Two men share securities regulation news

Breaking news and expert analysis on legal and compliance issues

[Back To Home][Back To Archives]

From Securities Regulation Daily, October 31, 2014

Federal court can hear state law claims over Facebook IPO

By Mark S. Nelson, J.D.

A federal court may not only hear state law claims arising from the flawed Facebook IPO, it can also decide if the parties must arbitrate their claims, said the Second Circuit. NASDAQ OMX Group, Inc. (NASDAQ) had asked a federal district court to declare that it need not arbitrate claims brought against it by UBS Securities, LLC (UBS). The court today upheld Judge Robert W. Sweet’s order preliminarily enjoining UBS from seeking to arbitrate claims that imply the federal duties of self-regulatory organizations (SROs). Circuit Judge Chester J. Straub dissented to emphasize how the majority stepped past the limits of federal jurisdiction (The NASDAQ OMX Group, Inc., et al. v. UBS Securities, LLC, October 31, 2014, Raggi, R.; The NASDAQ OMX Group, Inc., et al. v. UBS Securities, LLC, July 11, 2013, Sweet, R.).

Centenarian state law doctrine. The majority held that all of UBS’s state law claims can be heard in a federal court because each is deeply rooted in federal law. In reaching this conclusion, the majority relied on the Supreme Court’s nearly 100-year old doctrine embodied in the more recent Grable-Gunn test, which confers federal court jurisdiction over a limited set of state claims when they necessarily raise a substantial federal issue that is actually disputed, and the case can be decided without altering the federal-state balance approved by Congress.

The Supreme Court’s 2005 Grable opinion upheld this approach (the court also declined to rehear that case), but not without drawing a concurring opinion from Justice Clarence Thomas, who noted that the court there had not been asked to upset any of its earlier opinions, but who also would look to a future case as a vehicle to reconsider the scope of federal question jurisdiction under 28 U.S.C. Sec. 1331.

Circuit Judge Reena Raggi, writing for herself and Circuit Judge Pierre N. Leval, said all four of UBS’s state claims necessarily raise actually disputed federal issues. According to the majority, federal law creates a duty to operate fair and orderly markets, as evidenced by the national market system requirements in Exchange Act Sec. 11A, including one that tells an SRO to state in its registration how its internal operating rules will satisfy the Exchange Act.

The majority also noted that the SEC’s review of alleged Facebook IPO goofs targeted the same duties UBS claims NASDAQ violated, including the need to have systems capable of handling pricing and order priority. UBS’s contract and tort claims implicate federal law because the UBS-NASDAQ services agreement incorporated by reference NASDAQ’s own rules for conducting an IPO cross, and Exchange Act Sec. 19(g) requires an SRO to follow its own rules.

Similar logic applied to UBS’s claim for breach of implied duty of good faith and fair dealing which, albeit couched in terms of New York law, implied federal duties undergirding NASDAQ’s own Rule 11890 for cancelling clearly erroneous transactions. Likewise, UBS’s gross negligence claim against NASDAQ had its roots in federal law, despite UBS’s assertion at oral argument to the contrary because, as the court said in a footnote, this line of reasoning fails due to existing court precedents, UBS’s own reference to the Exchange Act in its court papers, and UBS’s failure to cite any relevant state law.

The majority also found the federal issues at stake here to be substantial. Citing the Supreme Court’s Gunn opinion, the majority focused on how substantial the Exchange Act provisions for SROs are to the entire federal system, not just to NASDAQ and UBS. Likewise, the majority said “substantial” federal issues were at stake in a 1963 Supreme Court opinion noting the significance of stock exchanges and in the SEC’s release about the Facebook IPO. The majority also found support in Exchange Act Sec. 11A, which says: “[t]he securities markets are an important national asset which must be preserved and strengthened.”

UBS countered that it should be permitted to arbitrate its claims against NASDAQ because questions about an SRO’s internal rules are not substantial enough for federal court decision. The majority said UBS placed too much emphasis on the Second Circuit’s 1996 Barbara opinion. There, the court found the specific issues were insubstantial to the entire federal system, but here the majority said the “most important” distinction between this case and Barbara is that NASDAQ’s “massive failure” in the Facebook IPO implicated its core federal duty to maintain fair and orderly markets.

As for the federal-state balance envisioned by Congress, the majority said that federal court jurisdiction here would not run afoul of the federal scheme for regulating stock markets. But the majority stopped short of upsetting a portion of its Barbara opinion holding that Exchange Act Sec. 27’s jurisdictional grant applies only to suits created by that law, not to ones created under state laws. This limitation, the majority noted, goes against Ninth and Fifth Circuit opinions finding that Sec. 27 confers exclusive federal jurisdiction over some state law claims against SROs.

Court can rule on arbitration. The majority looked anew at the question of whether, even though a federal court has jurisdiction of the case, that court or an arbitrator should decide if the UBS-NASDAQ matter is arbitrable. The majority said a federal court can make that call here.

UBS had argued that the UBS-NASDAQ services agreement gave the decision to an arbitrator either because NASDAQ did not adopt limits under the applicable carve-out provision or because the agreement referenced the American Arbitration Association’s rules. The majority rejected both of UBS’s arguments because the arbitration clause was ambiguous.

Moreover, UBS and NASDAQ did not quarrel over whether they had a contract to arbitrate some disputes, so the question left was whether the specific claims fell within the preclusive text of NASDAQ’s Rule 4626. The majority found that arbitration was not required because the limits in the rule applied. The majority also noted the lack of precedent for UBS’s argument that the intent not to arbitrate must be shown via an “affirmative rejection” of arbitration.

Big IPO flop led majority astray. Circuit Judge Straub said in a lengthy dissent that he would have reversed Judge Sweet’s preliminary injunction and dismissed the case for lack of jurisdiction. According to Judge Straub, the majority’s decision to let the case go ahead may open the federal courthouse doors to many lookalike claims if only because the majority was lulled into an expansive view of federal jurisdiction by the bigness of the Facebook IPO.

Judge Straub said, “The high-profile nature of this case sways the majority’s analysis. It is true that the Facebook IPO was front-page news. But it simply cannot be true that every time a case involves a famous company or a multi-billion dollar IPO, federal courts have jurisdiction.”

The dissent questioned the majority’s holding on each of the Grable-Gunn factors. Judge Straub said there was no actual dispute over the broad Exchange Act duty to maintain fair and orderly markets. He also said NASDAQ’s internal rules are driven by state law and that the existence of voluminous federal securities regulations cannot tip the scales in favor of conferring jurisdiction. He also cited the Second Circuit’s Barbara opinion in support of this view. The majority had countered that while no dispute existed about the federal duty, there was a dispute about whether NASDAQ violated that duty.

As for Grable-Gunn’s substantial issue prong, Judge Straub questioned the majority’s rationale, including its “core duty” theory of the maintenance of fair and orderly markets, which he said was at least as “core” as the discipline issue in Barbara. He also said the majority confused “large” or “significant” with the importance of an issue to federal jurisprudence.

Judge Straub questioned whether this case needed a court to interpret federal law. “Grable-Gunn jurisdiction must therefore be exercised only over state law claims that implicate a federal issue that is a pure question of law concerning the validity or construction of a federal statute or the U.S. Constitution,” said Judge Straub. But the majority said in a footnote that it had opted not to rule, as Judge Straub would, that federal jurisdiction of state law claims must turn on the interpretation of federal law.

Judge Straub also worried that the majority’s opinion runs counter to the federal-state balance Congress thought it had achieved for stock exchanges. He noted that the Exchange Act says nothing about private suits for violations of stock exchange rules, but the legislative history of the relevant provision implies that the SEC’s enforcement apparatus can deal with these violations. Judge Straub said the SEC’s inquiry into the Facebook IPO and its sanction of NASDAQ had vindicated any federal interests here.

Moreover, Judge Straub said the majority ignored the “litigation-provoking” issues the Supreme Court warned against in its 1986 Merrell Dow and other opinions. The judge noted the numerous stock exchange rules that already exist and the prospect of wasteful litigation in cases where a court later finds no federal jurisdiction.

But Judge Straub invoked one of his more dramatic arguments when he warned that the majority’s holding could now be applied to myriad federal laws, including those for other types of SROs. Specifically, he said the Financial Industry Regulatory Authority (FINRA) has a similar arbitration regime to NASDAQ and those cases alone could swamp federal courts.

The judge cited data showing the number of FINRA arbitrations filed each year between 1999 and 2013 ranged from 3,238 to 8,945. For comparison, he noted that civil cases filed in the U.S. District Court for the Southern District of New York in 2013 hit 8,574. The majority downplayed the possible impact of its opinion in a footnote in which it questioned whether the cases that piqued Judge Straub’s interest could fit into the “special and small” Grable-Gunn exception.

The case is No. 13-2657-cv.

Attorneys: Stephen J. Kastenberg (Ballard Spahr LLP) for NASDAQ Stock Market L.L.C. and The NASDAQ OMX Group Inc. Leslie Gordon Fagen (Paul, Weiss, Rifkind, Wharton & Garrison LLP) for UBS Securities LLC.

Companies: Facebook, Inc.; NASDAQ OMX Group, Inc.; NASDAQ Stock Market LLC; UBS Securities, LLC; American Arbitration Association; Financial Industry Regulatory Authority

MainStory: TopStory ConnecticutNews NewYorkNews VermontNews BrokerDealers ExchangesMarketRegulation InvestmentAdvisers Arbitration

Securities Regulation Daily

Introducing Wolters Kluwer Securities Regulation Daily — a daily reporting service created by attorneys, for attorneys — providing same-day coverage of breaking news, court decisions, legislation, and regulatory activity.


A complete daily report of the news that affects your world

  • View full summaries of federal and state court decisions.
  • Access full text of legislative and regulatory developments.
  • Customize your daily email by topic and/or jurisdiction.
  • Search archives for stories of interest.

Not just news — the right news

  • Get expert analysis written by subject matter specialists—created by attorneys for attorneys.
  • Track law firms and organizations in the headlines with our new “Who’s in the News” feature.
  • Promote your firm with our new reprint policy.

24/7 access for a 24/7 world

  • Forward information with special copyright permissions, encouraging collaboration between counsel and colleagues.
  • Save time with mobile apps for your BlackBerry, iPhone, iPad, Android, or Kindle.
  • Access all links from any mobile device without being prompted for user name and password.