Katz v. Gerardi: CAFA Trumps Anti-Removal Provisions of 1933 Act

In Katz v. Gerardi, 552 F.3d 558 (7th Cir. 2009), the Seventh U.S. Circuit Court of Appeals splits with the Ninth Circuit in determining that a securities class action can be removed to federal court under the Class Action Fairness Act of 2005 despite the anti-removal provisions of the Securities Act of 1933. Writing for the court, Judge Frank Easterbrook takes the Ninth Circuit to task for failing to properly read and apply the statutes at issue.

Background

Plaintiffs Jack Katz brought this securities class action in an Illinois state court against a real estate investment trust (the “REIT”), its partnership and managers, relating to the 2007 merger of the REIT with Tishman-Lehman Partnership. Katz was a holder of real estate security interests (“units”) in the REIT. With the impending merger, REIT investors were given the option of cashing out existing A-1 shares or converting them into shares in the new entity – neither of which, claimed Katz, provided the tax benefits of the original units.

Katz cashed out his shares then filed suit under the Securities Act of 1933 (the “1933 Act”), which provides a right of action only for purchasers of securities who were misled by falsehoods or omissions in a registration statement or prospectus. Katz claimed that he and the nationwide class he purported to represent were “purchasers” under the merger as defined by the “fundamental change doctrine” – Katz asserted that he had involuntarily “purchased” units in the new entity that were then converted to cash.

The defendants removed the suit to federal court under the Class Action Fairness Act of 2005 (CAFA), claiming minimal diversity, more than $5 million in controversy and more than 100 class members. The district court remanded the case to state court, however, finding that Section 22(a) of the 1933 Act prohibits removal of cases brought under that statute. The defendants appealed the district court’s order to remand the case.

Plaintiff’s “fundamental change” theory does not hold water

Judge Frank Easterbrook, writing for the Seventh Circuit panel, decimated Katz’s theory that he and the other class members could bring an action under the 1933 Act because they were “purchasers” under the “fundamental change doctrine.” Easterbrook points out that Katz and the other class members sold their REIT units for cash; they were not purchasers of anything. Katz v. Gerardi, 552 F.3d 558, 560 (7th Cir. 2009).

Easterbrook points out that Katz could have brought his suit under the Securities Exchange Act of 1934, which applies to both buyers and sellers, but the 1934 Act does not include the non-removal provision found in Section 22(a) of the 1933 Act. Id. Easterbrook made it clear that the court will not tolerate a parties’ use of rhetorical games and legal fictions to try to evade removal. Easterbrook wrote: “Using legally fictitious (and factually nonexistent) “new A-1Units” to nullify a legislative decision that only buyers have rights under the 1933 Act would be wholly unjustified.” Id.

The 1933 Act does not trump the right to remove under CAFA

The fact that Katz’ claim is not properly a 1933 Act claim, and therefore Katz cannot properly invoke the anti-removal provisions of that Act, would be enough to enable removal under CAFA. But the Circuit Court found that even if Katz had articulated a proper 1933 Act claim, the defendants still would have been able to remove the case under the CAFA.

Easterbrook recognized that Section 22(a) of the 1933 Act and the CAFA are in conflict, and that “one or the other must yield.” 552 F.3d at 561. Easterbrook cited the general rule that the older law yields to the newer law – and the 1933 Act is clearly older than the CAFA—but noted that both the district court and the Ninth Circuit, in its decision in Luther v. Countrywide Home Loans Servicing LP, 533 F.3d 1031 (9th Cir. 2008), determined that Section 22(a) of the 1933 Act trumps the CAFA because it is “more specific” than the CAFA. Both the district court and the 9th Circuit found that because Section 22(a) applies only to securities actions, whereas the CAFA applies to all civil actions, Section 22(a) is more specific and therefore prevails.

Judge Easterbrook found the Ninth Circuit and district court’s reasoning to be faulty and based on an erroneous reading of the statutes. First, he stated that the “canon favoring preservation of specific statutes arguably affected by newer, but more general, statutes works when one statute is a subset of the other.” 552 F.3d at 561.  However, he noted that Section 22(a) is not a subset of the CAFA – Section 22(a) applies to all securities actions of every type and size, while CAFA applies only to large, multi-state class actions. Id. Neither law is a subset of the other, so “the canon favoring the specific law over the general one won’t solve our problem.” Id. at 561-562.

Instead, Easterbrook pointed out that Section 1453(b) of the CAFA itself specifically states how it applies to securities actions – allowing removal of all securities class actions except those specifically identified in the statute. Id. at 562. Easterbrook criticized the Ninth Circuit for failing to recognize this language of the CAFA in Luther. Id. Although Katz tries to insist that his claim falls into one of the Section 1453(b) exceptions, thus preventing removal under the CAFA, the court is suspicious, because in making that argument, Katz seems to undermine his own reliance on the 1933 Act. Id. at 563. However, the 7th Circuit remanded the case for a determination of whether in fact Section 1453 prevents removal of Katz’ case. Id.

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