A key Sotomayor ruling in Dabit v. Merrill Lynch may become an issue in her confirmation. It’s worth discussing because the implications aren’t obvious.
Dabit involved the Securities Litigation Uniform Standards Act, in which Congress tried to close a state law end run around limits on securities class actions by preempting state actions based on "an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security." The language leaves it open whether the action had to be in connection with any purchase or sale, or the plaintiff’s purchase or sale – that is, does it apply to holders of securities?
The Act says “the,” not his or her. So Judge Sotomayor interpreted it, finding that the state law survived SLUSA, and taking a cautious and narrow approach to preemption of state law. The Supreme Court reversed, based primarily on policy considerations relating to constraining abusive litigation.
In my article Dabit, Preemption, and Choice of Law, I questioned the Supreme Court’s result. I noted, among other things, that there were other relevant policy considerations, notably including federalism concerns and constraining fraud. Moreover, the class action abuse problem was not clear in this fact setting. The Second Circuit opinion sensibly allowed a class action only for those who were induced to hold, rather than letting the holders carry along the purchasers and sellers. And unlike the most problematic non-purchaser/seller cases, the plaintiffs in Dabit had clearly bought their shares, so the ruling did not pose a risk of open-ended liability. Although we can’t be sure plaintiffs were harmed by defendant’s fraud, similar concerns arise in every “fraud on the market” case.
My main problem with the Supreme Court’s decision is that it precludes a potentially large swath of state remedies, and sets the stage for more federalization of corporate law. As I said in my article:
Reduced to its essence, Dabit rests on the primacy of federal over state securities law. As Justice Stevens emphasized at the beginning of his opinion, ‘‘[t]he magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities cannot be overstated.’ Thus, Dabit gives Congress a green light to regulate under the securities laws. This power may extend even to matters like those covered in Sarbanes-Oxley that arguably relate closely to internal corporate governance. * * * In short, Dabit gives momentum to the federalization of corporate law.
To be sure, business interests will like the Supreme Court’s result in Dabit, given the counterproductive nature of securities class action remedies and because, as Fortune's Roger Parloff notes (HT PoL), “businesses usually find it cheaper to comply with one federal regulatory regimen rather than with 50 state regulatory schemes.”
But there is a broader principle of federalism, particularly as applied to corporate law, which business can ill afford to sacrifice. Competing states have advantages over a single, inflexible, federal regulator. And as discussed in The Law Market, various constraints often keep state law from getting out of hand.
Since the Court decides securities cases only rarely, the general principles of these cases tend to outlast their specific holdings. I would rather have the case-by-case narrow-preemption principle of Sotomayor’s opinion than the Supreme Court’s policy-based result. Parloff notes research that Sotomayor “has been a moderate in preemption cases, finding preemption in about half the cases in which she was asked to do so.” I'm ok with that.
Update: A reader points out an ambiguity in the third paragraph above. To clarify, Judge Sotomayor effectively interpreted SLUSA to apply to "his or her" transaction and therefore did not preempt the holding claim.
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