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

Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, 578 U.S. ___ (2016), was a United States Supreme Court decision in which the Court unanimously ruled, 8–0, that the jurisdictional standard set forth in §27 of the Securities Exchange Act of 1934 corresponds to the federal question jurisdiction test under 28 U.S.C. § 1331 for cases "arising under" federal law.

Background

Greg Manning initiated legal action against Merrill Lynch, the wealth management division of Bank of America, along with other brokerage firms, accusing them of conducting naked short selling involving shares of a publicly traded company in which Manning held two million shares. The plaintiffs, former shareholders, filed their lawsuit in a New Jersey state court, alleging breaches of New Jersey statutes. Merrill Lynch petitioned to transfer the case to federal court, anticipating a more advantageous legal environment.

The Third Circuit, through an opinion authored by Judge D. Brooks Smith, determined that federal jurisdiction was lacking and sent the case back to state court. This ruling contributed to a divergence among the Second Circuit, Fifth Circuit, and Ninth Circuit courts concerning the interpretation and reach of §27 of the Securities Exchange Act of 1934.

Defendants

The lawsuit named multiple financial services entities as defendants, including Merrill Lynch, Knight Capital Americas, UBS Securities, E-Trade Capital Markets, National Financial Services LLC, and Citadel Derivatives Group. The plaintiffs alleged that these firms benefited from a scheme involving naked short sales intended to manipulate the stock price of Escala.

Regulation SHO

The complaint was brought under New Jersey state law, asserting that the defendants’ naked short selling amounted to unlawful market manipulation that depressed the value of their shares. The plaintiffs claimed that Merrill Lynch and other defendants repeatedly violated Regulation SHO, a federal regulation designed to oversee naked short sales of common stock. The SEC enforces Regulation SHO pursuant to the Exchange Act with the goal of preventing deliberate failures to deliver securities and restricting manipulative practices in the market. Nevertheless, Manning and his co-plaintiffs did not assert any federal claims nor did they initiate proceedings in federal court; their action was exclusively a state law claim of illegal market manipulation filed in New Jersey courts, referencing alleged breaches of Regulation SHO without raising federal causes of action.

Claims under State Law

Manning brought allegations against Merrill Lynch and other financial entities, asserting violations of the New Jersey Racketeer Influenced and Corrupt Organizations Act, the New Jersey Criminal Code, and the New Jersey Uniform Securities Law. The lawsuit further included claims based on New Jersey common law, such as negligence, unjust enrichment, and interference with contractual relations.

Court's Ruling

The court delivered a unanimous decision permitting the case to continue in state court, despite citations of federal statutes like the Securities Exchange Act of 1934 and Regulation SHO. Justice Elena Kagan authored the majority opinion, interpreting Section 27 of the 1934 Securities Act as conferring jurisdiction to state courts. This ruling concerned jurisdictional authority exclusively and did not address the substantive issues of the case.

Justice Kagan clarified that Section 27 provides exclusive federal jurisdiction in a manner analogous to "aris[e] under" in federal question jurisdiction. She observed that Manning's claims were based on state law and did not inherently raise federal questions, thereby supporting the decision made by the Third Circuit (772 F. 3d 158).

Justice Clarence Thomas issued a concurring opinion, underscoring that Section 27 establishes a definitive criterion: federal jurisdiction applies only if a claim depends on violating a requirement created by the Securities Act. Since Manning’s allegations failed to satisfy this criterion, he concurred that state court was the proper venue.

External links