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Supreme Court Upholds State Law Claims for Securities Fraud

TThe Supreme Court held that state claims for securities fraud were properly brought in state court.

Background

The Supreme Court’s decision resolves a split among federal circuit courts regarding where defrauded investors can sue when the wrongdoing violates both federal and state law.  The Court held that investors who chose to pursue state law remedies could sue in state court.  The result is a victory for investors since state law claims provide more robust investor protection than federal claims.

In this case corporate shareholders in Escala Group, Inc. as well as Escala’s former CEO challenged the actions of Merrill Lynch and other financial institutions, alleging the defendants intentionally depressed stock prices by effecting unlawful short sales of company stock. The lawsuit alleges that this market manipulation caused the stock prices to deflate and enabled defendants to reap enormous profits through their short selling positions.

The investors invoked the protections of New Jersey state law, including both racketeering law, consumer protection law, and laws that seek to ensure the fairness of securities markets. The investors sued in state court because of the enhanced remedies that state law provides for financial wrongs. Federal courts are courts of limited jurisdiction, limiting the claims available to investors. Defendants sought to dismiss the case, arguing that state courts lack jurisdiction over short sales of stock, even if those sales are fraudulent.  Notably, those federal laws do not provide individual claims for violations of the federal regulation at issue in this case. In short, defendants’ position would limit the investors’ remedies to other more limited federal claims.

State laws around the country provide enhanced remedies for investors in securities to challenge unlawful practices. While some misdeeds are prohibited in federal law, state laws often step into the gaps left by federal legislators and enhance accountability. The issue was whether state courts can hear lawsuits grounded on state law. An appeals court ruled that the lawsuit could proceed in state court, and the U.S. Supreme Court agreed.

AARP Foundation Litigation filed AARP’s friend-of-the-court brief on behalf of the investors, pointing out that with the rise in individual investments in stocks and mutual funds, investors need to have as many tools available to them as possible to protect against market manipulation. Although the particular facts of this case involve large corporate shareholders, the ramifications of the decision will impact even the smallest investor. Individual shareholders should have multiple remedies available, including suing in state court for fraud and deceit when appropriate.

What’s at Stake

Investors need every available tool to protect against stock market wrongdoing, including the option of suing in state court. State laws and state regulators provide additional protection to investors beyond what federal law provides. The number of investors owning individual stocks and mutual funds has grown enormously in the last several decades. The decreased ability of retirees to rely solely on Social Security has accelerated that trend, and as Social Security is projected to provide proportionately less retirement income as a percentage of prior earnings in the years ahead, this trend toward individual stock and mutual fund investment can be expected to continue.

Case Status

Merrill Lynch, Pierce, Fenner & Smith  v. Manning was decided by the U.S. Supreme Court.