Kircher, Carl, et al. v. Putnam Funds Trust, et al. (06/15/2006)

Question presented: Whether a party may appeal a district judge's decision to remand a case to state court pursuant to the Securities Litigation Uniform Standards Act of 1998 (SLUSA)?

BY ANDREW HARMON, MEDILL NEWS SERVICE

In September 2003, Carl Kircher and Robert Brockway filed suit in state court in Illinois against several mutual funds, including Putnam Funds Trust and Evergreen International Trust, claiming that the funds had "diluted" their investments by failing to protect against the slick dealings of "arbitrageurs" who cost investors billions of dollars per year.

Here's how arbitrage works: Since the markets in New York, Tokyo, and other major financial centers close at different times throughout the day, the value of foreign securities is in a constant state of flux. A stock that closes at, say, an equivalent of $100 in London may close in New York at $102. Given that mutual funds are only valued once per day per market, prices may be "stale" within a matter of hours.

Therefore, an arbitrageur may buy a security at an artificially low price in one market and sell it a much higher price in another. Over time, this activity can lead to the devaluing of the stock portfolios held by millions of Americans. Kircher's case and suits filed by others encompassed more than 50 investors. They alleged that the mutual fund groups should have implemented rules to guard against arbitrageurs, including adding fees for "short-swing transactions" and valuing a foreign security's price for every market, not just the market of origin.

In response to the suits, the mutual funds petitioned to have the cases moved from Madison County, Ill., to a federal district court and dismissed under the Securities Litigation Uniformity Standards Act (SLUSA). Passed by Congress in 1998 to stem frivolous litigation, SLUSA blocks suits that allege manipulation "in connection with the sale or purchase" of a security.

The district judges in Illinois, however, remanded Kircher and seven other similar cases back to state court, finding that they lacked jurisdiction. Since Kircher's case involved mutual fund holders rather than purchasers and sellers, the courts ruled that the suit was not blocked by SLUSA.

The investment groups, which by then included Janus Investment Fund and Artisan Funds, appealed to the 7th Circuit Court of Appeals. In a previous decision the year before against Kircher, the 7th Circuit had held that an appeals court has the authority to review the remand orders of district courts. This time it was being asked if SLUSA blocks the litigation in state court.

On April 5, 2005, the 7th Circuit ruled again in favor of the mutual fund groups. In writing the opinion for the court, Judge Frank Easterbrook called the investors' effort to avoid SLUSA by claiming they were neither purchasers nor sellers during the period of time in question to be a "flop."

"[S]ome of the investors who held shares during the class period must have purchased [securities] during that time," Easterbrook wrote. "[O]thers, who owned shares at the beginning of the period, undoubtedly sold some of their investment during that window.

"Each of the funds has substantial daily turnover, so the class of ‘all holders' during even a single day contains many purchasers or sellers. All of these class actions therefore must be dismissed," he wrote.

Easterbrook also speculated that Kircher's motivation to pursue the suit in state court rested on "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," Easterbrook wrote.

The decision was consistent with those made in similar cases by the 3rd and 11th circuit courts.

Plaintiffs in another related case before the 7th Circuit, Spurgeon v. Pacific Life Company, attempted to avoid the trap that Kircher fell into. Unlike Kircher, the Spurgeon plaintiffs were a group of mutual fund holders that excluded any purchasers or sellers. Nevertheless, the 7th Circuit ruled in favor of the mutual fund company.

On Jan. 6, 2006, the U.S. Supreme Court accepted the case for review. However, the Court agreed to hear argument only on the question of whether or not federal appeals courts have the jurisdiction to review a district court's order to remand lawsuits to state court. The other question raised by Kircher — whether SLUSA prohibits securities holders from filing suit in state court — is addressed in a separate case on the Court's 2005-2006 docket, Merrill Lynch v. Dabit.

In Merrill, the 2nd Circuit Court of Appeals ruled in January 2005 that stockholders were not preempted by SLUSA from filing suit against brokerage firms that misrepresent or inflate stock values.

David C. Frederick, Kircher's attorney, says the authority of appeals courts to review remand orders denies "normal people affected by market timing a speedy resolution to their lawsuits."

Submitting an amicus, or "friend of the court" brief in support of Kircher, Harvard Law Professor Arthur R. Miller and University of Mississippi Law Professor E. Farish Percy argued that in passing SLUSA, Congress did not intend to allow appeals courts to review a lower court's remand orders.

University of Cincinnati Law Professor Donna Nagy says that if the Court upholds the 7th Circuit ruling, investors will have little recourse against companies who mismanage their mutual funds, should remands be under appellate review.

"The fact is that because of federal limitations, these investors have no real federal avenue," Nagy said.

On the other hand, Nagy says that a victory for Kircher could open the floodgates for frivolous class action suits against mutual funds which would lack the uniforms standards that SLUSA was designed to create. A securities suit filed in Illinois, for example, may have a completely different outcome than one filed in New York or California.

On June 15, 2006, the Court sided 9-0 with Kircher, concluding that the mutual funds may not appeal the district judge's decision to remand the case to state court pursuant to the SLUSA.

Writing for the Court, Justice David Souter concluded that section 1447(d) applies to all remands, including cases removed under the general removal statute, "1441.