Two recent decisions make it harder for defendants to challenge securities claims in federal district court. In Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, the US Supreme Court raised the bar for defendants in state court securities lawsuits to remove cases to federal courts (, at *7 (May 16, 2016)). In Tilton v. SEC, the US Court of Appeals for the Second Circuit ruled that federal district courts lack subject matter jurisdiction to hear constitutional challenges to the appointment of an administrative law judge during the pendency of a parallel SEC enforcement proceeding ( (2d Cir. June 1, 2016)).

On May 16, 2016, the Supreme Court held that a plaintiff may bring a state law claim in state court even if the case seeks to enforce certain duties created under the Securities Exchange Act of 1934 (as amended) (Exchange Act). The case involved a suit under New Jersey state law asserting that the petitioners were short selling securities to manipulate their price downwards, a practice addressed by an SEC regulation.

Exchange Act Section 27 grants federal district courts exclusive jurisdiction over all suits brought to enforce any liability or duty under the Exchange Act and related regulations (15 U.S.C. § 78aa(a)) . The petitioners argued that Section 27 creates a broader jurisdictional grant than 28 U.S.C § 1331 (Section 1331), the general federal question statute. The Supreme Court reviewed the US Court of Appeals for the Third Circuit's ruling that:

The Supreme Court affirmed, finding that the petitioner's approach would allow removal to federal court whenever a state cause of action happens to mention an Exchange Act duty. It held that the statutory reference in Section 27 to cases "brought to enforce" federal securities laws does not go beyond the general grant of federal question jurisdiction over cases arising under federal law under Section 1331. Therefore, under Section 27, a state court may retain jurisdiction over a case that is closely related to federal securities laws, unless the jurisdictional test under Section 1331 requires a federal court to hear the case. The jurisdictional test under Section 1331 vests federal district courts with exclusive jurisdiction when the plaintiff pleads:

(Merrill Lynch Pierce, Fenner & Smith Inc. v. Manning, , at *7 (citing Grable & Sons Metal Prods., Inc. v. Darue Eng'g & Mfg., 545 U.S. 308, 314-15 (2005).)

The Supreme Court's decision makes it more difficult for defendants to remove state law claims that implicate the Exchange Act to federal court, where defendants benefit from the safeguards of the Private Securities Litigation Reform Act of 1995 (PSLRA). Nonetheless, defendants faced with securities lawsuits styled as state laws claims should analyze removal possibilities and whether removal would remain proper under Section 1331's jurisdictional test.

For more information, see Practice Notes:

On June 1, 2016, in Tilton v. SEC, the Second Circuit upheld the dismissal of an action brought by the respondents in an ongoing SEC administrative proceeding for lack of subject matter jurisdiction. The court held that the respondents could not challenge the appointment in a separate federal district action, but could raise the constitutional challenge in an appeal after the SEC's final decision in the administrative proceeding. (.)

The respondents brought suit in a federal district court to enjoin the SEC's proceeding before its completion, on the theory that the administrative law judge's (ALJ's) appointment violated the Appointments Clause of Article II of the US Constitution. Their arguments echoed those raised by respondents in numerous ongoing SEC administrative proceedings that Article II bars the agency's ALJs from acting as hearing officers due to their insulation from presidential removal and the SEC's appointment process (see, for example, Hill v. SEC, 114 F. Supp. 3d 1297, 1319 (N.D. Ga. 2015)) .

The Second Circuit affirmed the lower court's dismissal, finding that Congress precluded federal jurisdiction over the Appointments Clause claim while the Commission's proceeding remains pending. Among other things, the court found that the respondents in an SEC administrative proceeding have access to meaningful judicial review because they could appeal the final decision to a federal court of appeals. Participation in the administrative proceeding does not create any additional and irremediable harm beyond the burdens associated with the dispute resolution process.

The Second Circuit ruled consistently with the US Courts of Appeals for the DC and Seventh Circuits (See Jarkesy v. SEC, 803 F.3d 9 (D.C. Cir. 2015); Bebo v. SEC, 799 F.3d 765 (7th Cir. 2015), cert. denied, 136 S. Ct. 1500 (2016)). Given these decisions, securities defendants may face added pressure to settle administrative proceedings rather than rely on federal review of their constitutional challenges. However, the law on this continues to evolve rapidly. Divergent opinions from other courts poised to rule on similar issues may call for a legislative fix to resolve the split or a Supreme Court opinion directly addressing the constitutionality of current SEC administrative proceedings.

For more information see: