Avoiding the Inevitable: The Continuing Viability of State Law Claims in the Face of Primary Jurisdiction and Preemption Challenges under the Securities Exchange Act of 1934

151 Pages Posted: 15 Mar 2019 Last revised: 19 Jun 2019

See all articles by Francis (Jay) Facciolo

Francis (Jay) Facciolo

St. John's University School of Law

Richard L. Stone

Florida Atlantic University

Date Written: January 1, 1995

Abstract

Primary jurisdiction is a judicially created doctrine pursuant to which a court may elect to defer consideration of a complex case pending disposition of a salient issue in that case by an appropriate administrative or regulatory body. The result is not to remove the courts totally from the process but rather to allocate the initial decision to an agency, subject to a subsequent judicial review. The doctrine of primary jurisdiction is applied by a court to temporarily stay proceedings in cases where there is a precise legal issue that can be effectively addressed by the agency and a prescribed method exists for the agency to address the issue. Primary jurisdiction arises in securities litigation when allegedly complicated securities practices regulated by the Securities and Exchange Commission (the "SEC") are subject to judicial scrutiny.

Preemption issues arise in securities litigation when conduct that is either explicitly or implicitly regulated by the federal securities laws is the basis of alleged violations of state law. Although there are some common policies underlying these two sets of issues, e.g., uniformity in the application of law, two distinct theories are involved: Primary jurisdiction is a matter of administrative law and judicial economy; preemption is a matter of constitutional law involving the validity of state law. As many of the preemption cases involving the securities industry have arisen under the Securities Exchange Act of 1934 (the "Exchange Act"), this article focuses upon caselaw involving the Exchange Act. The Exchange Act generally regulates securities trading on domestic securities exchanges and in the over-the-counter market, as well as the operation of broker-dealers.

The doctrines of preemption and, to a lesser extent, primary jurisdiction have immense importance in securities litigation and, except in limited contexts, have not been thoroughly analyzed. This lack of analysis in the preemption context reflects the courts' acceptance of the historical coexistence of federal and state securities claims arising out of the same factual predicate. Thus, it is commonplace in federal court to plead federal fraud claims pursuant to section 10(b) of the Exchange Act along with state fraud claims, state breach of contract claims, and state negligence claims, without ever facing the issue of preemption. Primary jurisdiction issues have been infrequently litigated because most securities claims involving fraud and misrepresentation do not present the complex issues appropriate for the application of primary jurisdiction.

In the last several years, however, there have been several class action lawsuits challenging certain industry-wide practices that were arguably consistent with federal law but that were subject to attack under various state fraud statutes and state common law doctrines. The prospect of industry participants complying with federal securities law and SEC rules and regulations, while remaining subject to challenge under state common law and statutory schemes, has focused judicial attention upon preemption and primary jurisdiction issues.

To date, there has been extensive caselaw involving preemption and the Exchange Act only in limited areas; there has been almost no caselaw on primary jurisdiction under the Exchange Act. This article discusses these issues in the context of the payment for order flow cases. In the seven ongoing payment for order flow cases, currently pending in state courts in Illinois, Louisiana, Maryland, Minnesota, and New York, the plaintiffs have challenged the practice of certain broker-dealers (such as market makers, wholesale firms, and regional specialists) that make monetary and non-monetary payments to retail brokers, particularly discount brokers, for the purpose of inducting the defendant retail brokers to send orders to the market makers for execution. The payment for order flow cases provide a good way to examine the preemption and primary jurisdiction issues, in part because they directly address these issues, especially preemption, in a developing body of caselaw, albeit primarily unpublished caselaw.

Preemption challenges to the application of state law are often raised in conjunction with Commerce Clause challenges to the same state action. The preemption argument arises from the existence of federal legislative or regulatory activity within the area of alleged federal law/state law conflict, while the Commerce Clause argument arises from alleged burdens imposed by the state action on interstate commerce "even absent congressional action." Of the two normally invoked constitutional bases for refusing to apply state law in the securities regulation context (the Commerce Clause and the Supremacy Clause), the Supremacy Clause is almost always relevant in cases involving the federal securities claims because of the existence of the federal securities laws. The Commerce Clause is applied less frequently.

This article first examines preemption, concluding that state law is rarely preempted pursuant to the Exchange Act because a clear intent to preempt state law cannot be found in the Exchange Act, which in fact expressly preserves the continued application of state law in section 28(a), and because direct conflicts between state and federal law in the securities area are infrequent. This conclusion is strengthened by the fact that state statutes and common law that augment federal law or provide additional claims or remedies for actions that also violate federal securities laws are not, under enunciated preemption standards, preempted by the Exchange Act. This article then examines primary jurisdiction, concluding that primary jurisdiction should have little application in the securities context because of the substantial judicial experience with the application of the federal securities laws and the SEC's active policy of intervening as an amicus curiae in securities cases to advise the courts.

Suggested Citation

Facciolo, Francis and Stone, Richard L., Avoiding the Inevitable: The Continuing Viability of State Law Claims in the Face of Primary Jurisdiction and Preemption Challenges under the Securities Exchange Act of 1934 (January 1, 1995). Columbia Business Law Review, Vol. 1995, Issue 3, (1995), St. John's Legal Studies Research Paper No. 19-0010, Available at SSRN: https://ssrn.com/abstract=3352873

Francis Facciolo (Contact Author)

St. John's University School of Law ( email )

8000 Utopia Parkway
Jamaica, NY 11439
United States
7189901832 (Phone)
7185911855 (Fax)

HOME PAGE: http://www.stjohns.edu/law

Richard L. Stone

Florida Atlantic University ( email )

Boca Raton, FL 33431
United States

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