Investment Fraud Suit Brought By Brokers Blocked By The Supremes

If you listen to your firm’s analyst and your client loses money, who is to blame? You, the client, the analyst or the firm?

If you listen to your firm’s analyst and your client loses money, who is to blame? You, the client, the analyst or the firm?

That’s a good question, and no doubt depends on the facts of any given scenario. But it might just have gotten harder to sue your firm and win money for bad research. In an important court ruling, the U.S. Supreme Court ruled on Wednesday that investors who believe they were duped into holding stocks by a brokerage firm are precluded from filing large class-action lawsuits in state courts, which tend to be more sympathetic to class-action suits than federal courts. In a unanimous 8-0 decision, the court ruled in favor of Merrill Lynch in a complaint brought by former Merrill broker Shadi Davit and a group of other brokers who bought certain stocks for themselves and their clients between December 1, 1999 and December 31, 2000.

“It is a landmark decision,” says Scott Musoff, an attorney who represented Merrill in the case. “Public companies don’t have to fear being sued in 50 states under 50 different sets of laws. If it had gone the other way, you would have seen an avalanche of state securities class actions.”

The case signals a big win for Merrill, which has faced lawsuits spurred by New York Attorney General Eliot Spitzer’s unearthing of conflicts of interest. “The fact that the court was unanimous confirms what we said from the start: This case had no merit,” says Merrill spokesman Bill Halldin. The case has far-reaching implications for the brokerage industry, which has drawn the ire of regulators and investors in recent years for systemic malfeasance.

At issue was the interpretation of the 1998 Securities Litigation Uniform Standards Act, enacted to curtail investor class-action suits. The SLUSA allows only federal courts to hear class-action suits involving more than 50 plaintiffs by folks who say they were hoodwinked into buying or selling securities. The law also prohibits federal claims by investors who already own stocks and claim that they missed an opportunity to sell due to withheld information or misrepresentation about what was really going on with the company. The loophole Dabit and his attorneys were looking to exploit was the fact that there was no explicit prohibition of filing complaints at the state level for those who held on to poor investments that were billed by analysts as worth keeping.

The decision puts stringent restrictions on legal options for investors who took it on the chin after the tech bubble of the late 1990s burst along with shareholders who believed they were tricked into hanging on to tumbling investments. It effectively eliminates state jurisdiction over stock fraud class action suits. Individuals can still file complaints at the state level but only in groups smaller than 50 individuals.

Justice John Paul Stevens, who delivered the court’s opinion, wrote, “The magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities cannot be overstated.” Stevens added that if the court did not preempt such cases, it would “give rise to wasteful, duplicative litigation.” (New Justice Samuel Alito did not vote on the case because it predated his appointment by President Bush).

Dabit had asserted that Merrill’s skewed research and manipulative tactics caused him to hold on to overvalued stocks and lost commissions when his clients, who when they became aware they had made poor investments, took their business elsewhere. However, the initial complaint that was dismissed by the lower courts claimed that he “purchased” the relevant stocks. After the case was dismissed, Dabit amended his complaint to remove all references to purchases and switched the language to read, “owned and continued to own” those stocks. “This was an end run around SLUSA,” says Musoff.

Dabit’s lawyer says Merrill’s statement about the case having no merit is curious considering the court ruled solely on the issue of jurisdiction. “They didn’t rule on the merits of the case at all,” says Bill Federman, the Oklahoma City attorney representing the brokers. Dabit’s case will be bounced back down to a federal district court for further review, although some of the claims have already been thrown out altogether.

“This is a real disturbing decision from the Supreme Court,” Federman says. “This is just another blow against consumers, which, in this case, are the brokers. It has given more license to the crooked.”

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