Manning v. Merrill Lynch Pierce Fenner & Smith, Inc.

• Decision Date: 10 November 2014
• Docket Number: No. 13–3693.,13–3693.
• Parties: 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.
• Court: U.S. Court of Appeals — Third Circuit

772 F.3d 158

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.

No. 13–3693.

United States Court of Appeals, Third Circuit.

L.A.R. 34.1(a) July 10, 2014.

Filed: Nov. 10, 2014.

Neal H. Flaster, Esq., Florham Park, NJ, Counsel for Appellants.

Brad M. Elias, Esq., Andrew J. Frackman, Esq., Abby F. Rudzin, Esq., O'Melveny & Myers, New York, NY, Thomas R. Curtin, Esq., Graham Curtin, Morristown, NJ, Counsel for Appellee Merrill Lynch Pierce Fenner & Smith Inc.

James H. Bilton, Esq., David G. Cabrales, Esq., Edwin R. DeYoung, Esq., W. Scott Hastings, Esq., Locke Lord, Dallas, TX, Joseph N. Froehlich, Esq., Locke Lord, New York, NY, Counsel for Appellee Knight Capital Americas, L.P.

Andrew B. Clubok, Esq., Beth A. Williams, Esq., Kirkland & Ellis, Washington, DC, Brian M. English, I, Esq., Tompkins, McGuire, Wachenfeld & Barry, Newark, NJ, Counsel for Appellee UBS Securities LLC.

Rebecca Brazzano, Esq., Michael G. Shannon, Esq., Thompson Hine, New York, NY, Jennifer S. Roach, Esq., Thompson Hine, Cleveland, OH, Counsel for Appellee National Financial Services, LLC.

Melissa Steedle Bogad, Esq., James S. Richter, Esq., Winston & Strawn, Newark, NJ, Stephen J. Senderowitz, Esq., Winston & Strawn, Chicago, IL, Counsel for Appellee Citadel Derivatives Group, LLC.

Kurt A. Kappes, Esq., Greenberg Traurig, Sacramento, CA, David E. Sellinger, Esq., Greenburg Traurig, Florham Park, NJ, Counsel for Appellee E. Trade Capital Markets.

Before: SMITH, VANASKIE, and SLOVITER, Circuit Judges.

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 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.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 following the purchase. Amendments to Regulation SH O, 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 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., 588 F.3d at 135–36.

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 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, 2013 WL 1164838, at *4 (D.N.J. Mar. 20, 2013).

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., 286 F.3d 661, 665 (3d Cir.2002).

III.

The sole issue on appeal is whether there is...