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News January 17, 2005 Issue

Merely Holding Securities Doesn’t Satisfy ‘In Connection With’ Standard

For the first time, the Second Circuit has addressed the question of whether merely holding securities satisfies the "in connection with" standard in the Securities Litigation Uniform Standards Act of 1998. The short answer: it doesn’t. But even if a plaintiff’s complaint doesn’t allege that plaintiff bought or sold securities, the court will look to the facts to see whether the plaintiff (or class members) might include those who have.

The question raised before the U.S. Court of Appeals for the Second Circuit in Dabit v. Merrill Lynch: do claims based on the mere "holding" of securities satisfy SLUSA’s "in connection with the purchase or sale" of a security standard? Defendant Merrill Lynch hoped the answer was yes: if so, SLUSA would preempt the state class action, requiring it to be brought in federal court with its tougher pleading standards for securities plaintiffs.

The case stemmed from Merrill’s allegedly misleading research reports. The plaintiffs, however, were careful not to allege that they suffered harm as a result of buying or selling stock in reliance on Merrill’s research reports. Rather, they claimed that they suffered harm because the research reports induced them to hold onto the stock, when they might have otherwise sold.

The court didn’t buy it.

First, the court held that phrase "in connection with the purchase or sale of a . . . security" in SLUSA should be interpreted the same as it is under Exchange Act Section 10(b) and Rule 10b-5. And there, they noted, the strict test was whether the plaintiff purchased or sold the securities.

However, the court went on to find that although plaintiffs were careful to discuss only the retention of securities, rather than purchases or sales, the complaint’s definition of the class swept in individuals who had purchased or sold securities on reliance on Merrill’s research reports. The court dismissed the portions of the plaintiffs’ cases that did not distinguish between class members who were simply "holders" during the class period and those that made purchases.