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Holtz v. JPMorgan Chase Bank, N. A.

United States Court of Appeals, Seventh Circuit

January 23, 2017

Patricia Holtz, et al, Plaintiffs-Appellants,
JPMorgan Chase Bank, N. A., et al, Defendants-Appellees.

          Argued April 2, 2014

         Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 12 C 7080 - John W. Darrah, Judge.

          Before Easterbrook, Manion, and Sykes, Circuit Judges.

          Easterbrook, Circuit Judge.

         JPMorgan Chase Bank offers to manage clients' portfolios of securities. Its affiliates sponsor mutual funds in which these funds can be placed. We refer to JPMorgan Chase Bank and all of its affiliates collectively as "the Bank." According to the complaint in this case, customers invested in these mutual funds believing that, when recommending them as suitable vehicles, the Bank acts in clients' best interests (as its website proclaims). But Patricia Holtz, on behalf of a class of other investors, alleges that the Bank gives its employees incentives to place clients' money in the Bank's own mutual funds, even when those funds have higher fees or lower returns than competing funds sponsored by third parties. Holtz maintains that the Bank violated its promises and its fiduciary duties by inducing its investment advisers to make recommendations in the Bank's interest rather than the clients'.

         Holtz filed this suit in federal court under the Class Action Fairness Act, 28 U.S.C. §1332(d)(2), because the class has more than 100 members, the stakes exceed $5 million, and at least one member of the class has citizenship different from the Bank's. This suit is also a "covered class action" for the purpose of the Securities Litigation Uniform Standards Act of 1998 (SLUSA or the Litigation Act), 15 U.S.C. §78bb(f), because mutual funds are securities. SLUSA requires the district court to dismiss any "covered class action" in which the plaintiff alleges "a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security" (§78bb(f)(1)(A)). Under SLUSA, securities claims that depend on the nondisclosure of material facts must proceed under the federal securities laws exclusively. See, e.g., Merrill Lynch, Pierce, Vernier & Smith Inc. v. Dabit, 547 U.S. 71 (2006); In re Mutual Fund Market-Timing Litigation, 468 F.3d 439 (7th Cir. 2006) (Kircher IV). Holtz does not want to invoke federal law and framed her claims entirely under state contract and fiduciary principles. But the district court concluded that these claims necessarily rest on the "omission of a material fact" and dismissed the suit under SLUSA. 2013 U.S. Dist. Lexis 90066 (N.D. 111. June 26, 2013).

         Holtz maintains that falsehoods and omissions have nothing to do with her claims. She tells us that they "are not in any way based on, dependent upon, or necessarily entangled with proof that [the Bank] made any false statements or omitted to disclose material information. Rather, [she] asserts] simply that [the Bank] failed to provide the independent research, financial advice, and due diligence required by the parties' contract and their fiduciary relationship." The district court's problem with this contention-our problem too-is that the suit depends on Holtz's assertion that the Bank concealed the incentives it gave its employees. If it had told customers that its investment advisors were compensated more for selling the Bank's mutual funds than for selling third-party funds, plaintiffs would have no claim under either state or federal law. This means that nondisclosure is a linchpin of this suit no matter how Holtz chose to frame the pleadings.

         We grant that the complaint omits any allegation of scienter, which is essential in private securities-fraud litigation. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007); Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). Yet the Litigation Act does not ask what state-law theory a plaintiff invokes. The statutory question is whether plaintiff alleges "a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security" (§78bb(f)(1)(A)). Whether the complaint pleads a particular state of mind is neither here nor there-a point we made in Brown v. Calamos, 664 F.3d 123, 126-27 (7th Cir. 2011), when holding that an investor cannot avoid the Litigation Act by omitting an allegation of scienter and attempting to frame common-law claims under state law. Every other circuit that has addressed the question likewise has held that a plaintiff cannot sidestep SLUSA by omitting allegations of scienter or reliance. See Miller v. Nationwide Life Insurance Co., 391 F.3d 698, 701-02 (5th Cir. 2004); Atkinson v. Morgan Asset Management, Inc., 658 F.3d 549 (6th Cir. 2011); Dudek v. Prudential Securities, Inc., 295 F.3d 875, 879-80 (8th Cir. 2002); Anderson v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 521 F.3d 1278, 1284 (10th Cir. 2008).

         Dabit concluded that the Litigation Act is designed to prevent persons injured by securities transactions from engaging in artful pleading or forum shopping in order to evade limits on securities litigation that are designed to block frivolous or abusive suits. See 547 U.S. at 81-84. See also Appert v. Morgan Stanley Dean Witter, Inc., 673 F.3d 609, 615 (7th Cir. 2012). Private class-action litigation about securities transactions must be conducted under federal securities law, so that limits adopted by Congress, or recognized by the Supreme Court, can be applied. Allowing plaintiffs to avoid the Litigation Act by contending that they have "contract" claims about securities, rather than "securities" claims, would render the Litigation Act ineffectual, because almost all federal securities suits could be recharacterized as contract suits about the securities involved.

         Federal law often permits genuine contract claims to survive preemption. So, for example, a contract requiring an investment manager to keep funds in an interest-bearing account pending the purchase of new securities could proceed under state law-if the manager by error failed to invest the money properly, or if a decision to break the promise occurred after the promise had been made and the money invested. (The significance of these qualifications will become clear later on.) But Holtz has not alleged that the Bank creat- ed the hidden conflict of interest only after she had invested her money.

         The possibility that plain vanilla contract claims can proceed under state law creates an incentive to characterize all securities claims as "contract" suits and avoid federal preemption. Here's an example drawn from the Airline Deregulation Act, which preempts suits under state law that concern the price or quality of air service, see 49 U.S.C. §41713, but permits suits that rest on contracts. That sets up an opportunity for artful pleading. The plaintiff in Northwest, Inc. v. Ginsberg, 134 S.Ct. 1422 (2014), conceded that when excluding him from its frequent-flyer program the airline had followed the letter of its contract but contended that it had nonetheless not engaged in good faith and fair dealing. The Court recognized that good faith and fair dealing is a longstanding doctrine of state contract law but held that it does not constitute a "contract" claim for the purpose of the Airline Deregulation Act. The Justices held that a claim "is preempted if it seeks to enlarge the contractual obligations that the parties voluntarily adopt." Id. at 1426. If the state-law duty is independent of the contract's terms, then it does not rest on contract.

         Much the same can be said about Holtz's claims. She does not point to any explicit term that the Bank violated; instead she relies (as Ginsberg did) on a state-law duty to treat the other party fairly. That's what a fiduciary claim is all about. Indeed, Holtz contends that it is not even possible under state law to contract out of this duty-that is why Holtz submits that the Bank could not have reserved the right to favor its own interests over those of investors (at least not without explicit disclosure). Holtz uses this sup- posed non-negotiable fiduciary duty to show why, in her view, the suit does not depend on nondisclosure. But if the duty is non-negotiable, then under Northwest it is also noncontractual.

         In Dabit, as in this case, the plaintiff tried to recharacterize as a state-law contract claim a situation that securities law sees as a nondisclosure claim. A mutual fund issued a prospectus asserting that the fund was operated in a way that held down transactions costs. Plaintiffs alleged that the fund broke this promise by secretly allowing some investors to make short-swing trades in order to take advantage of price differences between the closing price in one nation and the price elsewhere, where stock exchanges closed at different times. Allowing short-swing trades not only increased transactions costs but also diverted wealth from long-term holders to the arbitrageurs. Plaintiffs maintained that they had contract claims, based on promises in the prospectus and other documents the fund had issued; the Supreme Court held, however, that because claims based on false statements in (or material omissions from) a prospectus are in connection with securities covered by federal law, it does not matter what state-law characterization might be possible. (Kircher v. Putnam Funds Trust, 403 F.3d 478 (7th Cir. 2005) (Kircher T), explains the nature of the claim in Dabit more fully than the Justices did. In Dabit the Supreme Court expressly agreed with this circuit, 547 U.S. at 74, 86, and rejected the contrary view of the Second Circuit-though later it vacated Kircher I after concluding that this court had lacked appellate jurisdiction. 547 U.S. 633 (2006) (Kircher IIP).)

         The sort of situation we encounter-in which one party to a contract conceals the fact that it planned all along to fa- vor its own interests-is a staple of federal securities law. When one side in Wharf (Holdings) Ltd. v. United Int'l Holdings, Inc.,532 U.S. 588 (2001), contended that a suit alleging a broken promise was a simple contract claim, the Supreme Court replied that making a promise with intent not to keep it is fraud, and that when the subject of the contract is a security the claim involves securities fraud. The link to securities law is equally strong for Holtz's contention that the Bank promised to recommend investments in her best interest, while intending all along to make recommendations in its own interest. We observed above that Holtz would have a contract claim free of a securities component if she alleged that the ...

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