Merrill Lynch v. Manning: Federal Jurisdiction Under §27

In Merrill Lynch v. Manning, the U.S. Supreme Court ruled unanimously on May 16, 2016, that federal courts do not have exclusive jurisdiction over a securities lawsuit just because the complaint mentions federal securities rules. Section 27 of the Securities Exchange Act of 1934, the Court held, uses a jurisdictional test that is “identical and coextensive” with the familiar “arising under” standard for federal-question jurisdiction under 28 U.S.C. § 1331. If a plaintiff can win on state-law claims alone, without proving a violation of the Exchange Act, the case belongs in state court.¹

The Dispute Behind the Case

Greg Manning and six other former shareholders of Escala Group, Inc. sued Merrill Lynch and several other financial firms in New Jersey state court, including Knight Capital Americas, UBS Securities, E*TRADE Capital Markets, National Financial Services, and Citadel Derivatives Group. The plaintiffs alleged the firms engaged in “naked short sales” of Escala stock, selling shares without first borrowing or locating them, and that this drove down Escala’s share price.¹

Manning’s complaint raised only state-law claims: New Jersey’s RICO statute, portions of the state’s criminal code, the New Jersey Uniform Securities Law, and common-law theories including negligence, unjust enrichment, and interference with contractual relations. He did not sue directly under federal securities law. But the complaint repeatedly referenced the SEC’s Regulation SHO, which requires sellers to have reasonable grounds to believe a security can be delivered before short-selling it, and described the defendants’ conduct in terms that echoed Regulation SHO violations.²

Merrill Lynch removed the case to federal court, arguing that Section 27 of the Exchange Act, which gives federal courts “exclusive jurisdiction” over suits “brought to enforce any liability or duty created by” the Act, swept in Manning’s complaint because of its heavy reliance on Regulation SHO.² The Third Circuit disagreed and sent the case back to state court. The Supreme Court took the case to resolve a split among lower courts over how far Section 27’s “brought to enforce” language reached.

The Jurisdictional Question

The question was whether Section 27 provides a broader jurisdictional grant than § 1331. Merrill Lynch argued that the phrase “brought to enforce” should capture any complaint that explicitly or implicitly alleges a breach of an Exchange Act duty, even when the plaintiff frames the claims under state law. Manning argued that Section 27’s language tracks the general “arising under” test, and since his state-law claims did not necessarily raise a federal issue, no federal jurisdiction existed.²

The Court’s Ruling

Justice Elena Kagan, writing for six justices, sided with Manning. The Court held that the phrases “brought to enforce” in Section 27 and “arising under” in § 1331 are “materially indistinguishable.” That means Section 27 confers exclusive federal jurisdiction in two situations: when a suit is filed directly under the Exchange Act, and in the narrow category of cases where a state-law claim necessarily raises a disputed, substantial federal issue that a federal court can resolve without upsetting the balance between federal and state judicial power. That second category comes from the Court’s 2005 decision in Grable & Sons Metal Products v. Darue Engineering.¹

Kagan wrote that “brought to enforce” refers to the purpose of the lawsuit: a suit “commenced in order to give effect to an Exchange Act requirement.” If a plaintiff can prevail by proving only state-law violations, the case is not brought to enforce the Exchange Act, regardless of how much the complaint discusses federal rules along the way.¹

Two earlier decisions did much of the work in the majority’s reasoning: Pan American Petroleum Corp. v. Superior Court of Delaware (1961) and Matsushita Electric Industrial Co. v. Epstein (1996), both of which had read similar “brought to enforce” language as coextensive with the “arising under” standard.² The Court also stressed practical reasons for aligning the two provisions. Using a single, familiar standard promotes what Kagan called “administrative simplicity” and “predictability.” A broader reading, by contrast, would force judges to speculate about whether complaints had been artfully drafted to dodge federal jurisdiction.¹

The Thomas Concurrence

Justice Clarence Thomas, joined by Justice Sonia Sotomayor, agreed that Manning’s case belonged in state court but rejected the majority’s reasoning. Thomas saw no textual link between § 1331’s “arising under” and Section 27’s “brought to enforce,” and he opposed importing the Grable test into the Exchange Act. He proposed a narrower, text-focused rule: Section 27 gives federal courts exclusive jurisdiction when a complaint alleges a claim that “necessarily depends on a breach of a requirement created by the Act.” Under that standard, Manning’s claims still failed to trigger federal jurisdiction, because his state-law theories did not depend on proving a federal violation.²

What the Ruling Means

The decision preserved plaintiffs’ ability to keep securities-related state-law claims in state court, as long as those claims do not require proving an Exchange Act violation. That matters because federal court brings procedural rules that tend to favor securities defendants, including the heightened pleading requirements of the Private Securities Litigation Reform Act.²

The ruling also closed off a common removal argument. Before Manning, defendants in several circuits had some basis to argue that a state-court complaint referencing Regulation SHO or another SEC rule triggered exclusive federal jurisdiction under Section 27. After Manning, a passing reference to federal securities regulations is not enough. The suit still has to satisfy the “arising under” test.³

What the Court did not resolve was how tightly a state-law claim can be woven around federal securities duties before it crosses into Grable territory. The Justices did not disturb the Third Circuit’s specific finding that Manning’s claims could be decided entirely under New Jersey law, leaving future litigants to test the edges of the “necessarily raises” standard case by case.⁴ Commentators noted that the ruling gives plaintiffs an incentive to draft complaints that steer clear of any hint of federal reliance, a drafting strategy defense counsel will need to watch for.⁵

1
Justia US Supreme Court. Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning, 578 U.S. (2016)
2
Harvard Law Review. Merrill Lynch, Pierce, Fenner & Smith Inc. v. Manning
3
Bressler. High Court Limits Scope of Jurisdiction Granted to Federal Courts Under Section 27 of the Securities Exchange Act
4
Corporate Defense Disputes. Supreme Court’s Manning Decision Leaves Questions Unanswered
5
Harvard Law Forum on Corporate Governance. Merrill Lynch v. Manning