The Supreme Court’s primary interest in Chadbourne & Parke LLP was the SLUSA phrase “misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” A “covered security” only includes “securities traded on a national exchange,” although SLUSA equally applies to securities issued by investment companies. The fraudster must make a material misrepresentation “in connection with” a transaction of a “covered security” for the SLUSA bar to apply. Someone other than the fraudster must decide to buy or sell the “covered security” because of the fraudulent misrepresentation, according to the Court’s 7–2 majority.
Investors’ Class Actions May Go Forward against Fraudster’s Aiders and Abettors
Groups of investors who bought Stanford’s certificates of deposits brought claims in Louisiana state court and the U.S. District Court for the Northern District of Texas. The defendants removed the state court cases, transferred the removed cases to Texas, and a single federal judge presided over the four class actions. The defendants then sought dismissal under SLUSA, which the district court allowed.
Although acknowledging the certificates of deposit are not “covered securities” under the act, the district court found that Stanford’s ownership of “covered securities” was an integral part of the fraud and the necessary connection under SLUSA. All sets of plaintiffs appealed to the U.S. Court of Appeals for the Fifth Circuit, which reversed.
The court of appeals held that the misrepresentations of Stanford’s holdings of “covered securities” were too “tangentially related” to the “heart, crux, and gravamen of” the fraud. All the defendant groups sought certiorari, which the Supreme Court granted to resolve a circuit split between the Fifth and Ninth Circuits on one side and the Second, Sixth, and Eleventh Circuits on the other side.
SCOTUS Finds Five Reasons That SLUSA Did Not Bar the Actions
The Supreme Court held SLUSA allowed these class actions because the fraudulent misrepresentation must be “in connection with” a transaction by the fraud’s victim of a “covered security,” which did not occur here. The Court found the class actions could proceed because SLUSA focuses on transactions involving “covered securities,” while here the plaintiffs purchased uncovered certificates of deposit. The act’s prerequisite that the “misrepresentation or omission of a material fact” similarly suggests a connection that matters to the decision to transact a “covered security.” The Court also noted that prior case law always involved victims taking an ownership interest in the applicable surety instrument covered by the statute.
The Court found its interpretation consistent with the underlying regulatory scheme because the statutes suggest a “focus upon transactions involving the statutorily relevant securities.” Finally, the Court feared a more far-reaching interpretation could obstruct state efforts to compensate victims of fraud while its interpretation of the statute would not hinder future prosecutions similar to what the federal government had prosecuted in the past.
Narrow Ruling Helps Fraudster’s Victims
The Stanford Ponzi scheme reversed the typical roles of securities litigators. “Often times you see plaintiffs making the argument for broad application of securities laws and the broad protections afforded under those laws. Here you actually have somewhat of a reversal of that,” says Jeffrey D. Gardner, Phoenix, AZ, cochair of ABA Section of Litigation’s Class Actions & Derivative Suits Committee. “Plaintiff’s claims survive because of a narrow interpretation where plaintiffs normally seek a more expansive coverage under the federal and state securities laws,” adds Gardner.
The Court narrowly interpreted SLUSA’s “in connection with” clause “so as not to unduly broaden the preemption protection afforded to fraudsters,” says Kathryn A. Honecker, Phoenix, AZ, cochair of the Section of Litigation’s Class Actions & Derivative Suits Committee. A narrow ruling “enables plaintiffs to keep these state court claims where a broader interpretation would have resulted in preclusion,” states Gardner. A broader interpretation would “immunize aiders and abettors from liability any time the fraudster uses the victim’s investment in a non-covered security,” adds Honecker.
Despite the narrow holding, “going forward, you’re still going see the potential for a lot of fighting on both sides of the aisles on whether SLUSA will pre-empt,” says Gardner. The decision “was a clean ruling based on plain statutory language that may ultimately not result in very clean, subsequent battles by the plaintiff and defense bar over SLUSA preclusion,” concludes Gardner.
Chadbourne & Parke LLP clears up at least one disputed area. Aiders and abettors who “assist the primary wrongdoer can no longer argue that the class actions against them are preempted because the purchase or sale was tangentially related to a covered security,” concludes Honecker.
Joseph Callanan is an associate editor for Litigation News.