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December 10, 2019 Articles

The Securities Litigation Uniform Standards Act’s Prohibition of Artful Pleading

In reviewing a class action complaint involving securities, be mindful of the gravamen of the complaint when evaluating whether the act may bar non-fraud state law claims that may be fraud or omission claims in disguise.

By John N. Bolus and Mary K. Mangan

A key component of the federal regulatory scheme for securities litigation is the Securities Litigation Uniform Standards Act, or SLUSA, 15 U.S.C. § 78bb(f)(1). This act prevents plaintiffs from bringing mass or class actions asserting state law claims that could have been brought as federal securities fraud claims under the Securities Act of 1933 or the Securities Exchange Act of 1934. Most such claims also must be brought in federal court or may be removed to federal court. A notable exception is that 1933 Act claims may also be brought in state court under concurrent jurisdiction. Cyan, Inc. v. Beaver Cty. Emps. Ret. Fund, 138 S. Ct. 1061, 1066, 1078 (2018). Because Congress has enacted heightened requirements for plaintiffs to assert securities fraud claims on a class (or mass) basis, SLUSA requires courts to prevent plaintiffs from artfully characterizing their claims to evade those requirements. The U.S. District Court for the Southern District of New York recently applied this artful-pleading requirement to conclude that SLUSA precluded claims for breach of contract, breach of the implied covenant of good faith and fair dealing, and negligence, when the gist of those claims really was allegedly deceptive conduct.

Congress enacted SLUSA to ensure that class actions alleging securities violations would ordinarily be brought in federal court in compliance with the Private Securities Litigation Reform Act (PSLRA), which imposed heightened requirements on plaintiffs in response to “perceived abuses of the class-action vehicle in litigation involving nationally traded securities.” Merrill Lynn, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 81 (2006). Many plaintiffs, however, responded by bringing class actions based on state, instead of federal, law. Id. at 82. Congress then passed SLUSA to prevent plaintiffs from “evad[ing]” those heightened requirements. Rayner v. E*TRADE Fin. Corp., 899 F.3d 117, 120 (2d Cir. 2018) (quoting Holtz v. JPMorgan Chase Bank, N.A., 846 F.3d 928, 930–31 (7th Cir.), cert. denied, 138 S. Ct. 170 (2017)). SLUSA precludes actions that meet five conditions. It precludes any action that is “(1) a covered class action (2) based on state law claims, (3) alleging that defendants made ‘a misrepresentation or omission of a material fact’ or ‘used or employed any manipulative or deceptive device or contrivance’ (4) ‘in connection with’ the purchase or sale of (5) covered securities.” Id. at 119–20 (quoting 15 U.S.C. § 78bb(f)(1)). SLUSA requires courts to scrutinize the gravamen or substance of plaintiffs’ allegations to prevent plaintiffs from artfully pleading around those requirements. See id. at 120.

The Second Circuit applied that artful-pleading rule to the third element of SLUSA preclusion in Rayner v. E*TRADE Financial Corp., a July 2018 decision. 899 F.3d 117. The plaintiff had alleged, on behalf of a putative class, that two brokerage companies had promised to “seek best execution” when they placed trades for their clients but violated that duty by instead seeking—and not disclosing—kickbacks for the trades. Id. at 119 (citation and quotation marks omitted). The Second Circuit ruled that those allegations satisfied the third element for SLUSA preclusion. It explained that it analyzed SLUSA preclusion by “emphasiz[ing] substance over form.” Id. at 120. What matters for preclusion, it explained, is whether “falsity . . . is essential to the claim.” Id. (citation and quotation marks omitted). If it is, “plaintiffs should not be permitted to escape SLUSA by artfully characterizing a claim as dependent on a theory other than falsity.” Id. (citation and quotation marks omitted). “[B]ecause almost all federal securities suits could be recharacterized as contract suits about the securities involved,” the Second Circuit reasoned that “[a]llowing plaintiffs to avoid SLUSA by contending that they have ‘contract’ claims would render SLUSA ineffectual.” Id. (alterations adopted) (quoting Holtz, 846 F.3d at 930–31). For these reasons, it rejected the plaintiff’s argument that his claim was for the breach of a “non-fraud based duty.” Id.

Dale Miller, et al. v. Metropolitan Life Insurance Co.

In September 2019, the U.S. District Court for the Southern District of New York, Hon. Analisa Torres presiding, applied Rayner to the third element of SLUSA preclusion in Miller v. Metropolitan Life Insurance (Miller II), No. 17 Civ. 7284 (AT), 2019 WL 4450637 (S.D.N.Y. Sept. 17, 2019), appeal filed, No. 19-3383 (2d Cir. Oct. 15, 2019). That case was based on allegations that—without informing insureds of its internal policy—MetLife calculated life insurance premiums on certain variable group life insurance policies by using a smoker rate as the default when insureds failed to disclose in their application to MetLife whether or not they smoked. Id. at *1–2. One of the insureds alleged that a policy form had asked him for any changes in his smoking status and that he left this section blank because he had never smoked. Id. at *1. The insureds had pursued a fraud claim in their initial complaint. Id. at *2. The Miller court dismissed the class-wide fraud claim as barred by SLUSA. Miller v. Metro. Life Ins. (Miller I) No. 17 Civ. 7284 (AT) (SN), 2018 WL 5993477 (S.D.N.Y. Nov. 18, 2018).  It concluded that all elements of SLUSA preclusion were met and, in particular, that the alleged fraud was “in connection with” the purchase or sale of securities given the investment units involved in variable life policies. Id. at *4. It allowed the insureds to amend their complaint to state their alternative contractual claims more specifically. Id. at *7. In their amended complaint, the insureds argued that MetLife’s decision to charge them the smoker premiums breached the policy’s requirement that MetLife use a “reasonable method” to calculate the premiums. Miller II, 2019 WL 4450637, at *1 (citation and quotation marks omitted); accord id. at *4. And they contended that SLUSA could not preclude their claims because “their claims for breach of contract, contractual breach of the implied covenant, and negligence d[id] not require proof of misrepresentations or manipulation.” Id. at *3.

The Miller court disagreed. Finding again that all elements of SLUSA preclusion were met, the court focused on the third element and concluded that the amended contract claims were artfully pleaded claims of fraud, omission, or use of a manipulative device. The insureds’ complaint “‘plainly allege[d] fraudulent conduct,’” it found, because they “allege[d] a misrepresentation concerning the method they expected MetLife to use in calculating their premiums and the method MetLife used.” Id. at *4 (quoting Rayner, 899 F.3d at 120). And it concluded that the insureds’ “couching [of] their claims as a breach of MetLife’s discretion” should be rejected as artful pleading. Id. The court recognized that the insureds were “complaining about the deception” involved in MetLife’s alleged failure to inform them that they were charged the smoker rate, even though they had “styled” their claim “as a breach of contract.” Id. It reasoned that because each claim “hinges on the additional allegation that MetLife’s undisclosed policy of defaulting them to smoker status induced them to enroll and pay higher premiums,” id. at *5, MetLife’s alleged deception was “a necessary component of their claims,” id. at *4.

The insureds have appealed this decision to the Second Circuit. See Miller v. Metro. Life Ins., No. 19-3383 (2d Cir. filed Oct. 15, 2019).


When defending a case involving the purchase or sale of securities, including insurance or annuity products that are considered securities under the law because of variable components, counsel should be alert to the possibility that contractual claims that could make class certification appropriate in a non-securities case might actually constitute securities fraud claims in disguise. This argument is aided when the plaintiffs initially take a shotgun approach in their pleadings and then try to narrow the claims to avoid SLUSA preclusion. Where, as here, the very same conduct that plaintiffs initially pleaded as a fraud claim now forms the basis for an alleged breach of contract, it certainly makes it easier to show that falsity is at the heart of the complaint. Provided that all other elements of SLUSA preclusion are available­­—allegations on behalf of a covered class of that false conduct, in connection with the purchase or sale (or even holding) of a covered security—the federal court should find that SLUSA precludes state law claims and that the case, if it is to proceed as a class action, must be based on federal securities laws and pursued in federal court.

John N. Bolus is a shareholder and Mary K. Mangan is an associate with the law firm of Maynard Cooper & Gale, P.C., in Birmingham, Alabama.

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