Another term of the U.S. Supreme Court has come and gone and, as is usually the case, I will say something about it in this blog. This is the first of four posts devoted to that end.
I'm not going to have anything to say about the abortion case that came down on the final day of the term. It is politically consequential, but there isn't a lot to be said about it from a legal point of view except that it is a re-affirmation of what has been the law since Casey. And I've just said that.
I'm also not going to discuss the public corruption case the Court decided on the last day of its session, effectively granting Robert McDonnell a new trial. It does involve an intellectually interesting issue of statutory interpretation, and it may be said to involve a deserved rebuke to prosecutorial overreach, but I find the blatancy of the cronyism involved there too depressing, wish to avoid slitting my wrists today.
What's left? A heck of a lot. I'll start in a way that will probably surprise most of you, spending all of this post, when these introductory remarks are through, on a question of federal versus state court jurisdiction as to a securities fraud lawsuit.
In the next post, I will speak of two other matters of statutory construction with which the court tangled this session, and one that it scheduled for its wrestling next session.
In a third post, Thursday, we'll come to certain more high-profile and constitutional questions, including interpretation of the one-person one-vote rule, and separation of powers.
Finally, we'll address the idea of sovereignty, as SCOTUS repeatedly found itself addressing that matter this year, in our part four Friday.
Today, then, we begin with ... Merrill Lynch v. Manning.
Naked Short Selling
This was a naked short selling case, which the plaintiffs wanted to bring in state court, because it involved state-law claims, as well as referencing the SEC's Reg. SHO. There was a split in federal circuits over whether they get to make that choice, or whether the fed courts have exclusive jurisdiction under sect. 27 of the SEC Act (the '34 Act). The court unanimously upheld the Third Circuit, reading sect. 27 jurisdiction as concurrent given these facts, and remanding the case to the New Jersey state court. They disagreed on why they were doing this.
Let's back up a bit. What's "short selling"? And in what sense are some short sales "naked"?
In the broadest sense, one "shorts" an asset whenever one bets that its value will decrease over a certain interval of time, and (whatever the asset is) there are lots of ways to do this.
In the more specific sense, one "shorts" a security by selling shares one does not yet own. Suppose Smith promises Jones a bloc of shares of XYZ Corp. in 30 days. Jones pays the current market price for those shares. Over the course of the coming month, bad news about XYZ becomes public, and the price falls. Smith then buys the shares in question, and delivers them on time to Jones. In this case, everything has worked out properly for Smith. The usual formula for success in business is "buy low, sell high." The short seller does things in the other order: it sells high, then buys low [then delivers]. IF everything works out.
The practice though, raises the danger of failures-to-deliver (FtD, without the flowers). A lot of FtDs could distort prices and generally fok up the securities exchange system, so various legal systems have made various provisions to limit this. Generally, a short seller of stocks in the US has three days after the sale to arrange for a broker-dealer who will confirm that it will be able to make delivery. The concise way of saying this: three days to locate.
A short in the absence of a locate is called a "naked short." This is illegal except in the case of what is called "bona fide market making." We needn't concern ourselves right now with what that means.
After the dot-com collapse at the turn of the millennium there was a lot of concern that FtDs had gotten out of control, and agitation led to the SEC's "Reg SHO," creating more stringent rules on the subject than had existed before.
Now we get back to Merrill Lynch v. Manning.
Greg Manning was a stockholder, who at the relevant times (2006-07) in the facts underlying the lawsuit owned two million shares of Escala Group, a company in the collectibles market, specializing in stamps. He claims that he lost the value of his investment because defendant/petitioner Merrill Lynch, in conspiracy with other financial institutions, nakedly shorted Escala stock, driving the price down.
Here is a two-paragraph statement of what lawyers call the “procedural posture.” Manning and other equity owners filed this lawsuit in a New Jersey state court, even though it referenced a federal regulation, Reg SHO, in the complaint. Essentially, Manning said that Merrill Lynch was engaged in unjust enrichment etc. as defined by the common law in the state of New Jersey, and that the particular mechanisms of the common-law tort entailed the violation of Reg SHO.
Presumably the plaintiffs believed that state court was a friendlier forum for them than federal court. Merrill Lynch removed the case to federal court, presumably because it agreed. Then Manning moved to send it back to state court. The district court denied the latter motion, keeping the case in the federal system. But the appeals court reversed the district court on this point, sending the matter back to the New Jersey court. Merrill Lynch petitioned for cert after THAT decision, asking SCOTUS to keep this matter federal.
The Supreme Court, this May, agreed with the appeals court, so the matter goes back to the state court where the plaintiff/respondent has wanted it. At least on the margins this is a win for the adversaries of short selling in general and nakedness in doing so, in particular.
All eight Justices agreed on this disposition, although the case produced two distinct rationales. Justice Kagan wrote for the court in an opinion joined by the Chief Justice, Roberts, as well as by Kennedy, Ginsburg, Breyer, and Alito. Justice Thomas wrote a concurrence, joined by Sotomayor.
Here's some additional discussion, by Ronald Mann of SCOTUSBlog.
One odd feature of Mann's (generally quite able) discussion is his incidental assertion that Kagan's opinion for the court took the "simplest possible path," with the implication that Thomas' concurrence was unnecessarily complicated. My reading is exactly the other way around. The notion that Kagan's opinion is simple reminds me of an old joke from the '60s TV show Get Smart. The joke was probably old even then.
CHIEF: "The threat from KAOS is really quite simple. [Speaks techno-jargon ending with " ... so did you follow me?"]
MAX: "All but one part."
CHIEF: "What part was that?"
MAX: "The part after 'really quite simple.'"
Even Mann's effort to explain Kagan's simplicity seems to leave the matter in obscurity.
The Thomas rationale (written both for himself and Sotomayor -- an odd couple) is fairly simple. Thomas writes that a natural English-language reading of the section 27 test of the '34 Act does not allow "mere allegations of Exchange Act breaches" to rob state courts of jurisdiction over such classic common law issues as unjust enrichment, unlawful interference with economic advantage, etc.
So: a win for state-court jurisdiction and for securities-law plaintiffs who need it. I am a uniformity-is-good kind of guy in such matters and suspect this decision may work mischief.
No more digressions and contextualizing though. We have a lot of cases to cover over the next two posts. It has been a busy session for SCOTUS.