Patricia Holtz v. J.P. Morgan Chase Bank, N.A. , 846 F.3d 928 ( 2017 )

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In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 13-‐‑2609
PATRICIA HOLTZ, et al.,
Plaintiffs-‐‑Appellants,
v.
JPMORGAN CHASE BANK, N.A., et al.,
Defendants-‐‑Appellees.
____________________
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 12 C 7080 — John W. Darrah, Judge.
____________________
ARGUED APRIL 2, 2014 — DECIDED JANUARY 23, 2017
____________________
Before EASTERBROOK, MANION, and SYKES, Circuit Judges.
EASTERBROOK, Circuit Judge. JPMorgan Chase Bank offers
to manage clients’ portfolios of securities. Its affiliates spon-‐‑
sor mutual funds in which these funds can be placed. We
refer to JPMorgan Chase Bank and all of its affiliates collec-‐‑
tively 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
2 No. 13-‐‑2609
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 induc-‐‑
ing 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 Ac-‐‑
tion 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), be-‐‑
cause mutual funds are securities. SLUSA requires the dis-‐‑
trict court to dismiss any “covered class action” in which the
plaintiff alleges “a misrepresentation or omission of a mate-‐‑
rial 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 pro-‐‑
ceed under the federal securities laws exclusively. See, e.g.,
Merrill Lynch, Pierce, Fenner & 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 in-‐‑
voke federal law and framed her claims entirely under state
contract and fiduciary principles. But the district court con-‐‑
cluded 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. Ill. June 26, 2013).
No. 13-‐‑2609 3
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 entan-‐‑
gled with proof that [the Bank] made any false statements or
omitted to disclose material information. Rather, [she] as-‐‑
sert[s] simply that [the Bank] failed to provide the inde-‐‑
pendent research, financial advice, and due diligence re-‐‑
quired by the parties’ contract and their fiduciary relation-‐‑
ship.” 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 nondisclo-‐‑
sure is a linchpin of this suit no matter how Holtz chose to
frame the pleadings.
We grant that the complaint omits any allegation of scien-‐‑
ter, 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 con-‐‑
nection 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
4 No. 13-‐‑2609
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 Manage-‐‑
ment, Inc., 658 F.3d 549 (6th Cir. 2011); Dudek v. Prudential Se-‐‑
curities, 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 en-‐‑
gaging 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 secu-‐‑
rities transactions must be conducted under federal securi-‐‑
ties 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 “con-‐‑
tract” claims about securities, rather than “securities” claims,
would render the Litigation Act ineffectual, because almost
all federal securities suits could be recharacterized as con-‐‑
tract suits about the securities involved.
Federal law often permits genuine contract claims to sur-‐‑
vive preemption. So, for example, a contract requiring an in-‐‑
vestment manager to keep funds in an interest-‐‑bearing ac-‐‑
count 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 oc-‐‑
curred after the promise had been made and the money in-‐‑
vested. (The significance of these qualifications will become
clear later on.) But Holtz has not alleged that the Bank creat-‐‑
No. 13-‐‑2609 5
ed the hidden conflict of interest only after she had invested
her money.
The possibility that plain vanilla contract claims can pro-‐‑
ceed 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 De-‐‑
regulation 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
pre-‐‑empted 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-‐‑
6 No. 13-‐‑2609
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 non-‐‑
contractual.
In Dabit, as in this case, the plaintiff tried to recharacter-‐‑
ize 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 differ-‐‑
ent 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 I), explains the nature of the claim in Dabit more ful-‐‑
ly than the Justices did. In Dabit the Supreme Court express-‐‑
ly 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 III).)
The sort of situation we encounter—in which one party
to a contract conceals the fact that it planned all along to fa-‐‑
No. 13-‐‑2609 7
vor its own interests—is a staple of federal securities law.
When one side in Wharf (Holdings) Ltd. v. United Int’l Hold-‐‑
ings, 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 se-‐‑
curity the claim involves securities fraud. The link to securi-‐‑
ties law is equally strong for Holtz’s contention that the
Bank promised to recommend investments in her best inter-‐‑
est, 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 Bank broke its promise by mistake, or if the Bank
created the incentive to favor its own mutual funds only af-‐‑
ter she had invested her money (which would take Wharf out
of the picture). But she does not make either allegation.
A fiduciary that makes a securities trade without disclos-‐‑
ing a conflict of interest violates federal securities law. See In
re E.F. Hutton & Co., 49 S.E.C. 829 (1988) (the several opin-‐‑
ions in that decision collect many of the important deci-‐‑
sions). Likewise a broker-‐‑dealer that fails to achieve best ex-‐‑
ecution for a customer by arranging a trade whose terms fa-‐‑
vor the dealer rather than the client has a securities problem,
not just a state-‐‑law contract or fiduciary-‐‑duty problem. See
Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d
266 (3d Cir. 1998) (en banc). A broker-‐‑dealer that churns se-‐‑
curities (makes trades to generate commissions rather than
extra value for the customer) likewise has a securities prob-‐‑
lem in addition to a state-‐‑law contract and fiduciary duty
problem. See Costello v. Oppenheimer & Co., 711 F.2d 1361 (7th
Cir. 1983). Or consider United States v. Naftalin, 441 U.S. 768
(1979): a short seller assured the broker that he owned
8 No. 13-‐‑2609
enough shares to deliver, but he did not and the sale there-‐‑
fore was a “naked short”; his lie was a breach of contract as
well as fraud, and the Supreme Court held that it violated
the Securities Act of 1934.
E.F. Hutton in particular shows that Holtz has a securities
claim based on the Bank’s (asserted) failure to disclose the
conflict under which its employees were operating. Our de-‐‑
cision in Brown v. Calamos reiterates the point. Plaintiffs al-‐‑
leged that managers of an investment fund pooled assets in
a way that favored holders of preferred stock over holders of
common stock. They presented this as a contract and fiduci-‐‑
ary claim—which it was—but we thought that it was also a
securities claim because it depended on nondisclosure of the
procedures said to create the conflict. A statement along the
lines of “we will act in your best interest” plus nondisclosure
of a competing private interest is the basis of many securities
actions. It is hard to see much difference between Holtz’s
theory and Brown’s. After the Litigation Act, a plaintiff can-‐‑
not proceed by omitting the securities theory and standing
on state law in the sort of circumstances discussed in the
preceding paragraph.
At oral argument, Holtz’s lawyer told us that no sane
person would have invested through the Bank had it re-‐‑
vealed a bias for its own mutual funds—indeed, that the se-‐‑
cret information contradicted the promise to act in investors’
interest, and that the Bank never intended to keep its prom-‐‑
ise. All of this just brings the suit squarely within Wharf,
which, recall, held that a concealed plan not to keep a prom-‐‑
ise about a securities transaction is securities fraud. Indeed,
in Brown we rejected an argument that a plaintiff can avoid
SLUSA by contending that no sane investor would have
No. 13-‐‑2609 9
purchased the security (or the investment advice) if the truth
had been told, and that the suit therefore must be about sub-‐‑
stance rather than disclosure. 664 F.3d at 129.
Holtz has not pointed to any nondisclosure or fiduciary-‐‑
duty claim concerning investments in securities, traded in
interstate commerce, that is outside the scope of federal se-‐‑
curities law. Sometimes a plaintiff will be unable to show a
material lie or omission, intent to deceive, or the existence of
a purchase or sale, and thus will not have a winning federal
securities claim (even though he might have a good claim
under state law), but Dabit holds that SLUSA applies wheth-‐‑
er or not a federal securities theory would succeed. Holtz’s
decision not to plead scienter means that she could not pre-‐‑
vail under federal securities law, but as Dabit observes the
Litigation Act would be ineffectual if it covered only win-‐‑
ning securities claims. To protect defendants from weak or
abusive claims of wrongdoing in connection with securities
transactions, it is essential to block those that fail under fed-‐‑
eral law as well as those that could succeed.
Holtz has one more argument: that the Bank’s omissions
did not occur “in connection with” the purchase or sale of a
covered security. The Litigation Act deals only with fraud or
omissions in connection with covered securities. This branch
of Holtz’s argument rests on Gavin v. AT&T Corp., 464 F.3d
634 (7th Cir. 2006), which holds that the Litigation Act does
not block a suit concerning the terms on which shares of one
company were exchanged for shares of another following a
merger. AT&T acquired MediaOne in June 2000 and needed
to issue new AT&T shares to persons who had held stock in
MediaOne. Communications offered those investors several
options for conducting the exchange. Worried that investors
10 No. 13-‐‑2609
who ignored these communications might find their invest-‐‑
ments subject to escheat, AT&T hired Georgeson Sharehold-‐‑
er Communications six months after the merger closed and
told Georgeson to do what it could to get investors to take
the necessary steps. Georgeson sent letters that the plaintiffs
later characterized as fraudulent for omitting the fact that,
even long after the merger, people holding shares of Me-‐‑
diaOne stock had one option that did not require payment of
a fee for conducting the exchange.
As we saw matters in Gavin, the purchase or sale of secu-‐‑
rities was the merger in June 2000, not the ensuing swaps of
certificates, so Georgeson’s letter was not “in connection
with” the sale of a covered security. Gavin does not assist
Holtz, because the Bank’s omission was made in connection
with an impending investment decision (into which mutual
fund would Holtz invest) rather than with a record-‐‑keeping
decision. The Supreme Court held in Dabit that a decision
not to sell a security (when influenced by a material misrep-‐‑
resentation or omission) is “in connection with” a purchase
or sale of that security; the link between the secret fees to the
Bank’s employees and the choice of mutual funds is tighter
than the link between the nondisclosure and non-‐‑sale in
Dabit.
That some of the investment decisions were made by in-‐‑
vestment advisers as Holtz’s agent does not take this out of
the “in connection with” domain—otherwise suitability and
churning could not be a securities theory. SEC v. Zandford,
535 U.S. 813 (2002), holds that the “in connection with” re-‐‑
quirement is satisfied when a broker makes a purchase or
sale as an investor’s agent. That’s equally true of transactions
that the Bank made as Holtz’s agent.
No. 13-‐‑2609 11
The Litigation Act does allow state-‐‑law claims in which
the misrepresentations or omissions are not “material,” see
Appert, 673 F.3d at 616–17, but Holtz has not argued that the
Bank’s incentives to its employees were too small to be “ma-‐‑
terial” under the standard of Matrixx Initiatives, Inc. v. Sira-‐‑
cusano, 563 U.S. 27 (2011), and its predecessors. An omission
is “material” when a reasonable investor would deem it sig-‐‑
nificant to an investment decision. Holtz herself deems the
Bank’s incentives material to investments; that’s the basis of
this suit.
If she wants to pursue a contract or fiduciary-‐‑duty claim
under state law, she has only to proceed in the usual way:
one litigant against another. The Litigation Act is limited to
“covered class actions,” which means that Holtz could liti-‐‑
gate for herself and as many as 49 other customers. 15 U.S.C.
§78bb(f)(5)(B)(i)(I). What she can’t do is litigate as repre-‐‑
sentative of 50 or more other persons when the suit involves
“a misrepresentation or omission of a material fact in con-‐‑
nection with the purchase or sale of a covered security”. If
the Bank did wrong by its customers, the SEC could file its
own suit (or open an administrative proceeding) without re-‐‑
gard to the Litigation Act—and the Commission sometimes
can obtain relief without showing scienter. See Aaron v. SEC,
446 U.S. 680 (1980). What’s more, states and their subdivi-‐‑
sions can litigate in state court; the Litigation Act exempts
them. 15 U.S.C. §78bb(f)(3)(B). Thus there are plenty of ways
to bring wrongdoers to account—but a class action that
springs from lies or material omissions in connection with
federally regulated securities is not among them.
AFFIRMED