U.S. Securities and Exchange Commission headquarters.

A state judge in Morris County, New Jersey, has dismissed the last defendants in a shareholder suit accusing financial institutions of devaluing a stock through “naked short sales.”

Judge Louis Sceusi, in Manning v. Merrill Lynch, Pierce, Fenner & Smith, granted a motion to dismiss by defendants National Financial Services, E*Trade Capital Markets, Knight Capital Americas and UBS Securities for failure to state a claim, as well as a motion by E*Trade to dismiss for lack of personal jurisdiction.

The ruling brings an end to a nearly 6-year-old case in which financial institutions were accused of manipulating the price of stock in Escala Group, a New York-based network of companies specializing in collectibles such as stamps.

The case went to the Supreme Court in 2016, where the justices ruled that §27 of the Securities Exchange Act does not provide exclusive federal jurisdiction over claims that, although asserted under state law, allege underlying conduct that would have violated regulations in the federal act.

Lead plaintiff Greg Manning of Boonton, who claimed he owned 2.1 million shares of Escala, filed the suit in May 2012 in Superior Court in Morris County. He alleged the defendants' “naked” short selling of Escala's stock increased the amount of shares on the public market and drove down its stock price.

In a typical short sale, a person borrows stock from a broker, sells it to a buyer on the open market, then purchases the same number of shares to return to the broker. But the seller in a naked short sale does not borrow the stock he puts on the market, and therefore never delivers the promised shares to the buyer. The practice, which can drive down a stock's price, is restricted by U.S. Securities and Exchange Commission regulations.

The complaint in Merrill Lynch alleges only state law causes of action, including a violation of New Jersey's RICO Act and New Jersey securities fraud. However, to demonstrate liability on the state law claims, the complaint also includes extensive allegations of violations of SEC guidelines governing the practice of short selling.

The 10-count complaint alleged violation of the New Jersey Racketeer Influenced and Corrupt Organizations Act based on predicate acts of New Jersey securities fraud and theft and state common-law claims, including breach of contract, unjust enrichment and interference with economic advantage.

But the justices held that the claim had to affirmatively seek relief under federal law, and not merely track federal law with a parallel state law claim, for federal court jurisdiction to come into play.

Merrill Lynch was dismissed separately in 2017.

The defendants removed it to federal court in Newark in July 2012, asserting federal question jurisdiction on the grounds that the crux of the action was the violation of the federal regulatory scheme regarding short sales.

In particular, they relied on Regulation SHO, adopted by the SEC in 2005 to address problems with failure to deliver, including “potentially abusive 'naked' short-selling.” New Jersey has no analogous provision.

In December 2012, U.S. Magistrate Judge Michael Hammer of the District of New Jersey agreed with the plaintiffs that the case should be remanded because it consisted of state law claims that could be decided “without addressing the embedded federal issues.”

U.S. District Judge Jose Linares of the District of New Jersey, however, rejected Hammer's recommendation and denied a remand in March 2013.

The Third Circuit granted an interlocutory appeal and reversed on Nov. 10, 2014, finding that the issue of whether naked short-selling violates New Jersey law need not be answered by reference to Regulation SHO.

In January 2015, the Third Circuit denied rehearing en banc and refused a stay pending a decision on the defendants' anticipated petition for certiorari. Justice Samuel Alito denied a stay of the appeals court decision in March 2015.

The Supreme Court subsequently agreed to take the case and issued its ruling in May 2016. The justices' decision sent the case back to Morris County.

The lawyer for Manning and the other individual plaintiff, Claes Arnrup of Sweden, David Shivas of Bell & Shivas in Rockaway, did not return a call. Daniel Korb of Bressler, Amery & Ross in Florham Park, representing Knight Capital Markets; lawyers at Latham & Watkins in Washington, representing UBS Securities; and David Sellinger of Greenberg Traurig in Florham Park, who represented E*Trade Financial, did not respond to requests for comment.