In the

United States Court of Appeals

For the Seventh Circuit

____________

Nos. 04-1495, 04-1496, 04-1608, 04-1628, 04-1650,

04-1651, 04-1660, 04-1661, 04-2162 & 04-2687

CARL KIRCHER and ROBERT BROCKWAY,

individually and on behalf of a class, et al.,

Plaintiffs-Appellees,

v.

PUTNAM FUNDS TRUST and PUTNAM

INVESTMENT MANAGEMENT, LLC, et al.,

Defendants-Appellants.

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Appeals from the United States District Court

for the Southern District of Illinois.

Nos. 03-CV-0691-DRH et al.—G. Patrick Murphy, Chief Judge,

and David R. Herndon and Michael J. Reagan, Judges.

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ARGUED JANUARY 7, 2005—DECIDED APRIL 5, 2005

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Before EASTERBROOK, RIPPLE, and WOOD, Circuit Judges.

EASTERBROOK, Circuit Judge. Complaints filed in the

circuit court of Madison County, Illinois, charge several

mutual funds with setting prices in a way that arbitrageurs

can exploit. The funds removed the suits to federal court

and asked the district judges to dismiss them under the

Securities Litigation Uniform Standards Act of 1998
2 Nos. 04-1495, et al.

(SLUSA). Instead the federal judges remanded each suit.

Last year we held that these remands are appealable. See

Kircher v. Putnam Funds Trust, 373 F.3d 847 (7th Cir. 2004).

Now we must decide whether SLUSA blocks litigation in state

court. (Plaintiffs have asked us to overrule our decision about

appellate jurisdiction, but their arguments are unpersuasive.)

Mutual funds must set prices at which they sell and redeem their own shares once a day, and must do so at the net

asset value of the funds’ holdings. (All of the defendants,

which operate in interstate and international commerce, are

regulated under the Investment Company Act of 1940; we

call them “mutual funds” for convenience.) Each defendant

sets that price at 4 p.m. Eastern time, shortly after the New

York Stock Exchange closes. Orders placed before the close

of business that day are executed at this price.

When the funds hold assets that trade in competitive

markets, they must value the assets at their market price.

15 U.S.C. §80a-2(a)(41)(B)(ii), 17 C.F.R. §270.2a-4(a).

Defendants implement this requirement by valuing securities at the closing price of the principal exchange or market

in which the securities are traded. For domestic securities

this yields a current price; for securities of foreign issuers,

however, it may produce a price that is as much as 15 hours

old. (European markets close 5 or 6 hours ahead of New York;

Asian markets close 12 to 15 hours before New York.)

Many securities trade on multiple markets or over the

counter. Stock of a Japanese firm that closes in Tokyo at

¥10,000 might trade in Frankfurt at i75.22 (equivalent to

¥10,500) between the close in Tokyo and the close in

New York—but the mutual fund nonetheless would value

each share at ¥10,000, because that was its most recent

price in the issuer’s home market. If foreign stocks move

predominantly up during this interval (or if one foreign

security moves substantially higher), the mutual fund as a

whole would carry a 4 p.m. price below what would be
Nos. 04-1495, et al. 3

justified by the latest available information, and an arbitrageur could purchase shares before 4 p.m. with a plan to

sell the next day at a profit. Likewise arbitrageurs could

gain if the foreign stock falls after the close in its home

market, and the arbitrageur knows that the U.S. mutual

fund will be overpriced at 4 p.m. relative to the price it is

likely to have the next trading day when new information

from abroad finally is reflected in the fund’s valuation. See

Richard L. Levine, Yvonne Cristovici & Richard A. Jacobsen,

Mutual Fund Market Timing, Federal Lawyer 28 (Jan. 2005).

A short-swing-trading strategy would not be attractive

unless the foreign securities’ prices had moved enough to

cover the transactions costs of matched purchases and sales

of the mutual fund shares, but for no-load funds that have

substantial investments in foreign markets this condition

sometimes is satisfied. Arbitrageurs then make profits with

slight risk to themselves, diverting gains from the mutual

funds’ long-term investors while imposing higher administrative costs on the funds (whose operating expenses rise

with each purchase and redemption). Plaintiffs contend that

the mutual funds acted recklessly in failing to block

arbitrageurs from reaping these profits. Available means

might include levying fees on short-swing transactions,

adopting to a front-end-load charge, reducing the number of

trades any investor can execute (or deferring each trade by

one day), and valuing the securities of foreign issuers at the

most current price in any competitive market (organized or

over the counter), and not just the closing price on the

issuers’ home stock exchanges. Some mutual funds have

begun to take steps to curtail arbitrage, while disclosing

residual vulnerabilities more prominently, but the litigation

targets those funds that have not done so (or targets the

period before a given fund acted).

SLUSA added to the Securities Act of 1933 and the

Securities Exchange Act of 1934 parallel provisions curtail-
4 Nos. 04-1495, et al.

ing certain class actions under state law. As in last year’s

jurisdictional opinion, we limit attention to §16 of the 1933

Act, 15 U.S.C. §77p, because the additions to the 1934 Act

are functionally identical. See 15 U.S.C. §78bb. As amended

by SLUSA, §77p(b) reads:

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—

(1) an untrue statement or omission of a material fact in connection with the purchase or sale

of a covered security; or

(2) that the defendant used or employed any

manipulative or deceptive device or contrivance

in connection with the purchase or sale of a

covered security.

Investments in mutual funds are “covered securities,” see

§77p(f)(3), and all of these suits are “covered class actions,”

see §77p(f)(2), because plaintiffs seek to represent more than

50 investors and each action is direct rather than derivative.

(Derivative proceedings are not “covered class actions”. See

§77p(f)(2)(B). See also Burks v. Lasker, 441 U.S. 471 (1979),

and Kamen v. Kemper Financial Services, Inc., 500 U.S. 90

(1991), which note that state-law derivative claims may proceed against federally regulated mutual funds.) Section 77p(d)

contains a number of additional exceptions, but plaintiffs do

not contend that any of them applies to these actions. Thus

everything turns on subsection (b), which forecloses a suit

based on state law in which a private class alleges “(1) an

untrue statement or omission of a material fact in connection with the purchase or sale of a covered security; or (2)

that the defendant used or employed any manipulative or

deceptive device or contrivance in connection with the

purchase or sale of a covered security.”
Nos. 04-1495, et al. 5

That familiar language comes from Rule 10b-5, 17 C.F.R.

§240.10b-5, which is based on §10(b) of the 1934 Act, 15

U.S.C. §78j(b). Rule 10b-5 reads:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality

of interstate commerce, or of the mails or of any

facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to

defraud,

(b) To make any untrue statement of a material

fact or to omit to state a material fact necessary

in order to make the statements made, in the

light of the circumstances under which they

were made, not misleading, or

(c) To engage in any act, practice, or course of

business which operates or would operate as a

fraud or deceit upon any person, in connection

with the purchase or sale of any security.

Every court of appeals to encounter SLUSA has held that its

language has the same scope as its antecedent in Rule 10b-5.

Dabit v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 395

F.3d 25, 34-36 (2d Cir. 2005); Rowinski v. Salomon Smith

Barney Inc., 2005 U.S. App. LEXIS 2660 at *11-12 (3d Cir.

Feb. 16, 2005); Green v. Ameritrade, Inc., 279 F.3d 590, 596-

97 (8th Cir. 2002); Falkowski v. Imation Corp., 309 F.3d

1123, 1131 (9th Cir. 2002), amended, 320 F.3d 905 (2003);

Riley v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 292 F.3d

1334, 1342-43 (11th Cir. 2002). We agree with this conclusion. SLUSA is designed to prevent plaintiffs from migrating

to state court in order to evade rules for federal securities

litigation in the Private Securities Litigation Reform Act of

1995. See Spielman v. Merrill Lynch, Pierce, Fenner &

Smith, Inc., 332 F.3d 116, 122-24 (2d Cir. 2003) (discussing

how PSLRA and SLUSA work). SLUSA can do its job only if sub-
6 Nos. 04-1495, et al.

section (b) covers those claims that engage Rule 10b-5 (and

thus come within the 1995 statute) if presented directly

under federal law; this is why SLUSA borrows the Rule’s

language. Unfortunately, however, the other circuits do not

agree among themselves (or with the SEC) what Rule 10b-5

itself means. The phrase “in connection with the purchase or

sale” of a security is the sticking point.

The Supreme Court held in Blue Chip Stamps v. Manor

Drug Stores, 421 U.S. 723 (1975), that investors who neither

purchase nor sell securities may not collect damages in private litigation under §10(b) and Rule 10b-5, even if failure

to purchase or sell was the result of fraud. Assuming that

SLUSA’s “in connection with” language means “able to

pursue a private right of action after Blue Chip Stamps,”

plaintiffs attempted to frame complaints that avoid any

allegations of purchase or sale. All but one of the classes is

defined as investors who held shares of a given mutual fund

between two specified dates. As an effort to evade SLUSA,

this class definition is a flop: some of the investors who held

shares during the class period must have purchased their

interest (or increased it) during that time; others, who owned

shares at the beginning of the period, undoubtedly sold some

or all of their investment during the window. Each of the

funds has substantial daily turnover, so the class of “all

holders” during even a single day contains many purchasers

and sellers. All of these class actions therefore must be

dismissed. (Plaintiffs do not contend that any other part of

SLUSA is pertinent; in particular, they did not argue in their

briefs—and did not maintain at oral argument despite the

court’s invitation—that their suits allege mismanagement

rather than deceit or manipulation. See Santa Fe Industries,

Inc. v. Green, 430 U.S. 462 (1977). Counsel for the plaintiffs

declined to explain how state law would support a direct

action that did not rely on deceit or manipulation. A claim

based on mismanagement likely would need to be cast as a

derivative action, which none of these suits purports to be.
Nos. 04-1495, et al. 7

Nor does any of the suits assert that a mutual fund broke

a promise, so that state contract law would supply a

remedy.)

The complaint in Spurgeon v. Pacific Life Insurance Co.

avoids this pitfall. It defines the class as all investors who

held the fund’s securities during a defined period and neither purchased nor sold shares during that period. Blue Chip

Stamps would prevent such a private action from proceeding under Rule 10b-5. Plaintiffs insist that any private action

that is untenable after Blue Chip Stamps also is unaffected

by SLUSA. The district judge, agreeing with this perspective,

remanded Spurgeon to state court.

An equation between SLUSA’s coverage and the scope of

private damages actions under Rule 10b-5 has the support

of the second circuit (Dabit), the eighth circuit (Green), and

the eleventh circuit (Riley). The ninth circuit (Falkowski),

by contrast, has written that coverage of SLUSA tracks the

coverage of §10(b) and Rule 10b-5 when enforced by public

plaintiffs (the SEC or a criminal prosecutor). The third circuit

(Rowinski) has reserved decision on this issue. The Securities

and Exchange Commission filed a brief in Dabit as amicus

curiae supporting the view that SLUSA tracks the full scope

of §10(b) and Rule 10b-5, not just their enforcement in private actions. The way the Spurgeon class has been defined

prevents us from following the third circuit’s path: we must

answer the question rather than postpone its resolution.

To say that SLUSA uses the same language as §10(b) and

Rule 10b-5 is pretty much to resolve the point. Section 10(b)

defines a federal crime, and it also permits the SEC to enforce the prohibition through administrative proceedings.

Invocation of this anti-fraud rule does not depend on proof

that the agency or United States purchased or sold securities; instead the “in connection with” language ensures that

the fraud occurs in securities transactions rather than some

other activity. See SEC v. Zandford, 535 U.S. 813, 821-22
8 Nos. 04-1495, et al.

(2002); Superintendent of Insurance v. Bankers Life &

Casualty Co., 404 U.S. 6, 12 (1971).

Blue Chip Stamps came out as it did not because §10(b)

and Rule 10b-5 are limited to situations in which the

plaintiff itself traded securities, but because a private right

of action to enforce these provisions is a judicial creation

and the Court wanted to confine these actions to situations

where litigation is apt to do more good than harm. The

Justices observed that anyone can say that a failure to trade

bore some relation to what the issuer did (or didn’t) disclose, but that judges and juries would have an exceedingly

hard time knowing whether a given counterfactual claim (“I

would have traded, if only . . .”) was honest. The Court

thought it best to limit private actions to harms arising out

of actual trading, which narrows the affected class and simplifies proof, while leaving other securities offenses to public

prosecutors.

Decisions since Blue Chip Stamps reiterate that it deals

with private actions alone and does not restrict coverage of

the statute and regulation. See United States v. O’Hagan,

521 U.S. 642, 664 (1997); Holmes v. SIPC, 503 U.S. 258, 284

(1992); United States v. Naftalin, 441 U.S. 768, 774 n.6

(1979). By depicting their classes as containing entirely

non-traders, plaintiffs do not take their claims outside

§10(b) and Rule 10b-5; instead they demonstrate only that

the claims must be left to public enforcement. It would be

more than a little strange if the Supreme Court’s decision

to block private litigation by non-traders became the opening by which that very litigation could be pursued under

state law, despite the judgment of Congress (reflected in

SLUSA) that securities class actions must proceed under

federal securities law or not at all. Blue Chip Stamps combined with SLUSA may mean that claims of the sort plaintiffs

want to pursue must be litigated as derivative actions or

committed to public prosecutors, but this is not a good reason to undercut the statutory language.
Nos. 04-1495, et al. 9

Could the SEC maintain an action under §10(b) and

Rule 10b-5 against municipal funds that fraudulently or

manipulatively increased investors’ exposure to arbitrage?

Suppose the funds stated in their prospectuses that they

took actions to prevent arbitrageurs from exploiting the fact

that each fund’s net asset value is calculated only once a

day. That statement, if false (and known to be so), could

support enforcement action, for the deceit would have occurred in connection with investors’ purchases of the funds’

securities. Similarly, if these funds had stated bluntly in

their prospectuses (or otherwise disclosed to investors) that

daily valuation left no-load funds exposed to short-swing

trading strategies, that revelation would have squelched

litigation of this kind.

These observations show that plaintiffs’ claims depend on

statements made or omitted in connection with their own

purchases of the funds’ securities. They could have brought

them directly under Rule 10b-5 in federal court (to the extent that the purchases occurred within the period of limitations). Indeed, most of the approximately 200 suits filed

against mutual funds in the last two years alleging that the

home-exchange-valuation rule can be exploited by arbitrageurs have been filed in federal court under Rule 10b-5.

Our plaintiffs’ effort to define non-purchaser-non-seller

classes is designed to evade PSLRA in order to litigate a securities class action in state court in the hope that a local

judge or jury may produce an idiosyncratic award. It is the

very sort of maneuver that SLUSA is designed to prevent.

We hold that SLUSA is as broad as §10(b) itself and that

limitations on private rights of action to enforce §10(b) and

Rule 10b-5 do not open the door to litigation about securities

transactions under state law. Plaintiffs’ claims are connected

to their own purchases of securities and thus are blocked by

SLUSA, whose preemptive effect is not confined to knocking

out state-law claims by investors who have winning federal

claims, as plaintiffs suppose. It covers both good and bad
10 Nos. 04-1495, et al.

securities claims—especially bad ones. The judgments of the

district courts are reversed, and the cases are remanded

with instructions to undo the remand orders and dismiss

plaintiffs’ state-law claims.

A true Copy:

Teste: 

 ________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit 

USCA-02-C-0072—4-5-05