Case Information
*1 PRECEDENTIAL UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT _____________ No. 13-3693 _____________ GREG MANNING; CLAES ARNRUP; POSILJONEN AB; POSILJONEN AS; SVEABORG HANDEL AS; FLYGEXPO AB; LONDRINA HOLDING LIMITED,
Appellants
v.
MERRILL LYNCH PIERCE FENNER & SMITH, INC.;
KNIGHT CAPITAL AMERICAS, a/k/a Knight Equity
Markets L.P.; UBS SECURITIES LLC; E TRADE CAPITAL MARKETS LLC; NATIONAL FINANCIAL SERVICES LLC; CITADEL DERIVATIVES GROUP LLC; JOHN DOES 1-10 (names being fictitious); ABC COMPANIES (names being fictitious), jointly, severally
or in the alternative, individually ________________________ On Appeal from the United States District Court for the District of New Jersey District Court No. 2-12-cv-04466 District Judge: The Honorable Jose L. Linares *2 Submitted Pursuant to Third Circuit L.A.R. 34.1(a)
July 10, 2014
Before: SMITH, VANASKIE, and SLOVITER, Circuit Judges (Filed: November 10, 2014) Neal H. Flaster, Esq.
Suite 230
30A Vreeland Road
P.O. Box 21
Florham Park, NJ 07932
Counsel for Appellants
Brad M. Elias, Esq.
Andrew J. Frackman, Esq.
Abby F. Rudzin, Esq.
O'Melveny & Myers
7 Times Square
Time Square Tower, 33rd Floor
New York, NY 10036
Thomas R. Curtin, Esq.
Graham Curtin
4 Headquarters Plaza
P.O. Box 1991
Morristown, NJ 07962
Counsel for Appellee Merrill Lynch Pierce Fenner *3 & Smith Inc.
James H. Bilton, Esq.
David G. Cabrales, Esq.
Edwin R. DeYoung, Esq.
W. Scott Hastings, Esq.
Locke Lord
2200 Ross Avenue
Suite 2200
Dallas, TX 75201
Joseph N. Froehlich, Esq.
Locke Lord
Three World Financial Center
New York, NY 10281
Counsel for Appellee Knight Capital Americas, L.P.
Andrew B. Clubok, Esq.
Beth A. Williams, Esq.
Kirkland & Ellis
655 15th Street, N.W.
Suite 1200
Washington, DC 20005
Brian M. English, I, Esq.
Tompkins, McGuire, Wachenfeld & Barry 100 Mulberry Street
Four Gateway, Suite 5
Newark, NJ 07102
Counsel for Appellee UBS Securities LLC Rebecca Brazzano, Esq.
Michael G. Shannon, Esq.
Thompson Hine
335 Madison Avenue
12th Floor
New York, NY 10017
Jennifer S. Roach, Esq.
Thompson Hine
3900 Key Center
127 Public Square
Cleveland, OH 44144
Counsel for Appellee National Financial Services, LLC.
Melissa Steedle Bogad, Esq.
James S. Richter, Esq.
Winston & Strawn
The Legal Center
One Riverfront Plaza, 7th Floor
Newark, NJ 07102
Stephen J. Senderowitz, Esq.
Winston & Strawn
35 W. Wacker Drive
Chicago, IL 60601,
Counsel for Appellee Citadel Derivatives Group, LLC
Kurt A. Kappes, Esq.
Greenberg Traurig
Suite 1100
1201 K Street
Sacramento, CA 95814
David E. Sellinger, Esq.
Greenburg Traurig
200 Park Avenue
Florham Park, NJ 07932
Counsel for Appellee E Trade Capital Markets _____________________ OPINION _____________________
SMITH, Circuit Judge.
After the District Court denied Plaintiffs’ motion to remand this case to New Jersey state court, we granted their petition for an interlocutory appeal. The issue before us is whether there is federal-question jurisdiction over Plaintiffs’ state-law claims, which allege that defendants manipulated the price of a stock via abusive “naked” short sales. Short sales are subject to detailed *6 federal regulation under Regulation SHO. New Jersey does not have an analogous provision. However, the question of whether the naked short selling at issue in this case violates New Jersey law (including the state’s general securities fraud provisions) need not be answered by reference to Regulation SHO. Because the success of Plaintiffs’ state-law causes of action does not “necessarily” depend upon the contents of federal law, this case does not “arise under” the laws of the United States. The presence of an exclusive jurisdiction provision governing Regulation SHO does not change the analysis, as such provisions cannot independently generate jurisdiction.
We hold that there is no federal-question jurisdiction over this suit. Accordingly, we will reverse the order denying remand, and direct the District Court to remand this case to the Superior Court of New Jersey.
I.
Plaintiffs are shareholders in Escala Group, Inc. (“Escala”). Named Defendants are financial institutions that engage in equity trading. Plaintiffs filed this lawsuit in the Superior Court of New Jersey alleging that Defendants participated in “naked” short selling of Escala stock, which “increased the pool of tradable shares by electronically manufacturing fictitious and unauthorized phantom shares.” (Am. Compl. ¶ 4.) Plaintiffs also refer to these shares as “counterfeit.” (Am. *7 Compl. ¶ 37.) Plaintiffs claim that this alleged increase in Escala shares diluted their voting rights and caused their shares to decline in value. The Amended Complaint pleads ten causes of action, with all claims asserted under New Jersey law. These causes of action address: (i) claims under the New Jersey Racketeer Influenced and Corrupt Organizations (“RICO”) Act based on predicate acts of New Jersey securities fraud and theft; and (ii) common law claims for unjust enrichment, interference with economic advantage and contractual relations, breach of contract, breach of the covenant of good faith and fair dealing, and negligence.
A normal (i.e., non-naked) short sale is usually accomplished in six steps: (1) “[t]he short seller identifies securities she believes will drop in market price;” (2) arranges to “borrow[] these securities from a broker;” (3) “sells the borrowed securities on the open market;” (4) waits some period of time hoping the securities decline in value; (5) “purchases replacement securities on the open market;” and (6) “returns them to the broker—thereby closing the short seller’s position.” Elec. Trading Grp., LLC v. Banc of Am. Sec. LLC , 588 F.3d 128, 132 (2d Cir. 2009). “The short seller’s profit (if any) is the difference between the market price at which she sold the borrowed securities and the market price at which she purchased the replacement securities, less [transaction costs].” Id . Usually a buyer takes delivery of the borrowed securities within three days *8 following the purchase. Amendments to Regulation SHO, SEC Release No. 34-58773, 73 Fed Reg. 61706, 61707 n.8 (Oct. 14, 2008).
However, “[i]n a ‘naked’ short sale . . . the short seller does not borrow securities in time to make delivery to the buyer within the standard three-day settlement period. As a result, the seller fails to deliver securities to the buyer when delivery is due (known as a ‘fail’ or ‘fail to deliver’). Sellers sometimes intentionally fail to deliver securities as part of a scheme to manipulate the price of a security, or possibly to avoid borrowing costs associated with short sales, especially when the costs of borrowing stock are high.” Id . at 707-08. Naked short selling is not per se illegal under federal law. However, some naked short selling schemes may run afoul of federal antifraud laws, as well as Regulation SHO. ‘Naked’ Short Selling Antifraud Rule, SEC Release No. 34-58774, 73 Fed. Reg. 61666, 61667 (Oct. 14, 2008).
Regulation SHO, 17 C.F.R. § 242.200
et seq
., was
adopted in 2004 by the Securities and Exchange
Commission (“SEC” or “Commission”), pursuant to its
authority under the Securities Exchange Act of 1934
(“Exchange Act”), 15 U.S.C. § 78a
et seq. See
Short
Sales, SEC Release No. 34-50103, 69 Fed. Reg. 48008
(July 28, 2004). Among other restrictions, Regulation
SHO imposes “locate” and “close out” requirements on
broker-dealers in an attempt to minimize fails to deliver.
Under the locate requirement, before executing a short
*9
sale order, a broker-dealer must have “reasonable
grounds” to believe that the security can be borrowed and
delivered within three days. 17 C.F.R. § 242.203(b)(1).
If a fail to deliver has occurred and persists for thirteen
days, under the “close out” requirement broker-dealers
may be required to purchase and deliver securities “of
like kind and quantity.” 17 C.F.R. § 242.203(b)(3);
Elec.
Trading Grp.
,
Although Plaintiffs’ causes of action are all brought under state law, the Amended Complaint repeatedly mentions the requirements of Regulation SHO, its background, and enforcement actions taken against some Defendants regarding Regulation SHO. It also cites data maintained to assist broker-dealers in complying with Regulation SHO’s close out requirement, and at times couches its allegations in language that appears borrowed from Regulation SHO. Further, plaintiffs plead that “Defendants violated the trading rules and regulations requiring that they actually deliver shares . . . to settle short sale transactions.” (Am. Compl. ¶ 33.) There is no question that Plaintiffs assert in their Amended Complaint, both expressly and by implication, that Defendants repeatedly violated federal law. Moreover, there is no New Jersey analogue to Regulation SHO.
Defendants removed the suit from the Superior
Court of New Jersey to the United States District Court
for the District of New Jersey, premised on the existence
*10
of federal-question jurisdiction.
Plaintiffs sought
remand. On December 31, 2012, the Magistrate Judge
issued a Report and Recommendation suggesting that
Plaintiffs’ motion to remand be granted: “because
[Plaintiffs] may succeed on their New Jersey RICO
claims . . . and state common law claims . . . without
establishing liability under federal law, the Amended
Complaint, on its face, does not raise necessarily a
substantial issue of federal law.”
Manning v. Merrill
Lynch, Pierce, Fenner & Smith, Inc.
, 12–4466, 2012 WL
7783142, at *4 (D.N.J. Dec. 31, 2012). The District
Court disagreed in a March 20, 2013 opinion: “the case
at bar is premised upon and its resolution depends on the
alleged violation of a regulation promulgated under the
[Exchange] Act.”
Manning v. Merrill Lynch, Pierce,
Fenner & Smith, Inc.
, No. 12–4466,
Noting “substantial ground for difference [of opinion] here, as evinced by the different outcome reached by this Court and [the] Magistrate Judge . . . in this case,” on May 23, 2013, the District Court certified an interlocutory appeal to this Court, pursuant to 28 U.S.C. § 1292(b), to answer “the question of whether remand is appropriate in this case.” Manning v. Merrill Lynch, Pierce, Fenner & Smith, Inc. , No. 12–4466, 2013 WL 2285955, at *2 (D.N.J. May 23, 2013). On August 28, 2013, we granted Plaintiffs’ petition to appeal.
II.
Defendants removed this suit to federal court pursuant to 28 U.S.C. § 1441, asserting federal jurisdiction under 28 U.S.C. §§ 1331 and 1337 and 15 U.S.C. § 78aa. We have jurisdiction over this interlocutory appeal pursuant to 28 U.S.C. § 1292(b).
“We exercise plenary review over [a] district
court’s order denying [a] motion for remand.”
Werwinski
v. Ford Motor Co.
,
III.
The sole issue on appeal is whether there is
federal-question jurisdiction over Plaintiffs’ claims.
“The removing party . . . carries a heavy burden of
showing that at all stages of the litigation the case is
properly before the federal court. Removal statutes are to
be strictly construed, with all doubts to be resolved in
favor of remand.”
Brown v. Jevic
,
A.
Section 1331 “is invoked by and large by plaintiffs
pleading a cause of action created by federal law.”
Grable & Sons Metal Prods., Inc. v. Darue Eng’g &
Mfg.
, 545 U.S. 308, 312 (2005);
see also Gunn v.
Minton
,
For a federal issue to be necessarily raised,
“vindication of a right under state law [must] necessarily
turn[] on some construction of federal law.”
Franchise
Tax Bd. of State of Cal. v. Constr. Laborers Vacation
Trust for S. Cal.
,
The “classic example,” id . at 312, of this type of arising under jurisdiction similarly required a determination of federal law as an essential element of the plaintiff’s state law claim. In Smith v. Kansas City Title & Trust Co. , 255 U.S. 180 (1921), plaintiff sued under a state law which forbade the defendant from investing in illegal securities. The alleged source of illegality was that the federal bonds purchased by the *14 defendant were unconstitutional (on the theory that Congress did not have the power to issue them). Because the “decision depend[ed] upon the determination of [the constitutional] issue,” “which [was] directly drawn in question,” federal jurisdiction was proper. Id . at 245-46.
By contrast, Regulation SHO is not an element of any of Plaintiffs’ claims. The claims, therefore, could be decided without reference to federal law. Plaintiffs alleged a market manipulation scheme and sued exclusively under New Jersey law, including its common law. The District Court, “noting that Plaintiffs do not point to a New Jersey law or regulation which similarly prohibits the type of alleged conduct at issue here,” found that the claims were necessarily predicated on the violation of Regulation SHO. Manning , 2013 WL 1164838, at *5. We conclude it was improper for the District Court to foreclose the possibility that particular state causes of action could permit recovery solely under state law. It is true that New Jersey’s laws are not as robust as federal laws. But we have previously held that even where “[t]here may be some basis to agree with defendants that [plaintiffs’] view of the state law is incorrect and will be so found[, i]t is . . . for the state court to make the determination as to the applicability of its state law.” United Jersey Banks v. Parell , 783 F.2d 360, 367 (3d Cir. 1986).
Indeed, even under federal law, a claim based on
“abusive ‘naked’ short selling as part of a manipulative
*15
scheme,” can be maintained without a predicate violation
of Regulation SHO, because such schemes are “always
illegal under the general antifraud provisions of the
federal securities laws . . . .” ‘Naked’ Short Selling
Antifraud Rule, 73 Fed. Reg. at 61667.
Such
manipulative schemes may “drive down a company’s
stock price” and “undermine
the confidence of
investors,” which may, in turn, make investors more
“reluctant to commit capital.”
Id
. at 61670. If naked
short selling can result in a violation of federal general
antifraud provisions independently of Regulation SHO, it
is difficult to imagine why naked short selling cannot
similarly result in a violation of state general antifraud
provisions independently of Regulation SHO. Moreover,
the Supreme Court of New Jersey, exercising its
common-law authority over New Jersey’s general
securities fraud provisions, has not shied away from
deviating from federal law.
See Kaufman v. i-Stat Corp.
,
As we read the Amended Complaint, no causes of
action are predicated
at all
on a violation of Regulation
SHO.
Cf. Lippitt v. Raymond James Fin. Servs., Inc.
,
But even if Plaintiffs’ claims were
partially
predicated on federal law, federal law would still not be
necessarily raised.
See Christianson v. Colt Indus.
Operating Corp.
, 486 U.S. 800, 810 (1988) (“[A] claim
supported by alternative theories in the complaint may
not form the basis for [federal] jurisdiction unless
[federal] law is essential to each.”).
[2]
Where “[p]laintiffs’
state [law] RICO claims allege both federal and state
predicate acts,” no federal question is necessarily raised
because a Plaintiff could “prevail upon their New Jersey
RICO claims or any of their other state-law claims
*17
without any need to prove or establish a violation of
federal law.”
Fairfax Fin. Holdings Ltd. v. S.A.C.
Capital Mgmt., LLC
, No. 06-4197,
Defendants also assert jurisdiction under § 1331 on the basis of a Frequently Asked Questions (“FAQ”) page on the SEC’s website. The website is clear from the outset that the FAQ responses are “not rules, regulations, or statements of the [SEC],” nor has the Commission approved them. [3] This website, which we are told refutes Plaintiffs’ theory of damages, says that naked short selling does not create “counterfeit shares”—a term Plaintiffs employ liberally in the Amended Complaint. But the phrase “counterfeit shares” does not appear a single time anywhere in the United States Code or the Code of Federal Regulations. Defendants simply cannot carry their burden of establishing jurisdiction based on a “disputed issue of federal . . . law,” Grable , 545 U.S. at 310, without identifying a particular source of federal law for the judiciary to interpret.
*18
Even
if Plaintiffs’
theories are
factually
contradicted by actual rules with the force of law, as the
Eighth Circuit thought similar theories were in
Pet
Quarters, Inc. v. Depository Trust & Clearing Corp.
, 559
F.3d 772, 781 (8th Cir. 2009) (referencing National
Securities Clearance Corporation rules), Defendants
would at best be entitled to a preemption defense.
“Federal pre-emption is ordinarily a federal defense to
the plaintiff’s suit. As a defense, it does not appear on the
face of a well-pleaded complaint, and, therefore, does not
authorize removal to federal court.”
Metro. Life Ins. Co.
v. Taylor
,
We conclude that § 1331 does not provide a basis to exercise jurisdiction over Plaintiffs’ claims.
B.
preemption-like arguments would always create federal- question jurisdiction.
[5] Defendants contend D’Alessio supports jurisdiction under § 27. But it was plainly decided under § 1331, id. at 101, and § 27 was only mentioned in the context of what is now prong three of Grable (substantiality) after the necessarily raised issue was resolved. 258 F.3d at 104.
Having concluded that there is no arising under
jurisdiction here pursuant to § 1331, we must decide
whether the exclusive jurisdiction provision in § 27 of the
Exchange Act might nonetheless provide a more
expansive basis
for
federal-question
jurisdiction.
Although Defendants, in advancing this argument,
contend that “every circuit court has reached the same
conclusion,” Appellees’ Br. 2, the issue has actually split
the two circuits that have most directly addressed it.
Compare Barbara v. N. Y. Stock Exch., Inc.
,
We believe the Supreme Court all but answered
this question in
Pan American Petroleum Corp. v.
Superior Court of Delaware In & For New Castle
County
,
Accordingly, we disagree with the line of Ninth
Circuit cases which have held that there can be
jurisdiction under § 27 (and other exclusive jurisdiction
provisions) even when there is not under § 1331.
[9]
We
note that the Ninth Circuit in its seminal decision in
Sparta
did not consider the Supreme Court’s holding in
Pan American
. The incongruity between
Sparta
and
Pan
*23
American
was brought squarely before the Ninth Circuit
in
Dynegy
. At issue in
Dynegy
was the import of § 317
of the Federal Power Act—an exclusive jurisdiction
provision substantially identical to both § 27 (which was
at issue in
Sparta
) and § 22 (which was at issue in
Pan
American
). Although the Ninth Circuit, in a footnote,
acknowledged that
Pan American
made clear that such
provisions were not “‘generator[s] of jurisdiction,’” it
nonetheless “fe[lt] bound . . . by
Sparta
’s subsequent
interpretation.”
[10]
Dynegy
,
Although it does not appear that any court has
expressly relied on
Pan American
to hold that § 27 does
not authorize a departure from the
Grable
line of cases,
courts have cited
Pan American
in holding that § 27 does
not depart from § 1331 in other ways.
See Calvert Fire
Ins. Co. v. Am. Mut. Reinsurance Co.
, 600 F.2d 1228,
1231 (7th Cir. 1979) (§ 27 does not prevent state courts
from hearing Exchange Act defenses);
Gold v. Blinder,
Robinson & Co.
,
jurisdiction does not bar a plaintiff from pursuing at his option remedies based solely on state law. Pan Am .”). We agree with the Second Circuit’s holding in Barbara that § 27 is coextensive with § 1331 for purposes of establishing subject-matter jurisdiction—the exclusive jurisdiction provision merely serves to divest state courts of jurisdiction. [11] Accordingly, § 27 does not provide an independent basis to exercise jurisdiction over Plaintiffs’ claims.
IV.
Having concluded that federal-question jurisdiction is lacking, we will reverse the District Court’s March 20, 2013 order, and remand with instructions that the District Court remand this case to the Superior Court of New Jersey.
Notes
[1] 28 U.S.C. § 1441(a) authorizes removal of “any civil action” over which district courts “have original jurisdiction.”
[2] Although
Christianson
concerned 28 U.S.C. § 1338
(dealing with actions “arising under” the patent laws)
rather than § 1331, the Supreme Court noted the
“identical language” in the two provisions and applied
the “same test” to both.
[3] Division of Market Regulation: Responses to Frequently Asked Questions Concerning Regulation SHO, http://www.sec.gov/divisions/marketreg/mrfaqregsho120 4.htm (last visited October 24, 2014).
[4] The Eighth Circuit in
Pet Quarters
held that state law
claims against SEC-registered clearing agencies for
maintaining a program under rules approved by the SEC
(which allowed some naked short selling to occur) were
all conflict preempted. Although ostensibly recognizing
the rule that preemption does not usually give rise to
federal-question jurisdiction, the Eighth Circuit held that
the
Grable
test was satisfied as the complaint “presents a
substantial federal question because it directly implicates
actions taken by the Commission . . . .”
[6]
See also Marel v. LKS Acquisitions, Inc
.,
[7]
Opinion amended on other grounds on denial of
rehearing
,
[8] In an “odd[] . . . discuss[ion],” id. at *33 (Straub, J. dissenting), on substantially different facts than at issue here, the Second Circuit considered Sparta and similar decisions relevant to its analysis of the fourth prong of Grable (whether exercising jurisdiction under § 1331 would upset the federal-state balance of judicial responsibilities). Specifically, that court declared that exercising jurisdiction under § 1331 would not upset the federal-state balance given that jurisdiction could be exercised in other circuits under § 27, even though it acknowledged that its own decision in Barbara “declined to adopt such a broad reading of [§ 27]”—a decision it was not revisiting. Id . at *17.
[9] Hawkins v. National Ass’n of Securities Dealers Inc. , 149 F.3d 330, 331-32 (5th Cir. 1998) (per curiam), although not as explicit as Sparta and Dynegy , could be read as holding that § 27 can provide subject-matter jurisdiction independently of § 1331. To the extent Hawkins so holds, we disagree with it.
[10] Although the Ninth Circuit acknowledged in that
footnote that the Supreme Court’s holding in
Pan
American
actually meant something relevant, the text of
its opinion belies that admission: “The
Pan American
court’s holding is unremarkable insofar as it held that
cases falling
outside
the scope of the exclusive
jurisdiction provision are not subject to it.”
Dynegy
, 375
F.3d 831 at 843. In reality,
Pan American
stands for the
proposition that cases otherwise falling outside the scope
of the district courts’
original jurisdiction
are not brought
within it by virtue of an exclusive jurisdiction provision.
See In re W. States Wholesale Natural Gas Antitrust
Litig.
,
[11] The District of New Jersey already reached this
conclusion in a prior short selling case by relying on
Barbara
.
Fairfax
,