“Naked short cases have been slaughtered in federal courts,” Aguirre said. “Now there’s a crack in the door. But plaintiff lawyers will have to do a lot of creative designing in state courts to open it further.”
Bank of America Merrill Lynch said it believes the underlying lawsuit is without merit. “We will defend against the substantive allegations in state court where we already have filed for dismissal,” said spokesman Lawrence Grayson.
In the suit, filed four years ago, investors in Spectrum Group International Inc. -- a dealer of precious metals and collectibles formerly known as Escala Group Inc. -- blame Merrill Lynch and other brokerages for helping to drive down the company’s market capitalization by $800 million over 11 months by aiding naked short sellers whose bets against the company pushed down the value of its shares.
A short sale is a way of using borrowed shares to bet that a stock or other security will fall in price; in a naked short, the trader never borrows the shares needed to complete the transactions.
The Securities and Exchange Commission’s Regulation SHO seeks to restrict investors’ ability to short stocks that haven’t been borrowed, in order to restrict the supply and prevent price manipulation.
Narrow and Technical
While that regulation makes it illegal to use naked short sales to manipulate a security, cases against the practice haven’t fared well in federal court, attorneys said. That’s in part because the Supreme Court has required plaintiffs in federal court to cite specific statutes that they believe have been violated, Wharton’s Zaring said.
Under the Supreme Court’s latest ruling, plaintiff attorneys would still have to bring suits in jurisdictions with applicable anti-fraud or securities laws -- which also include California and Georgia -- and avoid conflicts with federal statutes, Aguirre said.
The case is Merrill Lynch v. Manning, 14-1132.