Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-07-07162/USCOURTS-caDC-07-07162-0/pdf.json

Nature of Suit Code: 190
Nature of Suit: Other Contract Actions
Cause of Action: 

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued September 15, 2008 Decided November 7, 2008

No. 07-7162

IN RE: SERIES 7 BROKER QUALIFICATION EXAM SCORING

LITIGATION,

WILLIAM LOWE, ET AL.,

APPELLANTS

v.

THE NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.

AND EDS CORPORATION,

APPELLEES

Appeal from the United States District Court

for the District of Columbia

(No. 06mc00355)

Gerald E. Martin argued the cause for appellants. With him

on the briefs was Herbert E. Milstein. Jonathan W. Cuneo and

Steven A. Skalet entered appearances.

Douglas R. Cox argued the cause for appellees The National

Association of Securities Dealers, Inc., et al. With him on the

brief was F. Joseph Warin.

Michael A. Carvin argued the cause for appellee EDS

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Corporation. With him on the brief were James E. Gauch and

Juliet J. Karastelev.

Before: BROWN, Circuit Judge, and EDWARDS and

SILBERMAN, Senior Circuit Judges.

Opinion for the Court filed by Circuit Judge BROWN.

BROWN, Circuit Judge: The question before us is whether

common law causes of action can be alleged against a SelfRegulatory Organization (“SRO”) for the negligent performance

of its duties under the Securities Exchange Act of 1934

(“Exchange Act”). 15 U.S.C. § 78o-3(b). Despite a seemingly

impenetrable wall of contrary precedent, plaintiffs argue that

while suits challenging an SRO’s discretionary decisions are

clearly prohibited, SROs may be sued for the negligent

performance of ministerial functions. The district court did not

buy it. Neither do we. We affirm the district court’s grant of the

defendants’ motion to dismiss.

I. Background

The National Association of Securities Dealers (“NASD”)

(now known as the Financial Industry Regulatory Authority,

Inc.), an SRO, administers the Series 7 examination, a

computerized multiple-choice test, as part of the comprehensive

regulation of the securities industry. Electronic Data Systems

(“EDS”) is a private corporation, hired by NASD for technical

services related to administration of the Series 7 exam.

For each exam, NASD randomly draws 250 questions of

varying difficulty from a larger pool; each applicant receives

only a 250-question subset of the larger pool on her particular

examination. After an applicant takes the Series 7 exam, a

software program developed by EDS scores the exam, adjusting

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for level of difficulty, and reports the results immediately to the

applicant. 

Sometime before October 1, 2004, an EDS maintenance

technician inadvertently switched two of the three difficulty

variables for approximately 213 questions. On October 1, 2004,

those 213 questions were added into NASD’s pool of questions.

From that point forward, tests for many applicants included at

least some of the 213 affected questions. Although the answer

choices for the affected questions were not disturbed, the

mistaken alteration of the difficulty ratings caused some test

scores to be misreported. Between October 1, 2004 and

December 20, 2005, when NASD discovered the mistake,

60,500 applicants had taken the test.

 On January 6, 2006, NASD issued a press release, publicly

acknowledging the results for 1,882 applicants had been misreported as failing scores. All affected applicants had their

results corrected and their applications approved. 

Some of the applicants who received incorrect Series 7

scores filed suit and these actions became part of a nationwide

consolidated class complaint asserting causes of action for

common law breach of contract, negligence, and negligent

misrepresentation. The district court dismissed the complaint,

noting plaintiffs are “seeking remedies for negligent

performance of an SRO’s regulatory duties that Congress did

not see fit to provide.” In re Series 7 Broker Qualification Exam

Scoring Litig., 510 F. Supp. 2d 35, 49, 50 (D.D.C. 2007).

II. Discussion

Under the Exchange Act, any person conducting securitiesrelated business must be associated with a registered securities

association such as NASD. 15 U.S.C. §§ 78o(a)(1), (b)(8). The

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Act requires all such persons to meet “standards of training,

experience, competence, and such other qualification as the

[SEC] finds necessary or appropriate in the public interest or for

the protection of investors.” Id. § 78o(b)(7). The SEC has, in

turn, delegated to NASD the responsibility of devising a broker

qualification exam to measure the competency of applicants.

See 17 C.F.R. § 240.15b7-1. The delegation involves close

oversight; the SEC approves all rule changes by an SRO such as

NASD, no matter how minor. 15 U.S.C. § 78s(b). If the SEC

deems it necessary, it may also amend an SRO’s rules itself. Id.

§ 78s(c). The Exchange Act requires SROs to comply with the

Act, the SEC’s rules, and their own rules. Id. § 78s(g). Failure

to do so can result in severe sanctions, such as revocation of

SRO registration. Id. § 78s(h).

NASD has the right to bar membership to any applicant

who does not meet the standards of competence prescribed by

NASD’s rules, including a passing score on the Series 7 exam.

Id. § 78o-3(g)(3)(B). Any individual barred from membership

by the NASD has statutorily guaranteed rights to appeal. See id.

§§ 78s(d), (f), 78y(a)(1). Congress has created a complex

system of review, involving several stages of appeal, for

precisely the type of harm plaintiffs allege here. Id. §§ 78s(d),

78y(a)(1) (allowing review of improper denials of membership).

Appeals can be brought before the SEC and, if desired, in the

federal courts of appeals. Id. §§ 78s(d), 78y(a)(1).

Additionally, NASD rules (promulgated under the authority

delegated to it by the SEC, as envisioned by the Exchange Act)

provide for two internal layers of appeal. See NASD Manual,

Rules 9524, 9525, available at http://finra.complinet.com/finra

(last visited Oct. 21, 2008). In total, applicants who believe

their registration has been improperly denied have four potential

levels of appeal: two with NASD, one before the SEC, and one

in the federal courts of appeals.

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Plaintiffs, who have had the benefit of every available

administrative remedy, concede there is no federal implied

private right of action; nevertheless, they insist their state law

claims based on negligence and breach of contract are

permissible. Defendants argue that such causes of action are

impliedly preempted by federal law and, alternatively, that they

are immune from suit based on regulatory immunity. Whether

analyzed under preemption doctrine or a theory of regulatory

immunity, the result is the same: plaintiffs cannot raise a

common law complaint against defendants based on duties

arising under the Exchange Act.

It is well established that “the question whether a certain

state action is pre-empted by federal law is one of congressional

intent.” Allis-Chalmers Corp. v. Lueck, 471 U.S. 202, 208

(1985). When deciding the availability of such claims, “[t]he

purpose of Congress is the ultimate touchstone.” Retail Clerks

Int’l Ass’n v. Schermerhorn, 375 U.S. 96, 103 (1963). To assess

the availability of a state common law cause of action, we

therefore direct our attention to the intent of Congress. As the

Supreme Court has stated, “[s]tate action may be foreclosed by

express language in a congressional enactment, by implication

from the depth and breadth of a congressional scheme that

occupies the legislative field, or by implication because of a

conflict with a congressional enactment.” Lorillard Tobacco

Co. v. Reilly, 533 U.S. 525, 541 (2001).

Several other circuits have analyzed whether common law

claims can be raised based on an SRO’s duties under the

Exchange Act. Although the cases do not explicitly rely on

preemption, the reasoning of our sister circuits is instructive

regarding the preemptive intent of the congressional scheme. In

Barbara v. N.Y. Stock Exch., Inc., 99 F.3d 49 (2d Cir. 1996), the

Second Circuit held the New York Stock Exchange was immune

from claims arising out of disciplinary proceedings required

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under the Exchange Act. Id. at 59. “[A]llowing suits against the

Exchange arising out of the Exchange’s disciplinary functions

would clearly stand as an obstacle to the accomplishment and

execution of the full purposes and objectives of Congress,

namely, to encourage forceful self-regulation of the securities

industry.” Id.

Later, in Desiderio v. NASD, 191 F.3d 198 (2d Cir. 1999),

an applicant rejected for refusing to sign an arbitration clause

had her common law tort claim dismissed because “there is no

private right of action available under the Securities Exchange

Act to redress denials of membership.” Id. at 208. In Desiderio,

like in Barbara, the Second Circuit found common law causes

of action inconsistent with Congress’s intent under the Exchange

Act.

Similarly, the Ninth Circuit found a common law breach of

contract claim could not be raised against NASD because doing

so “would allow states to define by common law the regulatory

duties of a self-regulatory organization.” Sparta Surgical Corp.

v. NASD, 159 F.3d 1209, 1215 (9th Cir. 1998). The court in

Sparta felt such a result “cannot co-exist with the Congressional

scheme of delegated regulatory authority under the Exchange

Act.” Id. See also MM&S Fin., Inc. v. NASD, 364 F.3d 908,

912 (8th Cir. 2004) (“[A]llowing MM&S to assert a private

breach of contract claim [against NASD] would vitiate

Congress’s intent not to allow private rights of action against

self-regulatory organizations for violating NASD’s own rules.”).

Though not always explicitly identifying the underlying

premise, courts have consistently found Congress’s intent under

the Exchange Act precludes common law causes of action, and

we agree with the reasoning of our sister circuits.

The common law claims in this case—whether presented in

tort or contract—seek monetary damages based on NASD’s

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wrongful determination of competency standards for specific

applicants. Plaintiffs attempt to distinguish their case from the

long line of precedent by arguing the previous cases involved

violations of the Exchange Act which were artificially described

as common law claims—that is, common law claims in name

only, but in substance actions under the Exchange Act.

Although plaintiffs insist their claims are “genuine” common

law claims, this contention is beside the point, because it is those

claims which Congress intended to preempt in the Exchange

Act, and which would “stand as an obstacle to the

accomplishment and execution of the full purposes and

objectives of Congress.” Barbara, 99 F.3d at 59.

As the Supreme Court has noted in another context, the

structure of a statute may imply that Congress intended to

preclude challenges arising under a statute when those

challenges are outside the system of review prescribed by the

statute. See Block v. Cmty. Nutrition Inst., 467 U.S. 340, 349

(1984). We are confident that any actions against SEC

regulators, or those acting in their stead, are limited to the four

levels of review specified by the Exchange Act. The multiple

layers of review evince Congress’s intent to direct challenges

based on denials of membership to the avenues Congress

created. Had Congress been silent on this issue, a more

plausible case for common law suits might be made. But its

clear designation of an appellate process shows a contrary

intent: rather than allowing plaintiffs to sue under common law

theories, Congress created a self-contained process to review

and remedy such complaints.

Plaintiffs may be troubled by the fact that Congress’s

approach does not include damage-remedies for wrongfully

rejected applicants. But plaintiffs’ disenchantment changes

nothing. By specifically adopting an appeals process which

does not provide monetary relief, Congress has displaced claims

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for relief based on state common law. A common law suit for

recovery of monetary damages is merely an “attempt . . . to

bypass the Exchange Act” and the process Congress envisioned

therein. MM&S Fin., 364 F.3d at 912.

Turning to an immunity analysis, the Exchange Act reveals

a deliberate and careful design for regulation of the securities

industry. This regulatory model depends on the SEC’s

delegation of certain governmental functions to private SROs,

such as NASD’s administration and scoring of the Series 7

exam. Absent the unique self-regulatory framework of the

securities industry, these responsibilities would be handled by

the SEC—“an agency which is accorded sovereign immunity

from all suits for money damages.” DL Capital Group, LLC v.

Nasdaq Stock Mkt., 409 F.3d 93, 97 (2d Cir. 2005). When an

SRO acts under the aegis of the Exchange Act’s delegated

authority, it is absolutely immune from suit for the improper

performance of regulatory, adjudicatory, or prosecutorial duties

delegated by the SEC. See Weissman v. NASD, 500 F.3d 1293,

1298–99 (11th Cir. 2007).

The comprehensive structure set up by Congress is

suggestive both of an intent to create immunity for such duties

and of an intent to preempt state common law causes of action.

The elaboration of duties, allowance of delegation and oversight

by the SEC, and multi-layered system of review show

Congress’s desire to protect SROs from liability for common

law suits. “The presumption that a remedy was deliberately

omitted from a statute is strongest when Congress has enacted

a comprehensive legislative scheme including an integrated

system of procedures for enforcement.” Feins v. Am. Stock

Exch., Inc., 81 F.3d 1215, 1221 (2d Cir. 1996) (quoting Nw.

Airlines v. Transp. Workers Union of Am., 451 U.S. 77, 97

(1981)).

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The claims here challenge errors in developing the Series 7

exam, scoring the exam, and reporting scores correctly. All of

these duties exist only because of NASD’s Exchange Act

responsibilities. See 15 U.S.C. § 78o(b)(7). NASD has no freestanding obligation to design, score, or report results—its

obligations to do so arise only because of regulations under the

Exchange Act. See 17 C.F.R. § 240.15b7-1. Were it not for the

regulations that flow from the Exchange Act, NASD would not

be administering the Series 7 examination. Courts have

consistently barred suits which seek monetary relief for actions

taken by agency regulators — or those acting in their place —

in performance of their regulatory, adjudicatory, or prosecutorial

duties. See, e.g., MM&S Fin., 364 F.3d at 912; Desiderio, 191

F.3d at 208; Niss v. NASD, 989 F. Supp. 1302, 1307–08 (S.D.

Cal. 1997). Congress did not intend the regulatory duties at

issue here to be enforced by common law causes of action.

Where courts accord immunity to SROs, the protection has

been absolute. Courts have declined to craft exceptions for bad

faith (Desiderio, 191 F.3d at 208), fraud (DL Capital Group,

409 F.3d at 98), negligence, or even gross negligence (Sparta,

159 F.3d at 1215). Unable to breach this formidable barrier of

precedent or sneak past it in disguise, plaintiffs attempt to vault

over it. Even if there is no exception for negligence generally,

plaintiffs insist no immunity should exist for the negligent

performance of purely ministerial functions. Plaintiffs borrow

this distinction from tort cases in which courts sought to balance

the scope of common law immunity with the doctrine’s central

purpose of insulating decision-making from the harassment of

prospective litigation. In such cases, the invocation of absolute

immunity would deprive a litigant of any remedy. See Westfall

v. Erwin, 484 U.S. 292, 295 (1988). But this feint fails when

Congress itself has resolved the question. The functional

approach to immunity is appropriate only when the question has

not been decided by express statutory enactment. Forrester v.

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White, 484 U.S. 219, 223–25 (1988). Here, plaintiffs, who have

taken full advantage of the existing remedial scheme, try to

defeat the SRO’s immunity to get a different and more generous

remedy than Congress saw fit to provide.

Congress designed a specific remedial structure for

wrongful denials of membership and did not provide monetary

relief. Having considered the issue, Congress decided

consequential damages should not be given for improper denials

of membership under the Exchange Act.

Regardless of the approach taken, the conclusion is not

changed: plaintiffs cannot bring a common law cause of action

based on errors in design, scoring, or reporting of results of the

Series 7 exam. These duties arise only under the Exchange Act,

and they are not open to suit under state common law theories.

Both preemption and regulatory immunity support our holding,

and the intent of Congress is clear under each approach.

Because we find such claims are not allowable under the

Exchange Act, we affirm the district court’s judgment of

dismissal.

So ordered.

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