Ofthe Northe rnDis t ri c tofI l l i noi s , s i t t i ng by des i gna t i on.  

## In the 

# U n ited S ta tes Co urt o f Ap p ea ls

F o rth eS e v e n th C ir cu it
N o. 08

- 2733 D AVI D K URZ an d R AY MOND H EINZL , o n behal fo fa cl ass , P laint if fs -App el lants , v.
F IDE LITY M ANAGEM ENT & R ES EA R CH C O . an d F M R C O ., I NC ., D efend a nts-A pp ellees
.
A pp eal from the United S t ates Di strictC our t fo r the S outhernDi stricto f Illino is. No . 07 -cv-709 -JPG

—J. Phil Gilbert, Ju dge
. A RG UE D J AN UA RY 20, 2009

— D ECI DE D F EB RU AR Y 23, 2009

Befo re E A S T E RB R OO K, Chi e f Judg e, S YKES, Cir cu i tJudg e, a nd K ENDALL, D i s t r i ctJudg e .  E AST E RB R OO K, Chi e

f Judg e . D a v i d Ku r z a n d R a y mon d H ei nzl ar e for m eri nv es to rs i n port f ol i os m anage d by Fi del i ty M anage m ent & Resear ch Co. and F M R Co., In c. ( W e r eferto the pla i nti ff s, and the cl ass they repre sent, as2 N o. 08

- 2733 K u rz an d th e d efe n d an ts as Fid elit y .) K u r z filed su it in sta te cour t, i nvok in g state l aw and ass er ti ng tha t F i del i ty bro ke a co ntra ct when som e o fi ts em p loy ees pl aced tr ades thro ugh J eff ri es & Co. A c c or ding to the c om pla i nt, J eff ri es bribed the em plo yee s to send busi ness i ts w ay. Tradi ng thr ough a brok erthatpai d und erthe tabl e v i ol at ed th e dut y o f“best ex ec ut i o n” s ta te d i n r ul es o fthe Na t i o n a l As s o c i a t i o n o fS ec u r i t i e s D e a l e r s ( n o w kn o wn j ust a s i ts acr onym N A SD), acc or ding to the c om pla i nt. “Be ste xe cuti on”

— get ti ng the o pti m alco m bi nati on o f pri ce, speed, and l i quidi ty f ora secur i ti es tr ade, se e J onathan R. M acey& M aure en O’Hara, TheLa w and Economic s of

Be s tExe cu t i on , 6 J. F i nanci alI nter m edi ati on 188 ( 1997 )

— affects the net pr i ce that invest or s pay or receive for secu riti es an d i s acco rd ingly w idely un d erst o o d a s a su bj ec t o fr egul at i o n un der t he S ec ur i ti es a nd Exch an g e Act o f1 93 4 an d r el at ed l aws, s ucha s th e I nv e s t me n tA d v i s e r s A c to f1 9 4 0 a n d th e I n v e s t men t C o mp an y A c t o f 19 40 . See , e.g., N ew t o n v . M errill Ly nc h, P ierce, Fe nne r& Sm i t h, Inc . , 135 F.3d 266 ( 3d Cir. 1998) (en ban c). Th e S e c ur i t i e s a nd Ex c ha ng e Co mm i s s i o n i ni t i a t e d a pr o ce edingunde r the I nv es tmentCo m pany A cta nd the I nvest m ent Ad vi ser s Act aga i nst F i del i ty, wh i ch ente re d in to a c on se n t o rd er th at gov er n s h o w f u t u re tra d es w ill be pl aced and execute d. Se e In re Fidel ity M ana gem ent& Re s e a r c h Co
. & FM R Co
. , Inc ., SE C Rele ase N o. I A

- 2713 ( M ar . 5 , 2 00 8) , a va i l ab l e atht tp: //ww w. se c. g o v/l i ti g at i o n/ ad m in/2008 /i a-2713.p d f. Li k e th e S EC, F i del i tyt o o kthe po si ti o n tha t th e m i sc o ndu ct o fi ts em plo yees ( m or e pr eci sel y, i ts f ai l ure to discl o s e tha tmi s c o nd uc tt o i nv e s t o r s ) i s a s e c ur i t i e s- l awN o. 08

- 2733 3 issue an d rem oved the p roceed ing to f e d eral court und er the Se curi ti es Lit i gat i on U ni f or m St andards A c t of 1998
. Th e relevant pa rt of th is statu t e , 1 5 U
. S. C
. §78bb (f ), provi des: ( 1) No c o ve r ed c la ss a ct i o n b as ed upo n the s ta tu
tor y o r c om m on l aw o fany St ate o r subdivi si on ther eofm ay be m ai ntai ned i n any S tat e o r Feder al co ur t bya ny pr i va te pa r tya l l eg i ng

— ( A ) a m i sr epres entat i on o r om i ssi on o fa m ate
ri alf act i n connecti on with the pu rchas e o r sal e o fa cove re d secur i ty; o r ( B) thatthe de fen dan t us ed o r e m pl o y ed an y m ani pu l ati ve ord ecepti ve devi ce o r contr i van c e in co n n ec t i o n w ith th e p u rc h as e o r sa le ofa cove re d secur i ty. ( 2) A ny co ver ed cl ass act i on br ought i n any St ate c ou rtinv o lvin g a co ve re d se c u rit y, as se t fo rt h in parag ra ph (1 ) , shal l be re m ovabl e t o the F edera l dist ri ct c ourtf orthe dist ri ct in w hi ch the acti on is pen d ing, an d shall be subject to pa ragrap h (1). Se e a l so M er ri ll Lynch, P ie rc e, Fe nner& Sm ith Inc. v. D abit, 547 U
. S. 71 (2006) ( d iscus sing scop e of 1998 A ct); Ki r ch e rv. P utn a m Fu nd s Trust, 403 F. 3d 478 ( 7th C ir. 2005 ) (s am e), vacat ed f or l ack ofappel l ate j uri sdic ti on, 54 7 U.S
. 63 3 ( 2006 )
. Fi del i ty m ai ntai ned that, a t l eas t bypl ai nti ff s’ l i ghts, i t had e i ther m i sr epres ented that bes t executi on woul d b e ac hi ev ed, o r f ai l ed to di sc l o se tha t be ste xe cuti on was notbeing ac hi eve d; ei therway, the w ro ng to ok pla ce “ i n connect i on with the pu rchas e orsa l e” ofco ver ed4 N o. 08

- 2733

secur i ti es because i t a ffecte d tra des i n thos e s ecuri ti es ( and potenti al l y the netpri ce obtained). The di str i ct cour t a gr eed and d en ied K urz’ s m oti on t o re m and. 2007 U .S. D ist . L EXIS80127( S. D
. I ll

. Oc t. 30, 2007). Th e cou rt lat er en te re d j u d gm en t fo r Fid elit y, 20 08 U .S. D i s t. L EXIS 45 33 2 (S .D . I ll. Ju n e 1 0, 20 08 ), be c au se K u rz filed su it afterthe federa l statute o fl i m i tat i ons had run and al so was unabl e to s ho w i nj ur y . ( A re po r t pr epared atthe b eh es t o f Fid el i t y’s ind ep en d en t t ru st ee s w as u n ab le to detectst ati sti cal l y s i gni fi cant e ffects o n the cos ts of ex ec u tio n . See ¶¶ 86 an d 87of SE C R ele as e I A

- 2 7 13 ; a r eda ct ed ve r si o n o fthe r epo r t i s av ai l ab l e o n the S EC ’s w eb sit e.) S e c t i o n 7 8 b b ( f ) ( 3 ) e xc l ud e s s o me a c t i o ns fr o m t he s c o pe ofr em ov al an d preem pti on. Fo r exam ple , a deri vati ve ac ti o n a g ains t ani ss ue r, u nd erthe l aw o fthe i ssuer ’ s s tat e o fi nc or p or ati on, i s e xcl ud ed by subsect i on (f)(3 ) ( A )(i). K u rz h as n otp u rs u ed a d er iva tiv e c laim

— not onl y because he did not i nvest i n Fi del i ty i tself bu t a l so b e cau se he no longer hold s a portfoli o un d er Fi d eli ty’s man a g e me n t
. ( T h a tF i d e l i t y fi r e d th e mi s b e h a v i n ge mpl o y ee s, no ne o fwho m was i n seni o r mana g ement, a nd coo perat ed w i th the S EC t o redu ce the r i sk ofr ecurr ence, also w ou ld p reven t resort to derivative l it igat ion.) K urz does not i nvoke any of the 1998 A ct’ s oth er exce pti ons. H e con tends i nstea d that the sui t r est s o n contr act l aw rath er than “a m isrepres en tation or om issi on of a m at er i alf ac t” a nd the r efo r e do es no t co m e wi th i n the 1998 A ct in the fi rs t pl ace. H e a l so conte nd s that the duty ofbes t e xecution is not“in connect i on with the pu rchas e orsa l e” ofse curi ti es. That argum ent i s fri vol ous, gi venN o. 08

- 2733 5 D abit, 5 4 7 U. S
. a t8 5

– 8 6 , a nd SE Cv. Z a nd fo rd, 53 5 U.S
. 81 3, 82 0–22 ( 2002 )
. S ee al so U ni t e d S t at e s v. O ’Hagan , 52 1 U
. S. 642 (1997); U nite d State s v. N aftali n , 441 U
. S. 768 (1979). O u r o p i n ion inK irch erobs er ve d tha t a g en ui ne contrac t a cti on would be o utsi de the sco pe ofthe 1998 A ct. See 403 F. 3d at 482– 83. B ut w he re’s th e con tract? K urz d o e s n o t c o n t e n d th a t F i d e l i t y b r o k e a p r o m i s e t o h i m; instea d he d ep icts him self as th e t h ir d -party ben efi ciary ofa contr act between Fi del i ty and Je ff ries, in w hi ch they prom i sed to obe y al l of N A SD’s rul es. W hen asked for a cop y oft hatco n tr ac t, K u rz ’s la w ye r sa id th at h e d id no t ha ve o ne

— an d fo r a llw e know non e exists. M em bersh ip in N A SD m e an s being bou nd by i ts rules, but th ere ma y b e no s e p a r a t e c o n t r a c tt o th a te ffe c tb e t we e n me mbe r s a nd NA S D, o r b etwee n o ne mem be r ( F i del i ty ) a nd an oth er (J effr ies). N A SD’s r ule s them sel ves ar e par t o fthe apparatus of fede ral s e c u r iti es regu lation. N A SD i s a “self- regu latory o r g a ni z a t i o n” ; i t s r e qu i r e men t s a r e a do pt e d b y n o t i c e - a nd

com m ent r ule m aking ( not by the m echani sm o fco ntra ct, w hich requ ires consen t by allaffecte d pers ons ) an d are s ubj e c tt o r e v i e w a nd c ha ng e b y the SEC. S e e 1 5 U. S
. C. §78 o , §7 8s. S om e o fthes e r ule s a re the sour ce o fl ega l du t i e s , a nd no t r e v e a l i ng t o i nv e s t o r s a f a i l ure to c om p ly w ith on e’s d u tie s a b ou t t ra n sa c tio n s in th eir secur i ti es can l ead to l i abi l i ty und ert h e securi ti es acts
. Se e O ’Hagan an d , e.g., Bas i c Inc . v. Le vi ns on , 48 5 U .S
. 22 4 (1988); Di rks v . S EC, 4 63 U. S
. 6 46 ( 19 83 )
. Thi s i s th e r ea so ni ng tha t l ed t h e SEC to thi nk tha t F i del i ty had vi ol ate d th e I nv es tmentCo m pany A cta nd the I nv es tment6 N o. 08

- 2733 A dvis er s Act; i t i s s om e di sta nce fro m a sta te- l aw co ntra ct ac ti o n. Fi del i ty did notbr eaka prom i se to K urz. T he pro m i se

— if ther e was any i nd ependent ofthe N A SD’s r ule s

— w as ma d e b y F i d e l i t y ’ s e mp l o y e e s t o F i d e l i t y i t s e l f

. T h e e mpl o y ee s pr o m i se d t o s uppl y the irho ne sts er vi ce s, a nd di dn’ t. Kur z ne eds a way t o tur n the e m pl o y ee s’ mis co ndu ct into a l ega l cl ai m i n i nvest or s’ f avo r. Contr act l aw does not do the tr i ck: i fso m e of IBM ’ s e m plo yee s t ake bribes an d th is l ead s to higher p rices f or com p ut ers, I B M ’s custo m er s co uld notsue I BM o n a c ontr act theo ry . W hat doe s pro du ce a cl ai m is s ecu ri ti es l aw . H ow Fi del i ty di schar ges i ts du ti es toward i nvest or s i s a su bj ec t r equi r i ng d i sc l o su r e unde r fede r all aw. And althou gh Fi d eli ty itself( w hich i s to say its t op m an agers an d b o ar d) di d no t k no w ab o utthe de f al ca ti o ns am ong m em ber s o f the sta ff, and thus di d not a ct with the s c i e nt e r r e qu i r e d fo r fe de r a l s e c ur i t i e s l i a b i l i t y, se e E rnst & E rnst v. H o c h felder, 4 2 5 U
. S
. 1 8 5 ( 1 9 7 6 ) , th e e mpl o y ee s who wer e o n the t ak e ac ted w ith ey es o pen . Fa i l ure to kee p one’ s pro m i ses abo ut the hand l i ng o f se c u r i tie s c an vio lat e fe d er al s ec u rit ies law . See , e.g., O ’Hagan ( partneri n a law fi rm vi ol ate d secur i ti es l aw by bre aking a prom i se hi s fi rm m ade to a custo m erto ke ep inform ation sec ret and n o t trad e); W har f (H ol di ngs ) Lt d. v. Un i t e d In t ’ l Hol d i n g s , Inc ., 53 2 U.S
. 58 8 ( 2001 ) ( m aking a p ro m ise ab ou t s ec u rit ies w ith in t e n t n otto ke ep it is secu riti es fraud ). Cf. C a rpen ter v. U nited Sta tes , 48 4 U
. S. 19 ( 1987 ) ( a re port er ’ s f ai l ure to kee p a prom i se to hi s newspap er ab ou t d ea lin g in se c u rit ies m ay be p u n ish ed as m ailN o. 08

- 2733 7 f r a u d )
. I fa n y o fi t s e mpl o y e e s v i o l a t e d s e c u r i t i e s l a w, Fi del i ty i s der i vati vel y l i abl e under the c ontr ol

- pe rson cl au se s, 1 5 U
. S
. C. § 78 t ( 19 34 Act ) , § 80 a– 64 ( I nv es tment CompanyAct ) , b ec au se i t ha d the r i g htto c o nt r o l the w ay i n w hi ch i ts sta ffexec uted tr ades. The dis tr i ct c ourtthus was righ t: K urz had a federa l se c u rit ies cla im , or h e h ad n ot h in g. A n d it is a b ad se c u riti es cl ai m , gi ven th e ex p ira ti on o fthe federa l st atute o f l i m i ta ti o ns a nd the c l as s’ s i nabi l i tyt o s ho w l o ss c au sa ti o n. Se e D ura Phar m ac e ut i ca l s , Inc . v. Br oudo , 544 U
. S. 336 (2005). F a i l u r e t o s h o w ma t e r i a l i t y ma y b e a n o th e r p r o b l e m; we n ee d n otd ec id e. T h e jud gm en t o f th e d ist ric t c ou rtis AFFI RMED .

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