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April 02, 2014 Articles

SCOTUS Permits State-Law Securities Class-Action Suits in Limited Situations

The door is open where the claims do not involve a "covered security" as defined by the Securities Litigation Uniform Standards Act.

By Kenneth C. Pickering

The U.S. Supreme Court, in the recent case of Chadbourne & Parke LLP v. Troice, 134 S. Ct. 1058, addressed the question of whether a securities class action based on state law could proceed where the plaintiffs’ claims were based on the purchase of certificates of deposit (CDs), allegedly backed by “covered securities.”

Statutory Framework / Limits on Class-Action Lawsuits
Federal law imposes significant limitations on the scope of securities class-action lawsuits. The Securities Litigation Uniform Standards Act of 1998 (the Litigation Act), 15 U.S.C. § 78bb, and the Private Securities Litigation Reform Act of 1995 (PSLRA), 15 U.S.C. § 77z-1, 78u-4, impose both substantive and procedural limits on securities actions.

The PSLRA requires that plaintiffs meet heightened pleading standards, provides for automatic stays of discovery, limits damages and attorney fees, and provides a safe harbor for forward-looking statements.

The Litigation Act prohibits class-action lawsuits of 50 or more class members based on state law, where the complaint alleges a misrepresentation made in connection with the purchase or sale of a “covered security.” In addition, section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, does not permit private rights of action against aiders and abettors or secondary actors.

Description of the Case
The case arose out of the Ponzi scheme perpetrated by Allen Stanford and Stanford International Bank. Following Stanford’s conviction of federal criminal charges, and being found liable in an action brought by the Securities Exchange Commission (SEC), the plaintiffs in the underlying class-action lawsuits brought state-law claims against various secondary actors and alleged aiders and abettors including two law firms. The defendants moved to dismiss the case, arguing that the state-law claims were barred by the Litigation Act’s prohibition against class-action claims based on misrepresentations made “in connection with the purchase or sale of a covered security.” The Litigation Act defines “covered security” to include only securities traded on a national exchange or sold by investment companies.

The plaintiffs alleged that they purchased CDs, debt instruments with a fixed rate of return, issued by Stanford International Bank. The plaintiffs claimed that they were defrauded in part because they were told that the bank had significant holdings including “covered securities” as defined by the Litigation Act. Instead, Stanford used the investment funds to pay off previous investors, invest in speculative real-estate ventures, and finance a lavish lifestyle.

The defendants argued that although the CDs themselves were not covered securities, the alleged fraud involved the claim that the CDs were backed by covered securities, and therefore the claims were precluded by federal securities laws. The plaintiffs claimed that because they purchased only CDs, and not any covered securities directly, their claims should be allowed to proceed.

“Security” as Distinct from “Covered Security”
The Securities Exchange Act defines “security” broadly to include any note, stock, treasury stock, security future, security-based swap, bond, debenture, or CD, whether or not it is traded on a national exchange. 15 U.S.C. § 78c(a)(10). However, the Litigation Act limits only class-action lawsuits involving a “covered security.” A covered security is one that is listed, or authorized to be listed, on a national securities exchange, or a security issued by an investment company. 15 U.S.C. § 77r(b)(2). The Litigation Act’s definition of a “covered security” is significantly narrower that the Securities Exchange Act’s definition of a “security.”

Supreme Court’s Holding
It was undisputed that the CDs purchased by the plaintiffs were not themselves covered securities. However, the Litigation Act prohibits state-law class actions based on a fraudulent misrepresentation or omission of a material fact made “in connection with” the purchase or sale of a “covered security.” 15 U.S.C. § 78bb(f)(1)(A). The Court held that a fraudulent misrepresentation is not made in connection with the purchase or sale of a covered security unless it is material to the decision “to buy or sell” a covered security.

In other words, the omission or misrepresentation must have had a significant impact on the plaintiff’s decision to purchase or sell a covered security. It is not enough that a misrepresentation about a covered security caused the plaintiff to buy or sell an uncovered security.

Impact of the Decision
The ruling permits class-action lawsuits based on state-law claims involving securities as defined by the Securities Exchange Act, as long as the misrepresentation was not made in connection with covered securities listed, or authorized to be listed, on a national securities exchange or issued by an investment company. An omission or misrepresentation is not material unless it causes one to buy or sell a covered security.

The Court’s decision does not affect the enforcement authority of either the Department of Justice (DOJ) or the SEC. The DOJ’s and the SEC’s enforcement authority is authorized by the underlying securities laws that define securities broadly. The Court’s decision here involves only the scope of private rights of action under the Litigation Act.

The case clarifies plaintiffs’ rights to bring state-law class actions against both primary actors as well as secondary actors and aiders and abettors. Under federal securities laws, plaintiffs do not have a private right of action against secondary actors or aiders and abettors. As a result, private plaintiffs will undoubtedly look to pursue state-law claims to avoid the limitations imposed by federal securities laws.

Keywords: criminal litigation, securities class action, state law claims, U.S. Supreme Court, secondary actors, covered securities, Chadbourne & Parke LLP v. Troice, Securities Litigation Uniform Standards Act, 15 U.S.C. section 78bb

Kenneth C. Pickering is a partner with Mirick O'Connell in Worcester, Massachusetts.

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