Of the Northern District of Illinois, sitting by designation. 

In the

United States Court of Appeals

For the Seventh Circuit

No. 08-2733

DAVID KURZ and RAYMOND HEINZL, on behalf of a class,

Plaintiffs-Appellants,

v.

FIDELITY MANAGEMENT & RESEARCH CO. and FMR CO., INC.,

Defendants-Appellees.

Appeal from the United States District Court

for the Southern District of Illinois.

No. 07-cv-709-JPG—J. Phil Gilbert, Judge.

ARGUED JANUARY 20, 2009—DECIDED FEBRUARY 23, 2009

Before EASTERBROOK, Chief Judge, SYKES, Circuit Judge,

and KENDALL, District Judge.



EASTERBROOK, Chief Judge. David Kurz and Raymond

Heinzl are former investors in portfolios managed by

Fidelity Management & Research Co. and FMR Co., Inc.

(We refer to the plaintiffs, and the class they represent, as
2 No. 08-2733

Kurz and the defendants as Fidelity.) Kurz filed suit in

state court, invoking state law and asserting that Fidelity

broke a contract when some of its employees placed

trades through Jeffries & Co. According to the complaint,

Jeffries bribed the employees to send business its way.

Trading through a broker that paid under the table violated the duty of “best execution” stated in rules of the

National Association of Securities Dealers (now known

just as its acronym NASD), according to the complaint.

“Best execution”—getting the optimal combination of

price, speed, and liquidity for a securities trade, see

Jonathan R. Macey & Maureen O’Hara, The Law and

Economics of Best Execution, 6 J. Financial Intermediation

188 (1997)—affects the net price that investors pay or

receive for securities and is accordingly widely understood as a subject of regulation under the Securities and

Exchange Act of 1934 and related laws, such as the Investment Advisers Act of 1940 and the Investment Company Act of 1940. See, e.g., Newton v. Merrill Lynch, Pierce,

Fenner & Smith, Inc., 135 F.3d 266 (3d Cir. 1998) (en banc).

The Securities and Exchange Commission initiated a

proceeding under the Investment Company Act and the

Investment Advisers Act against Fidelity, which entered

into a consent order that governs how future trades will

be placed and executed. See In re Fidelity Management &

Research Co. & FMR Co., Inc., SEC Release No. IA-2713

(Mar. 5, 2008), available at http://www.sec.gov/litigation/

admin/2008/ia-2713.pdf.

Like the SEC, Fidelity took the position that the misconduct of its employees (more precisely, its failure to disclose that misconduct to investors) is a securities-law
No. 08-2733 3

issue and removed the proceeding to federal court

under the Securities Litigation Uniform Standards Act of

1998. The relevant part of this statute, 15 U.S.C. §78bb(f),

provides:

(1) No covered class action based upon the statutory or common law of any State or subdivision

thereof may be maintained in any State or Federal

court by any private party alleging—

(A) a misrepresentation or omission of a material fact in connection with the purchase or

sale of a covered security; or

(B) that the defendant used or employed any

manipulative or deceptive device or contrivance in connection with the purchase or sale

of a covered security.

(2) Any covered class action brought in any State

court involving a covered security, as set forth in

paragraph (1), shall be removable to the Federal

district court for the district in which the action

is pending, and shall be subject to paragraph (1).

See also Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit,

547 U.S. 71 (2006) (discussing scope of 1998 Act); Kircher v.

Putnam Funds Trust, 403 F.3d 478 (7th Cir. 2005) (same),

vacated for lack of appellate jurisdiction, 547 U.S. 633

(2006). Fidelity maintained that, at least by plaintiffs’

lights, it had either misrepresented that best execution

would be achieved, or failed to disclose that best execution was not being achieved; either way, the wrong took

place “in connection with the purchase or sale” of covered
4 No. 08-2733

securities because it affected trades in those securities

(and potentially the net price obtained). The district

court agreed and denied Kurz’s motion to remand. 2007

U.S. Dist. LEXIS 80127 (S.D. Ill. Oct. 30, 2007). The court

later entered judgment for Fidelity, 2008 U.S. Dist. LEXIS

45332 (S.D. Ill. June 10, 2008), because Kurz filed suit

after the federal statute of limitations had run and also

was unable to show injury. (A report prepared at the

behest of Fidelity’s independent trustees was unable

to detect statistically significant effects on the costs of

execution. See ¶¶ 86 and 87 of SEC Release IA-2713; a

redacted version of the report is available on the SEC’s

web site.)

Section 78bb(f)(3) excludes some actions from the scope

of removal and preemption. For example, a derivative

action against an issuer, under the law of the

issuer’s state of incorporation, is excluded by subsection

(f)(3)(A)(i). Kurz has not pursued a derivative claim—not

only because he did not invest in Fidelity itself but also

because he no longer holds a portfolio under Fidelity’s

management. (That Fidelity fired the misbehaving employees, none of whom was in senior management, and

cooperated with the SEC to reduce the risk of recurrence,

also would prevent resort to derivative litigation.) Kurz

does not invoke any of the 1998 Act’s other exceptions.

He contends instead that the suit rests on contract law

rather than “a misrepresentation or omission of a

material fact” and therefore does not come within the

1998 Act in the first place. He also contends that the duty

of best execution is not “in connection with the purchase

or sale” of securities. That argument is frivolous, given
No. 08-2733 5

Dabit, 547 U.S. at 85–86, and SEC v. Zandford, 535 U.S. 813,

820–22 (2002). See also United States v. O’Hagan, 521

U.S. 642 (1997); United States v. Naftalin, 441 U.S. 768 (1979).

Our opinion in Kircher observed that a genuine

contract action would be outside the scope of the 1998

Act. See 403 F.3d at 482–83. But where’s the contract? Kurz

does not contend that Fidelity broke a promise to him;

instead he depicts himself as the third-party beneficiary

of a contract between Fidelity and Jeffries, in which they

promised to obey all of NASD’s rules. When asked for

a copy of that contract, Kurz’s lawyer said that he did

not have one—and for all we know none exists. Membership in NASD means being bound by its rules, but there

may be no separate contract to that effect between members and NASD, or between one member (Fidelity) and

another (Jeffries).

NASD’s rules themselves are part of the apparatus of

federal securities regulation. NASD is a “self-regulatory

organization”; its requirements are adopted by notice-andcomment rulemaking (not by the mechanism of contract,

which requires consent by all affected persons) and are

subject to review and change by the SEC. See 15 U.S.C.

§78o, §78s. Some of these rules are the source of legal

duties, and not revealing to investors a failure to

comply with one’s duties about transactions in their

securities can lead to liability under the securities acts.

See O’Hagan and, e.g., Basic Inc. v. Levinson, 485 U.S. 224

(1988); Dirks v. SEC, 463 U.S. 646 (1983). This is the reasoning that led the SEC to think that Fidelity had violated

the Investment Company Act and the Investment
6 No. 08-2733

Advisers Act; it is some distance from a state-law contract

action.

Fidelity did not break a promise to Kurz. The promise—if

there was any independent of the NASD’s rules—was

made by Fidelity’s employees to Fidelity itself. The employees promised to supply their honest services, and

didn’t. Kurz needs a way to turn the employees’ misconduct into a legal claim in investors’ favor. Contract law

does not do the trick: if some of IBM’s employees take

bribes and this leads to higher prices for computers, IBM’s

customers could not sue IBM on a contract theory.

What does produce a claim is securities law. How

Fidelity discharges its duties toward investors is a

subject requiring disclosure under federal law. And

although Fidelity itself (which is to say its top managers

and board) did not know about the defalcations

among members of the staff, and thus did not act with

the scienter required for federal securities liability, see

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), the employees who were on the take acted with eyes open.

Failure to keep one’s promises about the handling of

securities can violate federal securities law. See, e.g.,

O’Hagan (partner in a law firm violated securities law by

breaking a promise his firm made to a customer to keep

information secret and not trade); Wharf (Holdings) Ltd. v.

United Int’l Holdings, Inc., 532 U.S. 588 (2001) (making a

promise about securities with intent not to keep it is

securities fraud). Cf. Carpenter v. United States, 484 U.S. 19

(1987) (a reporter’s failure to keep a promise to his newspaper about dealing in securities may be punished as mail
No. 08-2733 7

fraud). If any of its employees violated securities law,

Fidelity is derivatively liable under the control-person

clauses, 15 U.S.C. §78t (1934 Act), §80a–64 (Investment

Company Act), because it had the right to control the

way in which its staff executed trades.

The district court thus was right: Kurz had a federal

securities claim, or he had nothing. And it is a bad securities claim, given the expiration of the federal statute of

limitations and the class’s inability to show loss causation.

See Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005).

Failure to show materiality may be another problem; we

need not decide. The judgment of the district court is

AFFIRMED.

2-23-09