Merrill Lynch v. Dabit: The Case of the Scorned Broker and the Death of the State Securities Fraud Class Action Suit

Summary

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I. Introduction. II. Federal and State Securities Laws and Congress's Blurring of the Lines. A. Federal Securities Laws and Section 10(b). B. State Securities Laws and Common Law Causes of Action. C. Congressional Shifts in the Balance. 1. The PSLRA of 1995. 2. The NSMIA of 1996. 3. SLUSA of 1998. III. The Scorned Broker: The Dabit Case and the Federal Circuit Split. A. The Dabit Case. B. The Majority Rule. 1. Presumption of Congressional Knowledge of Settled Judicial Interpretation. 2. No Congressional Intent to Go Beyond Closing the Federal Flight Loophole. C. The Minority Rule. 1. Congressional Intent to Go Beyond Closing the Federal Flight Loophole. 2. Policy Considerations Supporting Preemption. 3. Complete Preemption of State Securities Fraud Class Actions. IV. The Death of the State Securities Fraud Class Action Lawsuit. A. The Dabit Opinion. 1. Presumption of Congressional Knowledge of Settled Judicial Interpretation. 2. Policy Considerations. B. SLUSA and Complete Preemption. C. Collateral Impact on the SEC. V. Conclusion.

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Merrill Lynch v. Dabit: The Case of the Scorned Broker and the Death of the State Securities Fraud Class Action Suit

Merrill Lynch v. Dabit: The Case of the Scorned Broker and the Death of the State Securities Fraud Class Action Suit1Melanie P. Goolsby: I wish to thank Vice Chancellor Glenn G. Morris for his invaluable assistance and guidance throughout the drafting of this casenote. I also thank my husband Drake for his patience and support.

I. Introduction.

In a news conference on Tuesday, April 8, 2002, New York Attorney General Eliot Spitzer announced that his office had been conducting a nine month investigation into an investment analysis conducted by Merrill Lynch analysts.2 Spitzer alleged that Merrill

Lynch analysts had produced misleadingly positive assessments of stocks so that the investment banking arm of Merrill Lynch could secure fees from selling stock and advising on mergers. The New York Attorney General pointed to Merrill Lynch email messages that referred to the same stocks subject to rosy assessments as "piece[s] of junk" and "powder keg[s] as evidence to support his accusations."3 At the time of the announcement, Wall Street observers hinted that conflicts of interest and biased recommendations permeated the entire industry.4 Indeed, approximately one month later Spitzer announced that he had expanded the scope of his investigation to include Switzerland's UBS AG and Credit Suisse Group.5 Merrill Lynch quickly negotiated a $100 million settlement with Spitzer that outlined a series of reforms designed to eliminate the alleged conflicts of interest.6 Other Wall Street investment banks mimicked the reforms outlined in the settlement, including Credit Suisse First Boston.

The damage, however, was already done. Shadi Dabit, a former Merrill Lynch broker, filed a class action suit against his former employer alleging breach of fiduciary duty and the covenant of fair dealing on behalf of current and former Merrill Lynch brokers.7 Dabit pointed to Merrill Lynch's misleading analyst reports as the cause for his and his clients' decision to hold their securities beyond the point when they would have sold had they known the truth.8 Rather than relying on federal securities law, Dabit anchored his claim on Oklahoma state law which, according to Dabit's interpretation, recognized a securities fraud holding claim.

Dabit's choice was shrewd given the changing legal landscape of private securities fraud class action suits. Compared to state regulation, federal securities law imposes strict jurisprudential standing requirements and heightened pleading standards.9

Conversely, state securities regulation is less stringent given that some states recognize securities fraud holding claims,10 which are grounded in tort theories of fraudulent inducement.11

Nevertheless, the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") stands as a formidable obstacle to the viability of state securities fraud claims. If a court determines that the plaintiffs' state law holding claim falls within SLUSA's preemptive scope, the statute functions to invalidate the plaintiffs' state law claim.12 Once the action is removed to federal court, the plaintiffs' cause of action is dismissed altogether since federal securities law does not recognize analogous holding claims. Prior to the United States Supreme Court'...

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