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May 21, 2007

The Supreme Court granted certiorari today in two cases of interest to the business community:

 Dormant Commerce Clause—State Taxation

It is well-established that the Commerce Clause, which authorizes Congress to “regulate Commerce * * * among the several States,” Art. I, § 8, cl. 3, embodies a “negative” or dormant “command forbidding the States to discriminate against interstate trade,” Assoc. Indus. of Missouri v. Lohman, 511 U.S. 641, 646 (1994), and prohibits, in particular, a state from “tax[ing] a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State.” Armco Inc. v. Hardesty, 467 U.S. 638, 642 (1984). The Supreme Court granted certiorari in Kentucky Dep’t of Revenue v. Davis, No. 06-666, to determine whether a state violates the dormant Commerce Clause by, on the one hand, exempting from state income tax the interest derived from bonds issued by the state or its political subdivisions, while, on the other hand, requiring that taxes be paid on interest income derived from bonds issued by sister states or their political subdivisions.

Kentucky discriminates against out-of-state bonds in the taxation of interest income. The Court of Appeal of Kentucky held this practice “facially unconstitutional” under the dormant Commerce Clause because “it obviously affords more favorable taxation treatment to in-state bonds than it does to extraterritorially issued bonds.” The court rejected the argument that Kentucky could escape the limitations of the Commerce Clause because it was acting as a participant in the capital market, holding that “when a state chooses to tax its citizens, it is acting as a market regulator, not as a market participant.”

The decision conflicts with the decision of the Ohio Court of Appeals in Shaper v. Tracy, 647 N.E.2d 550 (1994), which upheld a similarly discriminatory tax scheme against Commerce Clause challenge. The Ohio court held that “neither the Supreme Court nor any case law examined has applied the Commerce Clause to a case such as this, where one governmental entity is taxing its residents for the interest earned on bonds issued by another government entity.” Id. at 552, 553. The Ohio court reasoned “that the Commerce Clause was simply never intended to apply to acts of a sovereign on behalf of itself where the end result is to provide the taxing state with a competitive advantage over another sovereign.” Id. at 552, 553-54.

This case could have a significant impact on the $2 trillion municipal bond market, in which favorable state taxation policy currently gives investors a strong incentive to prefer bonds issued from within their home states. In all, more than 40 states, including New York and California, give their own bonds special tax treatment. Absent an extension, which is likely, amicus briefs in support of the petitioner will be due on July 5, 2007; amicus briefs in support of the respondent will be due 35 days after petitioner’s brief is filed. Any questions about his case should be directed to appellate@mayerbrown.com.

 Commodities Regulation—Statutory Standing For Violations of Commodities Exchange Act

Individual customers typically do not buy or sell directly in the futures market. Instead, they carry out their transaction through future commission merchants (FCMs), who guarantee their customers’ performance. The Court granted certiorari in Klein & Co. Futures Inc. v. Board of Trade of the City of New York, Inc., No. 06-1265, to determine whether a FCM has standing to seek damages for losses caused by violations of the Commodities Exchange Act, even though the FCM did not itself purchase or sell any commodities but instead incurred those losses in its role as guarantor.

The case arose out of price manipulation by Norman Eisler, the chairman of the New York Futures Exchange (Exchange), a division of the New York Board of Trade. From approximately August 1999 through May 12, 2000, Eisler manipulated the settlement prices of P-Tech futures and options. This manipulation improperly inflated the value of the account of First West Trading Inc. (First West), a customer of Klein & Co. Futures Inc. (Klein), a FCM.

Though various members of the Exchange and Board of Trade purportedly became aware of the miscalculation of P-Tech settlement prices as early as March 2000, neither the Board of Trade nor the Exchange investigated the miscalculation until mid-May. At that time, the Board of Trade halted trade in P-Tech futures and calculated a new settlement price for the various accounts. First West’s margin account ballooned to $4.5 million. It could not meet the margin call and Klein, as guarantor, was required to take an immediate charge against its net capital. This capital charge put Klein below the applicable regulatory requirements, causing Klein’s trading license to be suspended. Klein subsequently went out of business.

Klein brought suit against the Exchange and other divisions of the Board of Trade seeking damages under § 5b of the Act for their allegedly bad faith failure to enforce their rules. The district court dismissed the claim because Klein lacked standing to bring a claim for damages. The Second Circuit affirmed. 464 F.3d 255 (2d Cir. 2006). The court reasoned that, although the relevant statutory section was 7 U.S.C. § 25(b)(1), which governs claims against a board of trade designated as a “contract market,“ the limitations set forth in subsection 25(a)(1), which governs claims against other types of defendants, applied. 464 F.3d at 260. Klein lacked standing under those criteria because it did not receive trading advice for a fee, purchase or sell P-Tech contracts, or own those contracts. Id.

Klein’s petition for certiorari argues that the Second Circuit’s decision conflicts with long-standing Seventh Circuit decisions that recognize that FCMs are essential market participants. Moreover, it claims, the Second Circuit’s ruling misapplies the statutory scheme by improperly grafting the limitations from subsection (a)(1) to subsection (b)(1). Unlike subsection (a)(1), subsection (b)(1) expressly provides a private right of action to any “person who engaged in any transaction on or subject to the rules of such contract market * * * to the extent such person’s actual losses resulted from such transaction and were caused by such failures to enforce or enforcement of such [rules or regulations].” FCMs meet this criteria, Klein claims, because of the regulatory requirement that FCMs execute transactions and bear financial liabilities for their customers.

This case raises an important question regarding the scope of statutory standing for violations of the Commodities Exchange Act. Over $110 billion is currently invested in the futures markets of the United States in a wide variety of agricultural and manufacturing industries. If the ruling of the Second Circuit is affirmed, the overall liquidity and depth of those markets may decline substantially because FCMs will lack recourse for the bad faith misconduct by registered entities. This will force FCMs either to increase the price of their services or cut back on their trading activity. The decision in Klein should thus be of interest to any business that uses futures to hedge against market risk. Absent an extension, which is likely, amicus briefs in support of the petitioner will be due July 5, 2007; amicus brief in support of the respondents will be due 35 days after petitioner’s brief is filed. Any questions about this case should be directed to appellate@mayerbrown.com.

Since our last Docket Report, the Supreme Court has invited the Solicitor General to file briefs expressing the views of the United States in the following cases of interest to the business community:

Wyeth v. Levine, No. 06-1249. The question presented is whether the FDA’s approval of a drug label pursuant to the Federal Food, Drug, and Cosmetic Act, 21 U.S.C. § 301 et seq., preempts a state-law failure-to-warn tort claim premised on the alleged inadequacy of that label. (Mayer, Brown, Rowe & Maw LLP filed an amicus brief in support of petitioner on behalf of Product Liability Advisory Council, Inc. and the United States Chamber of Commerce.)

General Electric v. New Hampshire Revenue Commissioner, No. 06-1210. The question presented is whether a state may discriminate in its corporate income tax between dividends that are paid to U.S. companies by, one the one hand, foreign subsidiaries that do business within the state and, on the other hand, those that do not.

Republic of the Philippines v. Pimentel, No. 06-1204, and Estate of Roxas v. Pimentel, No. 06-1039. The question presented is whether a foreign government that is a “necessary” party to a lawsuit under Rule 19(a) of the Federal Rules of Civil Procedure and has successfully asserted sovereign immunity is, under Rule 19(b), an “indispensable” party to an action brought in the courts of the United States to settle ownership of assets claimed by that government. (Mayer, Brown, Rowe & Maw LLP represents petitioner Republic of the Philippines.)

Metlife v. Glenn, No. 06-923. The case presents two questions. The first is whether the administrator of an ERISA plan has a conflict of interest that must be taken into account when a court reviews the administrator’s decision to deny a benefits claim if the administrator is the one who would pay the benefits if the claim were approved. The second question is whether, in denying a claim for benefits, an ERISA claim administrator must consider and refute in its written disability determination a contrary decision of a Social Security Administration administrative law judge.

Quanta Computer v. LG Electronics, No. 06-937. The question presented, which implicates the “first sale” doctrine in patent law, is whether the owner of a patent may demand royalties from purchasers of a product that incorporates a duly licensed copy of the patented item, or whether instead the patent owner exhausted its right to collect royalties upon licensing the patent to the product’s manufacturer.

U.S. Chamber of Commerce v. Brown, No. 06-939. The question presented is whether federal labor law preempts a California statute that bars employers from using state funds to pay for speech about union organizing.

Mayer Brown Supreme Court Docket Reports provide information and comments on legal issues and developments of interest to our clients and friends. They are not a comprehensive treatment of the subject matter covered and are not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed.

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