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Because the 2nd U.S. Circuit Court of Appeals includes the financial center of New York, it hears many important securities law cases. In the past year, the 2nd Circuit decided three issues of first impression in federal securities fraud law. The court held that the Securities Litigation Uniform Standards Act of 1998 pre-empts class actions under state statutory and common law only if the plaintiff satisfies the purchaser-seller rule set forth in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), but does not pre-empt “holding” claims, in which plaintiffs allege that defendants’ misstatements or omissions induced them to retain, rather than purchase or sell, securities. Dabit v. Merrill Lynch, Pierce, Fenner & Smith Inc., 395 F.3d 25 (2nd Cir. 2005). The court also held that the plead-with-particularity requirement of Fed. R. Civ. P. 9(b) applies to claims under �11 and �12(a)(2) of the Securities Act of 1933 when the claims are premised on allegations of fraud. Rombach v. Chang, 355 F.3d 164 (2nd Cir. 2004). Finally, the court held that the new, longer statute of limitations for federal securities claims adopted as part of the Sarbanes-Oxley Act does not revive claims that already were time-barred, before Sarbanes-Oxley became effective, under the old, shorter limitations period. Aetna Life Ins. Co. v. Enter. Mortgage Acceptance Co. LLC (In re Enter. Mortgage Acceptance Co. LLC Sec. Litig.) (EMAC), 391 F.3d 401 (2nd Cir. 2004). This article surveys those decisions. The Private Securities Litigation Reform Act heightened the pleading standards for fraud-based claims under the Securities Exchange Act of 1934 to make it difficult to bring strike-suits and coerce large settlements. A consequence was a perceived increase in securities suits being filed in state courts under state law to avoid the PSLRA’s stringent standards. Congress enacted SLUSA to combat this loophole. The statute pre-empts certain class actions based upon state law brought by private parties, in either state or federal court, that allege a misrepresentation or omission “in connection with the purchase or sale” of certain securities. Those suits are subject to summary dismissal. The appellants in Dabit sought to avoid dismissal under SLUSA by arguing that their claims did not allege misconduct “in connection with the purchase or sale” of securities. Shadi Dabit, a former Merrill broker, asserted state law claims in federal court for a class that allegedly held securities due to Merrill’s supposedly misleading research and recommendations (holding claims), and lost commissions because clients left when Merrill’s alleged misconduct was uncovered (lost-commission claims). Other appellants, including IJG Investments, asserted state law claims in state court for a class that paid an annual fee to Merrill for supposedly objective research (annual fee claims) and paid commissions to Merrill for trades made relying upon the allegedly fraudulent recommendations (commission claims). Merrill removed IJG’s suit to federal court, where it and the Dabit suit were dismissed pursuant to SLUSA because, the district court held, the appellants alleged misconduct “in connection with the purchase or sale” of securities. THE RULING IN ‘DABIT’ The 2nd Circuit affirmed in part and vacated and remanded in part. The decision turned on the phrase “in connection with.” The appellants argued that the purchaser-seller rule that the Supreme Court adopted as a substantive limit on the “in connection with” language in �10(b) and Rule 10b-5 of the Exchange Act limited the same language in SLUSA. (In Blue Chip, the Supreme Court held that only a plaintiff who had purchased or sold securities had standing to bring a private action under �10(b) and Rule 10b-5.) Therefore, they argued, SLUSA pre-empted only claims in connection with a purchase or sale, and did not pre-empt their claims, which did not allege misconduct in connection with a purchase or sale. The court agreed with the appellants’ legal analysis, but not with its application to the facts. The court found that, by using identical language, Congress intended “in connection with” to have the same meaning under SLUSA as it has under �10(b) and Rule 10b-5. Therefore, the court held, “Congress meant to import [into SLUSA] the settled standing rule [of Blue Chip] along with the ‘in connection with’ phrase as a substantive standard.” Id. at 40. The court acknowledged that, because SLUSA pre-empts only claims that satisfy Blue Chip‘s purchaser-seller rule, it does not pre-empt pure holding claims. The court then rejected Dabit’s argument that he alleged pure holding claims. The court found that Dabit’s class definition “fail[ed] to distinguish between those who came to hold [securities] before any relevant misrepresentation and those who purchased [securities] in reliance on such representations.” Id. at 45. The court held that, when plaintiffs allege that they both purchased and retained securities, their claims satisfy the Blue Chip rule and “plainly fall … within SLUSA’s prohibition.” Id. at 44. Dabit’s lost-commission claims fared better, however, because they did not rely on a purchase or sale in connection with the alleged fraud. Rather, they were based on commissions that the brokers never earned because clients stopped doing business with the brokers after the alleged fraud was disclosed. IJG’s claims also met a mixed reception. The court vacated dismissal of the annual fee claims because fees were paid whether or not the customer purchased or sold securities. But the court affirmed dismissal of the commission claims because the commissions “only accrued when plaintiffs purchased or sold securities” through Merrill and, thus, “necessarily involve[d] allegations of a purchase or sale.” Id. at 48-49. THE ‘ROMBACH’ DECISION Fed. R. Civ. P. 9(b) provides that “[i]n all averments of fraud … , the circumstances constituting fraud … shall be stated with particularity.” 2nd Circuit courts had split over whether plaintiffs must plead those Securities Act claims for which fraudulent intent is not a substantive element with particularity pursuant to Rule 9(b) when the misconduct complained of is allegedly fraudulent. Rombach resolved the split by holding that they must. Myrna Rombach brought a putative class action against underwriters and certain former officers of Family Golf Centers. The complaint alleged, among other things, that all the defendants violated �11 by issuing a false and misleading registration statement, and that the underwriters also violated �12(a)(2) by soliciting the sale of shares based on a false and misleading prospectus. The district court dismissed the �11 claims under Rule 9(b). The plaintiffs appealed. The 2nd Circuit affirmed. By its terms, the court explained, Rule 9(b) applies to all allegations of fraud, not just claims “styled or denominated as fraud.” The court then noted that although fraudulent intent is not an element of �11 and �12(a)(2) claims, “claims under those sections may be-and often are-predicated on fraud.” Rombach, 355 F.3d at 171. “While a plaintiff need allege no more than negligence to proceed under Section 11 and Section 12(a)(2),” the court held, “claims that do rely upon averments of fraud are subject to the test of Rule 9(b).” Id. The court added that pleading with particularity under Rule 9(b) means pleading facts that demonstrate why allegedly misleading statements were misleading. Applying those rules, the court found that the allegations supporting the appellants’ �11 claims against the former officers sounded in fraud because the appellants used phrases “classically associated with fraud,” such as pleading that the registration statement was “inaccurate and misleading” and contained “untrue statements of material facts,” and that “materially false and misleading written statements were issued.” Id. at 172. The court also found that “the complaint does not state with particularity the specific facts in support of [appellants'] belief that [respondents'] statements were false when made.” Id. at 172. Accordingly, the court affirmed dismissal of the �11 claims pursuant to Rule 9(b). (The court affirmed the finding that the allegations in support of the �11 and �12(a)(2) claims against the underwriters sounded in negligence, and affirmed dismissal of those claims, but on grounds that are not germane here.) THE ‘EMAC’ RULING Before Sarbanes-Oxley, plaintiffs alleging violations of �10(b) and Rule 10b-5 of the Exchange Act had to file their claims within one year of discovering the facts constituting (or giving rise to notice of) the alleged violation, or three years after the violation, whichever came first. To provide plaintiffs more time to uncover and investigate potential claims, Sarbanes-Oxley includes �804, which provides for a two-year and five-year statute of limitations. The longer limitations period applies “to all proceedings … commenced on or after the date of enactment of this Act.” Pub. L. No. 107-204, �804(b), 116 Stat. 745, 801. EMAC involved appeals from two district court decisions in which the lower courts declined to apply the new limitations period retroactively to revive claims that were time-barred under the old limitations period, even though the plaintiffs “commenced” their actions after Sarbanes-Oxley’s enactment date. The 2nd Circuit affirmed both decisions. To determine whether to apply �804 retroactively to revive the stale claims, the court relied on a two-prong test articulated by the Supreme Court in Landgraf v. USI Film Products, 511 U.S. 244 (1994). Under Landgraf‘s first prong, a court must “determine whether Congress has expressly prescribed the statute’s proper reach. If Congress has done so, the inquiry ends and the court enforces the statute as it is written.” EMAC, 391 F.3d at 405-406 (quoting 511 U.S. at 280). If Congress has not done so, the court proceeds to Landgraf‘s second prong and must “determine whether the new statute would have retroactive effect, i.e., whether it would impair rights a party possessed when he acted, increase a party’s liability for past conduct, or impose new duties with respect to transactions already completed.” Id. at 406 (quoting 511 U.S. at 280). If the statute would have a retroactive effect, it cannot be applied retroactively “absent clear congressional intent to the contrary.” Id. (quoting 511 U.S. at 280). Addressing the first prong, the court rejected the appellants’ argument that Congress intended to apply �804 retroactively. The court held that �804 does not contain the “unambiguous language that the Supreme Court has asserted would amount to an express retroactivity command” or words that “Congress has used in previous statutes to indicate its intent to revive time-barred claims.” Id. at 407. The absence of unambiguous language, and the court’s determination that �804′s legislative history did not clearly indicate an intent to revive stale claims, was dispositive of the first-prong analysis. Turning to Landgraf‘s second prong, the court held that applying the new statute of limitations to revive stale claims has a retroactive effect: “Extending the statute of limitations retroactively ‘increase[s] [a defendant's] liability for past conduct,’ Landgraf, 511 U.S. at 280, by increasing the period of time during which a defendant can be sued. This effect is particularly prevalent in the context of claims that have already expired. Resurrection of such claims puts defendants back at risk at a point when defendants reasonably believe they are immune from litigation, stripping them of a complete affirmative defense they previously possessed and may have reasonably relied upon.” Id. at 410 (footnote omitted). Because applying �804 to revive the stale claims would have a retroactive effect, the court deferred “to the longstanding presumption against retroactiv[ity],” and affirmed the district court decisions. Based on these cases, the following seems clear. Dabit immunizes pure holding claims from SLUSA. But plaintiffs are well advised to define their classes precisely, lest courts determine that the holding classes include sellers or purchasers and, therefore, warrant dismissal under SLUSA. Rombach likewise counsels precision in pleading. If allegations supporting Securities Act claims sound in fraud, Rule 9(b) applies. Finally, although Sarbanes-Oxley increases corporate accountability, EMAC puts plaintiffs on notice that they cannot avoid the old one-year/three-year limitations period when alleging misconduct that pre-dates Sarbanes-Oxley. Steven Brody is a partner in the business litigation group in the New York office of Atlanta-based King & Spalding. James Goldfarb is an associate in the group. Before joining the firm, Goldfarb was one of the attorneys representing defendant-appellee EMAC in the EMAC decision discussed here.

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