The U.S. Court of Appeals for the Eleventh Circuit, in one of its most detailed discussions of the Securities Litigation Uniform Standards Act of 1998 (SLUSA) to date, has affirmed the dismissal of an investor’s state law claims and its federal securities fraud claim against Merrill Lynch, Pierce, Fenner & Smith Incorporated (“Merrill Lynch”). In Instituto de Prevision Militar v. Merrill Lynch, No. 07-15079, 2008 WL 4723777 (11th Cir. Oct. 29, 2008) (not final and subject to a timely filed petition for rehearing), the Eleventh Circuit reaffirmed the four-part test for preclusion of state law claims under SLUSA, provided a detailed analysis of three of the four requirements for SLUSA preclusion, and acknowledged that its most comprehensive prior opinion regarding SLUSA preclusion is no longer good law. Sutherland was counsel for Merrill Lynch before the Eleventh Circuit and the District Court. To view the opinion, click here.

Background

Pension Fund of America (PFA), a non-party to the action, allegedly defrauded investors throughout Latin America by stealing their money under the guise of investing it in retirement trust accounts. One such investor was Instituto de Previsión Militar (IPM), a decentralized agency of the Republic of Guatemala that administers social security for the Guatemalan Armed Forces. IPM invested approximately $28 million with PFA, and $7.7 million of IPM’s investment was deposited in a Merrill Lynch account.

IPM alleged that PFA misappropriated money from a Merrill Lynch account, and IPM sued PFA and its principals in Florida state court in 2002. A few years later, the U.S. Securities & Exchange Commission (SEC) brought a receivership action against PFA, alleging widespread fraud and theft of investors’ money. In the aftermath of the SEC receivership action, three related cases relating to PFA’s fraud were filed in the U.S. District Court for the Southern District of Florida against PFA’s principals and several other defendants, including a putative class action against various financial institutions and separate lawsuits brought by IPM against Merrill Lynch and Lehman Brothers, with whom its money allegedly had been deposited.

IPM moved to consolidate its action against Lehman Brothers with the putative class action for discovery purposes, and IPM later asked the district court to consolidate its action against Merrill Lynch with the other two actions for discovery purposes as well.

IPM’s initial complaint against Merrill Lynch asserted seven state law tort claims but did not include any federal claims. Merrill Lynch moved to dismiss IPM’s complaint, alleging that IPM’s state law claims were precluded by SLUSA. The district court agreed that IPM’s state law claims were precluded and dismissed those claims. With the district court’s permission, IPM amended its complaint to allege a federal securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, but the district court dismissed the federal securities fraud claim because IPM had failed to adequately plead actionable misrepresentations/omissions, scienter, reasonable reliance, and loss causation. IPM appealed.

The Eleventh Circuit’s Opinion

Writing for a unanimous three-judge panel, Judge Stanley Marcus reaffirmed the Eleventh Circuit’s four-part test for SLUSA preclusion. To be precluded under SLUSA, the panel held, an action must be (1) a “covered class action” that (2) is “based upon the statutory or common law of any State” and that (3) alleges a misrepresentation or omission or the use of a manipulative device “in connection with the purchase or sale” of (4) a “covered security.” The panel then analyzed the first, third and fourth requirements for SLUSA preclusion in depth.

SLUSA: Covered Class Action. SLUSA defines a covered class action to include a group of lawsuits filed in or pending in the same court that involve common questions of law or fact, that seek damages on behalf of more than 50 persons, and that are joined, consolidated, or otherwise proceed as a single action for any purpose. Although IPM contended that none of those requirements was satisfied in this case, the Eleventh Circuit “remain[ed] unpersuaded.” Applying the plain meaning of the language of SLUSA’s “covered class action” definition, and rejecting IPM’s arguments regarding congressional intent, the Eleventh Circuit concluded that the consolidation of IPM’s action with the putative class action and the action against Lehman Brothers—consolidation that occurred at IPM’s behest—rendered IPM’s action a covered class action under SLUSA. Judge Marcus wrote: “Rather than try to rearrange the deck chairs of its sinking ship in this appeal, IPM might have avoided this plain-language iceberg altogether if it had argued to the district court that consolidation is inappropriate because the joinder for discovery purposes would result in SLUSA preclusion. But IPM did not do that. Instead, after the district court asked why this case should not be consolidated with the Class Action and the Lehman action, IPM expressly requested that the court consolidate all three cases for discovery purposes. IPM cannot now complain about the consequences of its own request . . . .”

SLUSA: In Connection With the Purchase or Sale. “[A]fter thoroughly reviewing the second amended complaint,” the panel also concluded that there was “little doubt” that IPM’s claims are in connection with the purchase or sale of a security. Although IPM attempted to avoid preclusion as to some of its allegations by characterizing them as relating to Merrill Lynch’s conduct after IPM had made its investment, the Eleventh Circuit rejected IPM’s approach, concluding that “even if SLUSA requires a court to assess preclusion claim-by-claim, [SLUSA] does not require district courts to act like a prospector panning for a few non-precluded theories amid a river of precluded ones.”

Among the most important aspects of the Eleventh Circuit’s discussion of the “in connection with” requirement, however, was its recognition that Riley v. Merrill Lynch, Pierce, Fenner & Smith, Inc.—the Eleventh Circuit’s most extensive precedent regarding the scope of SLUSA preclusion—“is no longer good law.” In Riley, the Eleventh Circuit had equated the “in connection with” requirement for SLUSA preclusion with the “in connection with” element of a private right of action under Section 10(b) and Rule 10b-5. Citing the U.S. Supreme Court’s subsequent decision in Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, the Eleventh Circuit concluded that Riley was incorrect in holding that SLUSA’s “in connection with” requirement has the same meaning that it has in the context of a private right of action under Section 10(b)/Rule 10b-5. Rather, the panel held, SLUSA’s “in connection with” requirement is broader, and “covers the same range of activities that the SEC could prosecute as violations of § 10(b) and Rule 10b-5.”

SLUSA: Covered Security. Citing two Eleventh Circuit cases heavily relied on by Merrill Lynch, the panel further held that the retirement trust accounts in this action—hybrid products consisting of a registered mutual fund component and an unregistered life insurance component—satisfied SLUSA’s definition of a “covered security.”

The Federal Securities Fraud Claim. Lastly, turning its attention to IPM’s federal securities fraud claim, the Eleventh Circuit recognized that IPM had abandoned its pursuit of that claim on appeal. Describing IPM’s argument on the Section 10(b)/Rule 10b-5 claim as “awkward,” the Eleventh Circuit held that IPM’s failure to address four elements of its claim required the panel to conclude that IPM “has abandoned the argument that it has adequately pleaded” a federal securities fraud claim.