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Kurz v. Fidelity Management & Research Co.

October 30, 2007


The opinion of the court was delivered by: Gilbert, District Judge


This matter is before the Court on preliminary review of the allegations of federal subject matter jurisdiction contained in the notice of removal filed by the defendants Fidelity Management & Research Company ("Fidelity") and FMR Co., Inc. ("FMR"). See Cox v. Strauch, Civil No. 07-680-GPM, 2007 WL 2915593, at *1 (S.D. Ill. Oct. 5, 2007) (reviewing sua sponte the allegations of federal subject matter jurisdiction contained in a defendant's notice of removal); Board of Educ. of Decatur Sch. Dist. No. 61 v. Rainbow/Push Coal., 75 F. Supp. 2d 916, 918 (C.D. Ill. 1999) (citing Wisconsin Knife Works v. National Metal Crafters, 781 F.2d 1280, 1282 (7th Cir. 1986)) (same); Waymar Med., Inc. v. American Med. Elecs., Inc., 786 F. Supp. 754, 755 (E.D. Wis. 1992) (same). For the following reasons, the plaintiffs David Kurz and Raymond Heinzl are hereby ORDERED TO SHOW CAUSE why this action should not be dismissed pursuant to the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), Pub. L. 105-353, 112 Stat. 3227 (codified at 15 U.S.C. § 77p(b)-(f) and 15 U.S.C. § 78bb(f)).

I. Background

This action is the successor to Kurz v. Fidelity Management & Research Co., Civil No. 07-592-JPG (S.D. Ill. filed Aug. 17, 2007), in which Kurz alleged federal subject matter jurisdiction on the basis of 28 U.S.C. § 1332, as amended by the Class Action Fairness Act of 2005 ("CAFA"), Pub. L. No. 109-2, 119 Stat. 4 (codified in scattered sections of 28 U.S.C.). See Kurz v. Fidelity Mgmt. & Research Co., No. 07-cv-592-JPG, 2007 WL 2746612, at *2 (S.D. Ill. Sept. 18, 2007); Kurz v. Fidelity Mgmt. & Research Co., No. 07-cv-592-JPG, 2007 WL 2746612, at *1 (S.D. Ill. Sept. 18, 2007). Thereafter, the Court ordered Kurz to show cause why this action should not be dismissed for lack of federal subject matter jurisdiction pursuant to 28 U.S.C. § 1332(d)(9)(A) and (C), the so-called "securities exception" to federal diversity jurisdiction under CAFA. See Kurz, 2007 WL 2746612, at **2-4. See also Davis v. Chase Bank U.S.A., N.A., 453 F. Supp. 2d 1205, 1207-08 (C.D. Cal. 2006). The Court further directed Kurz to show cause whether, if federal subject matter jurisdiction did not exist in Case No. 07-592 under CAFA, such jurisdiction nonetheless was proper pursuant to SLUSA. See Kurz, 2007 WL 2746612, at *4. Kurz then voluntarily dismissed Case No. 07-592 by notice pursuant to Rule 41(a)(1)(i) of the Federal Rules of Civil Procedure. See Kurz v. Fidelity Mgmt. & Research Co., No. 07-CV-592-JPG, 2007 WL 2908918 (S.D. Ill. Oct. 4, 2007).

Following the voluntary dismissal of Case No. 07-592, Kurz refiled his claims in the Circuit Court of the Twentieth Judicial Circuit, St. Clair County, Illinois, joining Heinzl as a party plaintiff. The case was timely removed from state court to this Court, with federal subject matter jurisdiction asserted on the basis of 28 U.S.C. § 1331, including SLUSA. After removal, this case was assigned initially to United States District Judge G. Patrick Murphy. However, in conformity with the Court's policy that related cases -- in this instance, Case No. 07-592 and this case -- should be concentrated before the same judge, see Vogel v. Merck & Co., 476 F. Supp. 2d 996, 998 (S.D. Ill. 2007), the case subsequently was reassigned to the undersigned United States District Judge for all further proceedings.

The gravamen of the claims asserted by Kurz and Heinzl has been outlined by the Court in a previous order in Case No. 07-592, see Kurz, 2007 WL 2746612, at **1-2, but bears some repeating here. Kurz and Heinzl allege that they are former investors in investment portfolios managed by Fidelity and FMR, who are alleged to be registered investment advisers or affiliated persons of such advisers. See 15 U.S.C. § 80b-2(a)(11), (a)(12); 15 U.S.C. § 80b-3. Kurz and Heinzl allege that Fidelity and FMR entered into confirmation agreements with securities brokers executing portfolio transactions directed by the defendants, and that an implied term of those agreements were rules of the National Association of Securities Dealers ("NASD") and the New York Stock Exchange ("NYSE") requiring investment advisers to obtain "best execution" for their customers in executing portfolio transactions for those customers. This duty of best execution, according to the complaint, "required Fidelity and FMR to choose execution brokers on the basis of the most favorable practicable execution costs, taking into consideration the size of each transaction, the number of transactions per year, the market impact of the transaction, brokerage commissions, services provided by the broker, and other considerations." Complaint ¶ 10. Kurz and Heinzl allege that the agreements imposed on Fidelity and FMR a contractual duty of best execution enforceable by the defendants' customers.

Kurz and Heinzl allege that Fidelity and FMR breached their contractual duty by retaining Jeffries & Co. ("Jeffries") to execute portfolio transactions for the defendants' customers in return for lavish gifts to the defendants' traders from Jeffries. According to the complaint, as redress for this breach of the duty of best execution, the chairman of Fidelity's board of trustees E.C. Johnson, III, agreed to pay $42 million plus interest to Fidelity's family of mutual funds. Kurz and Heinzl assert claims for breach of contract against Fidelity and FMR based on the defendants' alleged violations of their duty of best execution as contained in the agreements. The plaintiffs seek to represent a class of persons who were clients of Fidelity and FMR from May 1, 2002, until October 31, 2004, and who liquidated their investments and/or terminated their management agreements with the defendants before December 21, 2006, and whose investment portfolios included at least one transaction in which the defendants used Jeffries as the executing broker.

II. Discussion

A. Federal Question Jurisdiction

Under 28 U.S.C. § 1441, "any civil action brought in a State court of which the district courts of the United States have original jurisdiction, may be removed by the defendant or the defendants, to the district court of the United States for the district and division embracing the place where such action is pending." 28 U.S.C. § 1441(a). In general, of course, federal courts have "original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States." 28 U.S.C. § 1331. As noted, the asserted basis for federal subject matter jurisdiction in this case is Section 1331. The usual test of whether an action arises under federal law for purposes of so-called "federal question" jurisdiction pursuant to Section 1331 is the "well-pleaded complaint" rule, which provides generally that a case arises under federal law within the meaning of the statute only when federal law appears on the face of a plaintiff's complaint. See Caterpillar Inc. v. Williams, 482 U.S. 386, 392 (1987); Louisville & Nashville R.R. Co. v. Mottley, 211 U.S. 149, 152-53 (1908); Rice v. Panchal, 65 F.3d 637, 639 (7th Cir. 1995). As Justice Holmes explained, "A suit arises under the law that creates the cause of action." American Well Works Co. v. Layne & Bowler Co., 241 U.S. 257, 260 (1916). See also In re Application of County Collector of Winnebago County, Ill., 96 F.3d 890, 895 (7th Cir. 1996); Clevenger v. Eastman Chem. Co., No. 07-cv-148-DRH, 2007 WL 2458474, at *2 (S.D. Ill. Aug. 24, 2007); Kuntz v. Illinois Cent. R.R. Co., 469 F. Supp. 2d 586, 589 (S.D. Ill. 2007). In this instance, as discussed, Kurz and Heinzl allege only state-law claims for breach of contract. However, that is not quite the end of the matter, in light of certain recognized exceptions to the well-pleaded complaint rule, specifically, the doctrine of a "substantial federal question" and the doctrine of "complete preemption," both of which are discussed infra.

1. Substantial Federal Question

The substantial federal question doctrine provides generally that "[e]ven though state law creates [a plaintiff's] cause of action, [the] case still might 'arise under' the laws of the United States if a well-pleaded complaint established that its right to relief under state law requires resolution of a substantial question of federal law in dispute between the parties." Franchise Tax Bd. of Cal. v. Construction Laborers Vacation Trust for S. Cal., 463 U.S. 1, 13 (1983). See also Gully v. First Nat'l Bank, 299 U.S. 109, 112-13 (1936); Smith v. Kansas City Title & Trust Co., 255 U.S. 180, 195-99 (1921); International Armor & Limousine Co. v. Moloney Coachbuilders, Inc., 272 F.3d 912, 915 (7th Cir. 2001); Kuntz, 469 F. Supp. 2d at 594-95. In this instance Fidelity and FMR argue that this case presents a substantial question of federal law because the duty of best execution they are alleged to have breached is a creature of federal law, and because resolution of this case necessarily will entail the construction of federal securities laws and regulations promulgated thereunder. However, the Court is not persuaded that this case comes within the scope of the substantial federal question doctrine for purposes of removal to federal court.

The duty of best execution, although extensively codified in federal law governing securities, originates in familiar common-law principles of agency. In Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266 (3d Cir. 1998), the court explained:

The duty of best execution, which predates the federal securities laws, has its roots in the common law agency obligations of undivided loyalty and reasonable care that an agent owes to his principal . . . . Since it is understood by all that the client-principal seeks his own economic gain and the purpose of the agency is to help the client-principal achieve that objective, the broker-dealer, absent instructions to the contrary, is expected to use reasonable efforts to maximize the economic benefit to the client in each transaction.

The duty of best execution thus requires that a broker-dealer seek to obtain for its customer orders the most favorable terms reasonably available under the circumstances.

Id. at 270 (collecting cases). See also Zannini v. Ameritrade Holding Corp., 667 N.W.2d 222, 230-31 (Neb. 2003) (reversing a grant of summary judgment as to a claim that a broker violated its duty of best execution under state law); Restatement of Agency (Second) § 424 (1958) (stating that an agent must "use reasonable care to obtain terms which best satisfy the manifested purposes of the principal."); Francis J. Facciolo, A Broker's Duty of Best Execution in the Nineteenth and Early Twentieth Centuries, 26 Pace L. Rev. 155 (2005) (tracing the best execution obligation back to state law). As the Securities and Exchange Commission ("SEC") has recognized, the "duty of best execution derives from common law agency principles and fiduciary obligations, and is incorporated both in [self-regulating organization] rules and, through judicial and [SEC] decisions, in the antifraud provisions of the federal securities laws." Order Execution Obligations, Exchange Act Release No. 34-37619, 62 SEC Docket 1795, 1996 WL 493303, at *51 (Aug. 29, 1996). Thus, it is not the case that, as Fidelity and FMR assert in their notice of removal, a claim based on an agent's duty of best execution necessarily arises under federal law.

To the extent that federal law forms an element of the state-law claims asserted by Kurz and Heinzl, it is well settled that a claim for a violation of state law based upon a breach of a duty created by federal law does not present a substantial federal question for purposes of federal question jurisdiction. As the Supreme Court of the United States admonished recently, "[a] general rule of exercising federal jurisdiction over state claims resting on federal mislabeling and other statutory violations would . . . herald[ ] a potentially enormous shift of traditionally state cases into federal courts." Grable & Sons Metal Prods., Inc. v. Darue Eng'g & Mfg., 545 U.S. 308, 319 (2005) (citing Merrell Dow Pharms. Inc. v. Thompson, 478 U.S. 804, 811-12 (1986)). Accordingly, federal courts must be cautious in entertaining "state claims with embedded federal issues" lest they "materially affect, or threaten to affect, the normal currents of litigation" as between federal and state courts. Id. at 318, 319. See also Bennett v. Southwest Airlines Co., 484 F.3d 907, 908-12 (7th Cir. 2007) (holding that state-law negligence claims did not present a substantial federal question, although some of the applicable standards of care were furnished by regulations promulgated by the Federal Aviation Administration); Vivas v. Boeing Co., 486 F. Supp. 2d 726, 729-32 (N.D. Ill. 2007) (holding that products liability and negligence claims arising out of an airplane crash during a landing approach were not removable on the basis of federal question jurisdiction, notwithstanding the fact that federal law and regulations concerning airplane safety set the standard of care for the state-law claims); Fuller v. BNSF Ry. Co., 472 F. Supp. 2d 1088, 1095 (S.D. Ill. 2007) (allegations of negligence based upon a defendant's violation of federal railroad safety regulations did not present ...

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