On May 16, 2016, the Supreme Court of the United States decided Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, No. 14-1132, holding that that the “arising under” test for federal-question jurisdiction under 28 U.S.C. § 1331 determines whether federal courts have exclusive jurisdiction under section 27 of the Securities Exchange Act of 1934 (the “Exchange Act”) of lawsuits to enforce liabilities or duties created by that Act. (The Court did not address the portion of section 27 that gives federal courts exclusive jurisdiction of “violations of this chapter or the rules and regulations thereunder” with respect to criminal and regulatory enforcement actions.)
Greg Manning owned stock in Escala Group, Inc., a company traded on the NASDAQ. Between 2006 and 2007, Escala’s share price plummeted and Manning lost most of his investment. Manning blamed Merrill Lynch and other financial institutions for devaluing Escala during that period through “naked short sales” of its stock, under which one borrows stock from a broker and sells it to a buyer on the open market, but never delivers the shares back to the buyer. “Naked” short sales of stock may be designed to drive down a company’s stock price, and are accordingly regulated by Regulation SHO.
Manning and other former Escala shareholders sued Merrill Lynch in New Jersey state court and alleged several state-law claims under New Jersey law, but he did not raise any claims under federal securities statutes. In addition to his state-law claims, Manning suggested in his Complaint that Merrill Lynch’s conduct also violated Regulation SHO. Merrill Lynch removed the case to federal court, arguing that the federal court had jurisdiction of Manning’s claims because: (1) they “arose under” federal law under 28 U.S.C. § 1331; and (2) Manning’s lawsuit was “brought to enforce any liability or duty created by [the Act] or the rules and regulations thereunder,” and therefore fell within the exclusive-jurisdiction provision of section 27 of the Exchange Act (15 U.S.C. § 78aa(a)). Manning moved to remand the case back to state court, but the district court denied his motion. The Third Circuit reversed, holding that Manning’s case did not “arise under” federal law for purposes of 28 U.S.C. § 1331 because his claims were “brought under state law” and did not “necessarily rais[e]” a federal question,” and did not fall under the exclusive-jurisdiction provision of section 27 for the same reason: the claims did not “arise under” the Exchange Act.
The Supreme Court affirmed, holding that the jurisdictional test in section 27 is the same as the one used to decide if a case “arises under” federal law under 28 U.S.C. § 1331. The Court rejected a broader test proposed by Merrill Lynch, because the text of section 27 did not extend to suits that merely “mention a duty established by the Exchange Act.” By the same token, it rejected a narrower test proposed by Manning, which would have limited jurisdiction under section 27 to only cases expressly asserting a cause of action under the Exchange Act. The Court concluded that the existing jurisdictional test for “arising-under” jurisdiction under 28 U.S.C. § 1331 should govern the “brought-to-enforce” language of section 27 of the Exchange Act. Under the “arising-under” test, a claim falls within section 27 if either: (1) the Exchange Act creates the cause of action, or (2) a state-law claim “necessarily raises” a claim under the Exchange Act. The Court explained that this reading of section 27 made particular sense because the Court had construed the identical phrase “brought to enforce” in several separate decisions and contexts, and each time it applied the “arising-under” test. Applying that standard likewise served the goals of giving deference to state tribunals for claims arising under state law and adopting straightforward and administrable standards for determining jurisdiction.
Justice Kagan delivered the opinion of the court, in which Chief Justice Roberts and Justices Kennedy, Ginsburg, Breyer, and Alito joined. Justice Thomas filed an opinion concurring in the judgment, in which Justice Sotomayor joined.