In Their Opinion : Seventh Circuit Court of Appeals Commentary : Lawyer & Attorney Michael E. Rigney : Kelley Drye & Warren Law Firm

ANDERSON v. AON CORP. (July 26, 2010)

Robert Anderson sold his California insurance brokerage firm to Aon Corporation in 1997. He received approximately 95,000 shares of Aon stock when it was trading around $69 per share. Within five years, its share price had fallen to approximately $14. Anderson brought suit in state court in California, his state of residency, and alleged only violations of California securities law. He alleged that the fall in share price was due to the company’s mismanagement, that the mismanagement was fraudulently concealed until 2002, and that he would have sold the shares earlier absent the concealment. Aon removed on diversity grounds. Anderson shortly thereafter dismissed without prejudice, anticipating that the federal court was going to transfer the case to Illinois under § 1404(a). He refiled, again in California state court, and added two California citizen defendants (to prevent diversity). Curiously, this time he included a federal claim (RICO) in his complaint. Aon removed on federal question grounds and also asserted that the additional defendants were fraudulently joined. Anderson dismissed his federal claim and asked that the case be remanded. Instead, the California district court transferred the case to Illinois. Judge Manning (N.D. Ill.) applied Illinois law and dismissed the complaint for failure to state a claim. Anderson appeals.

In their opinion, Chief Judge Easterbrook and Judges Williams and Tinder reversed and remanded. The Court first addressed its appellate jurisdiction, since one of Anderson's arguments was that the California federal court should have remanded to state court, instead of transferring, once he dismissed his RICO claim. The Court recognized that some circuits have held that appellate review in cases such as this is split between the transferor court's circuit and the transferee court's circuit -- but it concluded otherwise. A § 1404(a) transfer is not separately reviewable. The only review comes after a final decision when all rulings of the Illinois court (even if to apply law of the case) are reviewed. On the merits of the transfer decision, the Court concluded that the lower court acted appropriately. There was jurisdiction when the suit was filed because of the federal claim and there was supplemental jurisdiction over the state law claim under § 1367(a). Once the federal claim was dismissed, the district court had discretion to either remand or to assert its supplemental jurisdiction over the state court claims until resolution. The Court cited Andersen's legal maneuvering as one reason the court prudently kept (and transferred) the case. On the substantive merits of the claim, however, the Court found error. The transfer of the case should not affect the applicable law. Here, the court should have applied the California choice-of-law rules to determine which state's substantive law applied. The California choice-of-law rule has three parts: first, it asks whether the different states' laws are different; second (if they are different), it examines each states' interest to decide whether a true conflict exists; and third (if there is a true conflict), it applies the law of the state whose interests would be most impaired by the adoption of the other state's law. The Court noted that the substantive law at issue here was the viability of a "holder action." A holder action is a private action for damages by an investor who claims that he continued to hold the stock, when he would otherwise have sold, because of the deceit of the defendant. The Supreme Court, in Blue Chip Stamps, concluded that holder actions are not viable under federal securities laws. However, they are viable under California securities laws. The Illinois Supreme Court has not spoken, although Illinois generally follows federal law in this area. The Court therefore concluded that there was a true conflict under the choice of law rules in the California. It also concluded that the third prong of the test favored California in that California has affirmatively accepted the viability of a holder action and Illinois has not spoken on the issue. Anderson should thus be allowed to proceed with the action. The Court concluded by noting a number of significant obstacles in Anderson's path but left them to be addressed, in the first instance, by the district court.

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KURZ v. FIDELITY MANAGEMENT & RESEARCH CO. (February 23, 2009)

Kurz and Heinzl both invested in portfolios managed by Fidelity Management & Research Co. (“Fidelity”). Apparently, some Fidelity employees placed trades with Jeffries & Co. in return for kickbacks from Jeffries. The SEC initiated a proceeding under the Investment Company Act and the Investment Advisors Act. Fidelity and the SEC entered into a consent decree. Kurz and Heinzl thereafter filed a class-action suit in state court, alleging that the employees’ conduct resulted in a breach of contract by Fidelity. Fidelity removed to federal court on the basis that their failure to disclose the employees’ misconduct was a securities law issue. The district court denied Kurz’ motion to remand and entered judgment for Fidelity. Kurz appeals.

In their opinion, Chief Judge Easterbrook and Judges Sykes and Kendall affirmed. The Court referred to the Securities Litigation Uniform Standards Act of 1998 (the “Act”). The Act generally bars class actions based on state law which allege an omission of a material fact “in connection with the purchase or sale of a covered security. The Court noted that there are exceptions to the bar (like a derivative action) but Kurz did not invoke any exception. Instead, his position was that the claim was a contract claim -- not one for a misrepresentation or omission. The Court agreed that a true action for breach of contract would not be barred by the Act but concluded that Kurz could not maintain an action for breach of contract. The principal reason for his inability to do so was the complete absence of any promise made by Fidelity to Kurz.

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KATZ v. GERARDI (January 5, 2009)

Jack Katz brought this action on behalf of a class of persons who contributed real property to a real estate investment trust (“REIT”). In exchange, they received an interest in the REIT. The REIT merged into a new entity in 2007. The interest-holders were offered either cash or an interest in the new entity. Katz took the cash but filed suit in state court, alleging that the offer violated the terms of their original agreement with the REIT. He based the action on the Securities Act of 1933 ( “’33 Act”). Defendants removed the suit to federal court under the Class Action Fairness Act of 2005 (“CAFA”). The district court concluded that removal was not allowed by the ’33 Act. The defendants petition for appeal.

In their opinion, Chief Judge Easterbrook and Judges Kanne and Sykes granted the petition and vacated and remanded the decision of the district court. The Court first addressed whether Katz’ action was even one under the ’33 Act. The ’33 Act applies only to purchasers of securities – Katz and the class members are sellers of securities. The Court was inclined to believe that Katz was styling his claim as one under the ’33 Act in order to prevent removal. The district court had acknowledged the same issue. It decided that the weakness of the pleading went to the merits, not to whether it was removable. The Court recognized the difficulty in distinguishing between a claim designed to defeat federal jurisdiction and one, though ultimately unsuccessful, is properly pleaded. Ultimately, the Court decided to accept the pleading as one under the ’33 Act and address the conflict between the laws.

The ’33 Act provides that actions brought under the statute in state court are not removable except in particular circumstances. CAFA allows for removal of class actions if certain criteria are met – which admittedly are met here. The Court noted the canons of construction that apply when statutes are in conflict – an older statute yields to a newer and a less specific yields to a more specific. But the Court concluded that it did not have to apply those canons. The statutes, in fact, are not incompatible. The very language of CAFA provides the answer. The broad removal authority granted by CAFA is modified by the almost identical lists of exceptions in §1332(d)(9) and §1453(d). The Court concluded that class actions brought under the ‘33 Act are removable unless one of the §1453(d) exceptions applies. Katz relied on one of the exceptions – claims that relate to rights and duties relating to any security. The Court noted an inconsistency between Katz’ attempts to fit his claim into the exception while still relying on the ‘33 Act. Nevertheless, the Court decided the best course was to remand to determine whether the claim fit within the exception.

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STARK TRADING v. FALCONBRIDGE LIMITED (January 5, 2009)

Brascan Asset Management (“Brascan”) owned 41% of the common stock of Noranda, Inc. (“Noranda”). Noranda owned, in turn, 59% of Falconbridge, Inc. (“Falconbridge”). Noranda and Falconbridge were both large Canadian mining companies. In March 2005, Noranda offered the minority shareholders in Falconbridge 1.77 shares of Noranda stock for each share of Falconbridge. The offer was conditioned on being accepted by holders of more than half of Falconbridge’s shares. The plaintiffs (two hedge funds) bought Falconbridge shares in the months leading up to the tender-offer expiration date in May. The plaintiffs believed that Falconbridge was grossly undervalued. Before the expiration of the tender-offer, the plaintiffs learned of many problems in the transaction. They expressed their concerns to the Canadian regulators. They exposed a conflict of interest at the investment bank that did the valuation of Falconbridge and in the internal Falconbridge committee that considered the valuation. They also warned that Noranda overstated the value of its own shares. The plaintiffs tendered their shares and the tender-offer succeeded. A few months later, Noranda and Falconbridge merged. Shortly thereafter, another mining company offered to buy the merged company for a price substantially above the tender-offer price. The plaintiffs brought this action against both the merged company and Brascan. The suit was based on the SEC’s Rule 10b-5 and section 11 of the Securities Exchange Act. The district court dismissed the suit for failure to state a claim. Plaintiffs appeal.

In their opinion, Judges Posner, Kanne and Tinder affirmed. The Court first addressed the Rule 10b-5 fraud claims. A claim of fraud cannot be maintained without proof that the plaintiffs relied on the misleading misrepresentations or omissions of the defendant. The Court concluded that plaintiffs were not deceived. They knew Falconbridge was undervalued, they knew the offer was too low, and they knew that Noranda engaged in fraud. They did not try, however, to influence other minority shareholders or even to publicly disclose the information. What they had wanted was a higher offer. Not getting it and worried about the lack of minority shareholder protection under Canadian law, they tendered their shares. Other investors may have been deceived but the plaintiffs actually saw through the fraud. The Court agreed that they could not maintain a 10b-5 action. With respect to the §11 claim, the Court noted that it does not require reliance. A person may bring an action under §11 if the registration statement of the security contains an untrue statement or material omission. The plaintiffs fare no better under §11, however, than they did under 10b-5. The measure of damages is the difference between the purchase price paid by the plaintiff and the share price when it was sold or at the time of the suit, if still owned. Here, the value of the plaintiffs’ investment was higher at the time of the suit than when they purchased the shares.

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