both statutes were designed to address perceived abuses of class actions, such as nuisance filings. The only issue in Dabit was whether the holder action met SLUSA’s requirement that the alleged fraud be “in connection with” the purchase or sale of a covered security. Dabit won in the 2d U.S. Circuit Court of Appeals, which had held that the requirement applied only to purchasers and sellers, not holders of securities. But Stevens said that the court has generally given a broad interpretation of the “in connection with” phrase in other securities cases and has held that it is enough that the alleged fraud “coincide” with the securities transaction. Congress, he said, was aware of that broad interpretation when it used the phrase in SLUSA. Holder class actions, he added, pose a special risk of vexatious litigation, and it would be “odd, to say the least, if SLUSA exempted that particularly troublesome subset of class actions from its pre-emptive sweep.” Stevens noted that SLUSA “does not deny an individual plaintiff, or indeed any group of fewer than 50 plaintiffs, the right to enforce any state-law cause of action that may exist.” Illinois’ Ribstein said that one implication of Dabit concerns the extent of federal power over corporate law and securities regulation. Stevens, he noted, began his analysis in Dabit saying: “The magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities cannot be overstated. “This was a very strong statement,” said Ribstein. “So some of this was about the federal role in regulating corporations, which I think is a major ongoing issue, especially given Sarbanes-Oxley. I think that language could come back in the next securities opinion dealing with the application or interpretation of Sarbanes-Oxley. “For example, the Free Enterprise Fund’s constitutional challenge to the [Public Company Accounting Oversight Board]: If that ever gets to the Supreme Court, I wouldn’t be shocked to hear language from Dabit in that opinion.” Business voiced triumph over the Dabit decision because it shuts down the plaintiffs’ bar, Ribstein said, and the plaintiffs’ bar had the converse reaction. “But I think the triumph could turn sour if this opinion is later cited for an expansive reading of Congress’ power to regulate the securities market,” Ribstein added. Securities scholar Richard Booth of the University of Maryland School of Law said that it is too early to discern what the new Roberts court thinks about securities law. “I’d be surprised if they get expansive about federal power in this area,” he added. Another note sounded in Dabit, said Ribstein, concerns the substantive question of the role of securities class actions. “This opinion continues what the court started with the Dura Pharmaceuticals decision,” he said, referring to Dura Pharmaceuticals v. Broudo, 125 S. Ct. 1627 (2005). “There was really strong language there about the abusive nature of class actions. You see the same kind of language in this case.” Dabit‘s significance lies in what could have happened had the justices ruled against Merrill Lynch, said securities litigator John Bielema of Atlanta’s Powell Goldstein. “It could have opened the floodgates to a whole new breed of lawsuits,” he said. “Every time you had a traditional purchaser and seller class action, there would have been a tag-along suit by holders. Those would have proliferated, and that would have been a bad thing for corporate America. Dabit is important because it nips in the bud what started as a trend among the plaintiffs’ bar to start a new category of claims.” Skadden’s Kasner said that holder class actions have been filed throughout the country. The immediate impact of the Dabit decision, he said, is that “Now those claims will be dismissed.” Kasner added that “Companies now can access public capital markets without the threat of their conduct being judged by 50 different state laws in 50 different jurisdictions.” The court clearly was sympathetic to the floodgate argument, said Deborah Zuckerman of the AARP Foundation, which filed an amicus brief supporting Dabit. “A lot of older people tend to invest for the long term, and they’re not buying and selling frequently,” she said. “They may fall into the group of people whose claims will now, at least in state class actions, be foreclosed. Only individuals who have losses that are large enough to make it worthwhile going forward on an individual basis will be able to make a claim,” she said. Paul Hastings’ Reding agreed. “There are too many purchase and sale class actions out there for anyone to take these. Holder cases are a nightmare to deal with-the jury has to believe I would have bought or would have sold if I had known truth. It’s a cause of action easily manipulative of the system. Holder cases are very low on the list.” The high court will hear arguments in a second and final SLUSA case this term on April. In Kircher v. Putnam Funds Trust, No. 05-409, the justices will decide whether a district court’s decision to remand cases removed under SLUSA is appealable.

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