04-1608, 04-1628, 04-1650, 04-1651, 04-1660, 04-1661, 04-2162 & 04-2687 Carl Kircher v. PUTNAM FUNDS TRUST and PUTNAM INVESTMENT MANAGEMENT , LLC

In the
United States Court of Appeals
For the Seventh Circuit
____________
Nos. 04-1495, 04-1496, 04-1608, 04-1628, 04-1650,
04-1651, 04-1660, 04-1661, 04-2162 & 04-2687
C ARL K IRCHER and R OBERT B ROCKWAY ,
individually and on behalf of a class, et al.,
Plaintiffs-Appellees,
v.
P UTNAM F UNDS T RUST and P UTNAM
I NVESTMENT M ANAGEMENT , LLC , et al.,
Defendants-Appellants.
____________
Appeals from the United States District Court
for the Southern District of Illinois.
Nos. 03-CV-0691-DRH et al.—G. Patrick Murphy, Chief Judge,
and David R. Herndon and Michael J. Reagan, Judges.
____________
A RGUED J ANUARY 7, 2005—D ECIDED A PRIL 5, 2005
____________
Before E ASTERBROOK , R IPPLE , and W OOD , Circuit Judges.
E ASTERBROOK , Circuit Judge. Complaints filed in the
circuit court of Madison County, Illinois, charge several
mutual funds with setting prices in a way that arbitrageurs
can exploit. The funds removed the suits to federal court
and asked the district judges to dismiss them under the
Securities Litigation Uniform Standards Act of 1998

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2 Nos. 04-1495, et al.
( SLUSA ). Instead the federal judges remanded each suit.
Last year we held that these remands are appealable. See
Kircher v. Putnam Funds Trust, 373 F.3d 847 (7th Cir. 2004).
Now we must decide whether SLUSA blocks litigation in state
court. (Plaintiffs have asked us to overrule our decision about
appellate jurisdiction, but their arguments are unpersuasive.)
Mutual funds must set prices at which they sell and re-
deem their own shares once a day, and must do so at the net
asset value of the funds’ holdings. (All of the defendants,
which operate in interstate and international commerce, are
regulated under the Investment Company Act of 1940; we
call them “mutual funds” for convenience.) Each defendant
sets that price at 4 p.m. Eastern time, shortly after the New
York Stock Exchange closes. Orders placed before the close
of business that day are executed at this price.
When the funds hold assets that trade in competitive
markets, they must value the assets at their market price.
15 U.S.C. §80a-2(a)(41)(B)(ii), 17 C.F.R. §270.2a-4(a).
Defendants implement this requirement by valuing secur-
ities at the closing price of the principal exchange or market
in which the securities are traded. For domestic securities
this yields a current price; for securities of foreign issuers,
however, it may produce a price that is as much as 15 hours
old. (European markets close 5 or 6 hours ahead of New York;
Asian markets close 12 to 15 hours before New York.)
Many securities trade on multiple markets or over the
counter. Stock of a Japanese firm that closes in Tokyo at
¥10,000 might trade in Frankfurt at i75.22 (equivalent to
¥10,500) between the close in Tokyo and the close in
New York—but the mutual fund nonetheless would value
each share at ¥10,000, because that was its most recent
price in the issuer’s home market. If foreign stocks move
predominantly up during this interval (or if one foreign
security moves substantially higher), the mutual fund as a
whole would carry a 4 p.m. price below what would be

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Nos. 04-1495, et al. 3
justified by the latest available information, and an arbi-
trageur could purchase shares before 4 p.m. with a plan to
sell the next day at a profit. Likewise arbitrageurs could
gain if the foreign stock falls after the close in its home
market, and the arbitrageur knows that the U.S. mutual
fund will be overpriced at 4 p.m. relative to the price it is
likely to have the next trading day when new information
from abroad finally is reflected in the fund’s valuation. See
Richard L. Levine, Yvonne Cristovici & Richard A. Jacobsen,
Mutual Fund Market Timing, Federal Lawyer 28 (Jan. 2005).
A short-swing-trading strategy would not be attractive
unless the foreign securities’ prices had moved enough to
cover the transactions costs of matched purchases and sales
of the mutual fund shares, but for no-load funds that have
substantial investments in foreign markets this condition
sometimes is satisfied. Arbitrageurs then make profits with
slight risk to themselves, diverting gains from the mutual
funds’ long-term investors while imposing higher adminis-
trative costs on the funds (whose operating expenses rise
with each purchase and redemption). Plaintiffs contend that
the mutual funds acted recklessly in failing to block
arbitrageurs from reaping these profits. Available means
might include levying fees on short-swing transactions,
adopting to a front-end-load charge, reducing the number of
trades any investor can execute (or deferring each trade by
one day), and valuing the securities of foreign issuers at the
most current price in any competitive market (organized or
over the counter), and not just the closing price on the
issuers’ home stock exchanges. Some mutual funds have
begun to take steps to curtail arbitrage, while disclosing
residual vulnerabilities more prominently, but the litigation
targets those funds that have not done so (or targets the
period before a given fund acted).
S LUSA added to the Securities Act of 1933 and the
Securities Exchange Act of 1934 parallel provisions curtail-

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4 Nos. 04-1495, et al.
ing certain class actions under state law. As in last year’s
jurisdictional opinion, we limit attention to §16 of the 1933
Act, 15 U.S.C. §77p, because the additions to the 1934 Act
are functionally identical. See 15 U.S.C. §78bb. As amended
by SLUSA , §77p(b) reads:
No covered class action based upon the statutory or
common law of any State or subdivision thereof
may be maintained in any State or Federal court by
any private party alleging—
(1) an untrue statement or omission of a mate-
rial fact in connection with the purchase or sale
of a covered security; or
(2) that the defendant used or employed any
manipulative or deceptive device or contrivance
in connection with the purchase or sale of a
covered security.
Investments in mutual funds are “covered securities,” see
§77p(f)(3), and all of these suits are “covered class actions,”
see §77p(f)(2), because plaintiffs seek to represent more than
50 investors and each action is direct rather than derivative.
(Derivative proceedings are not “covered class actions”. See
§77p(f)(2)(B). See also Burks v. Lasker, 441 U.S. 471 (1979),
and Kamen v. Kemper Financial Services, Inc., 500 U.S. 90
(1991), which note that state-law derivative claims may pro-
ceed against federally regulated mutual funds.) Section 77p(d)
contains a number of additional exceptions, but plaintiffs do
not contend that any of them applies to these actions. Thus
everything turns on subsection (b), which forecloses a suit
based on state law in which a private class alleges “(1) an
untrue statement or omission of a material fact in connec-
tion with the purchase or sale of a covered security; or (2)
that the defendant used or employed any manipulative or
deceptive device or contrivance in connection with the
purchase or sale of a covered security.”

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Nos. 04-1495, et al. 5
That familiar language comes from Rule 10b-5, 17 C.F.R.
§240.10b-5, which is based on §10(b) of the 1934 Act, 15
U.S.C. §78j(b). Rule 10b-5 reads:
It shall be unlawful for any person, directly or in-
directly, by the use of any means or instrumentality
of interstate commerce, or of the mails or of any
facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to
defraud,
(b) To make any untrue statement of a material
fact or to omit to state a material fact necessary
in order to make the statements made, in the
light of the circumstances under which they
were made, not misleading, or
(c) To engage in any act, practice, or course of
business which operates or would operate as a
fraud or deceit upon any person, in connection
with the purchase or sale of any security.
Every court of appeals to encounter SLUSA has held that its
language has the same scope as its antecedent in Rule 10b-5.
Dabit v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 395
F.3d 25, 34-36 (2d Cir. 2005); Rowinski v. Salomon Smith
Barney Inc., 2005 U.S. App. L EXIS 2660 at *11-12 (3d Cir.
Feb. 16, 2005); Green v. Ameritrade, Inc., 279 F.3d 590, 596-
97 (8th Cir. 2002); Falkowski v. Imation Corp., 309 F.3d
1123, 1131 (9th Cir. 2002), amended, 320 F.3d 905 (2003);
Riley v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 292 F.3d
1334, 1342-43 (11th Cir. 2002). We agree with this conclu-
sion. SLUSA is designed to prevent plaintiffs from migrating
to state court in order to evade rules for federal securities
litigation in the Private Securities Litigation Reform Act of
1995. See Spielman v. Merrill Lynch, Pierce, Fenner &
Smith, Inc., 332 F.3d 116, 122-24 (2d Cir. 2003) (discussing
how PSLRA and SLUSA work). SLUSA can do its job only if sub-

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6 Nos. 04-1495, et al.
section (b) covers those claims that engage Rule 10b-5 (and
thus come within the 1995 statute) if presented directly
under federal law; this is why SLUSA borrows the Rule’s
language. Unfortunately, however, the other circuits do not
agree among themselves (or with the SEC ) what Rule 10b-5
itself means. The phrase “in connection with the purchase or
sale” of a security is the sticking point.
The Supreme Court held in Blue Chip Stamps v. Manor
Drug Stores, 421 U.S. 723 (1975), that investors who neither
purchase nor sell securities may not collect damages in pri-
vate litigation under §10(b) and Rule 10b-5, even if failure
to purchase or sell was the result of fraud. Assuming that
SLUSA ’s “in connection with” language means “able to
pursue a private right of action after Blue Chip Stamps,”
plaintiffs attempted to frame complaints that avoid any
allegations of purchase or sale. All but one of the classes is
defined as investors who held shares of a given mutual fund
between two specified dates. As an effort to evade SLUSA ,
this class definition is a flop: some of the investors who held
shares during the class period must have purchased their
interest (or increased it) during that time; others, who owned
shares at the beginning of the period, undoubtedly sold some
or all of their investment during the window. Each of the
funds has substantial daily turnover, so the class of “all
holders” during even a single day contains many purchasers
and sellers. All of these class actions therefore must be
dismissed. (Plaintiffs do not contend that any other part of
SLUSA is pertinent; in particular, they did not argue in their
briefs—and did not maintain at oral argument despite the
court’s invitation—that their suits allege mismanagement
rather than deceit or manipulation. See Santa Fe Industries,
Inc. v. Green, 430 U.S. 462 (1977). Counsel for the plaintiffs
declined to explain how state law would support a direct
action that did not rely on deceit or manipulation. A claim
based on mismanagement likely would need to be cast as a
derivative action, which none of these suits purports to be.

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Nos. 04-1495, et al. 7
Nor does any of the suits assert that a mutual fund broke
a promise, so that state contract law would supply a
remedy.)
The complaint in Spurgeon v. Pacific Life Insurance Co.
avoids this pitfall. It defines the class as all investors who
held the fund’s securities during a defined period and nei-
ther purchased nor sold shares during that period. Blue Chip
Stamps would prevent such a private action from proceed-
ing under Rule 10b-5. Plaintiffs insist that any private action
that is untenable after Blue Chip Stamps also is unaffected
by SLUSA . The district judge, agreeing with this perspective,
remanded Spurgeon to state court.
An equation between SLUSA ’s coverage and the scope of
private damages actions under Rule 10b-5 has the support
of the second circuit (Dabit), the eighth circuit (Green), and
the eleventh circuit (Riley). The ninth circuit (Falkowski),
by contrast, has written that coverage of SLUSA tracks the
coverage of §10(b) and Rule 10b-5 when enforced by public
plaintiffs (the SEC or a criminal prosecutor). The third circuit
(Rowinski) has reserved decision on this issue. The Securities
and Exchange Commission filed a brief in Dabit as amicus
curiae supporting the view that SLUSA tracks the full scope
of §10(b) and Rule 10b-5, not just their enforcement in pri-
vate actions. The way the Spurgeon class has been defined
prevents us from following the third circuit’s path: we must
answer the question rather than postpone its resolution.
To say that SLUSA uses the same language as §10(b) and
Rule 10b-5 is pretty much to resolve the point. Section 10(b)
defines a federal crime, and it also permits the SEC to en-
force the prohibition through administrative proceedings.
Invocation of this anti-fraud rule does not depend on proof
that the agency or United States purchased or sold secur-
ities; instead the “in connection with” language ensures that
the fraud occurs in securities transactions rather than some
other activity. See SEC v. Zandford, 535 U.S. 813, 821-22

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8 Nos. 04-1495, et al.
(2002); Superintendent of Insurance v. Bankers Life &
Casualty Co., 404 U.S. 6, 12 (1971).
Blue Chip Stamps came out as it did not because §10(b)
and Rule 10b-5 are limited to situations in which the
plaintiff itself traded securities, but because a private right
of action to enforce these provisions is a judicial creation
and the Court wanted to confine these actions to situations
where litigation is apt to do more good than harm. The
Justices observed that anyone can say that a failure to trade
bore some relation to what the issuer did (or didn’t) dis-
close, but that judges and juries would have an exceedingly
hard time knowing whether a given counterfactual claim (“I
would have traded, if only . . .”) was honest. The Court
thought it best to limit private actions to harms arising out
of actual trading, which narrows the affected class and sim-
plifies proof, while leaving other securities offenses to public
prosecutors.
Decisions since Blue Chip Stamps reiterate that it deals
with private actions alone and does not restrict coverage of
the statute and regulation. See United States v. O’Hagan,
521 U.S. 642, 664 (1997); Holmes v. SIPC, 503 U.S. 258, 284
(1992); United States v. Naftalin, 441 U.S. 768, 774 n.6
(1979). By depicting their classes as containing entirely
non-traders, plaintiffs do not take their claims outside
§10(b) and Rule 10b-5; instead they demonstrate only that
the claims must be left to public enforcement. It would be
more than a little strange if the Supreme Court’s decision
to block private litigation by non-traders became the open-
ing by which that very litigation could be pursued under
state law, despite the judgment of Congress (reflected in
SLUSA ) that securities class actions must proceed under
federal securities law or not at all. Blue Chip Stamps com-
bined with SLUSA may mean that claims of the sort plaintiffs
want to pursue must be litigated as derivative actions or
committed to public prosecutors, but this is not a good rea-
son to undercut the statutory language.

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Nos. 04-1495, et al. 9
Could the SEC maintain an action under §10(b) and
Rule 10b-5 against municipal funds that fraudulently or
manipulatively increased investors’ exposure to arbitrage?
Suppose the funds stated in their prospectuses that they
took actions to prevent arbitrageurs from exploiting the fact
that each fund’s net asset value is calculated only once a
day. That statement, if false (and known to be so), could
support enforcement action, for the deceit would have oc-
curred in connection with investors’ purchases of the funds’
securities. Similarly, if these funds had stated bluntly in
their prospectuses (or otherwise disclosed to investors) that
daily valuation left no-load funds exposed to short-swing
trading strategies, that revelation would have squelched
litigation of this kind.
These observations show that plaintiffs’ claims depend on
statements made or omitted in connection with their own
purchases of the funds’ securities. They could have brought
them directly under Rule 10b-5 in federal court (to the ex-
tent that the purchases occurred within the period of limi-
tations). Indeed, most of the approximately 200 suits filed
against mutual funds in the last two years alleging that the
home-exchange-valuation rule can be exploited by arbi-
trageurs have been filed in federal court under Rule 10b-5.
Our plaintiffs’ effort to define non-purchaser-non-seller
classes is designed to evade PSLRA in order to litigate a se-
curities class action in state court in the hope that a local
judge or jury may produce an idiosyncratic award. It is the
very sort of maneuver that SLUSA is designed to prevent.
We hold that SLUSA is as broad as §10(b) itself and that
limitations on private rights of action to enforce §10(b) and
Rule 10b-5 do not open the door to litigation about securities
transactions under state law. Plaintiffs’ claims are connected
to their own purchases of securities and thus are blocked by
SLUSA , whose preemptive effect is not confined to knocking
out state-law claims by investors who have winning federal
claims, as plaintiffs suppose. It covers both good and bad

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10 Nos. 04-1495, et al.
securities claims—especially bad ones. The judgments of the
district courts are reversed, and the cases are remanded
with instructions to undo the remand orders and dismiss
plaintiffs’ state-law claims.
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—4-5-05

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