The U.S. Supreme Court in its recent decision in Chadbourne & Parke, LLC v. Troice, 571 U.S. ____, limited the scope of the protection that the Securities Litigation Uniform Standards Act (“SLUSA”) provides to defendants facing state law fraud class actions. SLUSA generally bars state law class actions relating to misrepresentations or omissions in connection with “the purchase or sale of a covered security.”1 A covered security under SLUSA is a security “listed or authorized for listing on a national securities exchange”2 or a security “issued by an investment company that is registered . . . under the Investment Company Act.”3 Prior to Troice, some courts had found that so long as the misrepresentation related to an investment was more than tangentially related to a covered security, the SLUSA bar would apply.4 In Troice, the Court, in a 7-2 ruling, held that in order for the bar to apply, the misrepresentation at issue must have been made in connection with a person’s decision to buy or sell a covered security.5 The Court held that the SLUSA bar does not apply to claims relating to investments in non-covered securities even if they are backed by covered securities like they were in Troice. Consequently, neither issuers of non-covered securities that are backed by covered securities nor advisors of such issuers can argue that SLUSA bars state law class actions against them.
Troice arose out of the Ponzi scheme perpetrated by Allen Stanford. Stanford sold certificates of deposit (“CDs”) in Stanford International Bank that promised rates of return much higher than typical U.S. certificates of deposit.6 Stanford used proceeds from sales of CDs to repay earlier investors and finance a lavish lifestyle. After Stanford’s ponzi scheme collapsed and his fraud was discovered, several classes of plaintiffs brought suits against Stanford and other parties, including, in Troice, a class action asserting aiding and abetting liability under the Texas securities laws against two law firms, Proskauer Rose and Chadbourne & Parke. Plaintiffs alleged that the law firms helped Stanford perpetrate the fraud and conceal it from regulators.7 The law firm defendants moved to dismiss on the ground that SLUSA barred the state law claims and that the plaintiffs were limited to federal securities fraud claims (under which there is no liability for aiders and abettors). Defendants conceded that Stanford’s CDs were not, themselves, covered securities.8 But defendants argued that because plaintiffs purchased the CDs thinking that the CDs were backed by covered securities and that their proceeds would be used to purchase other covered securities, plaintiffs’ claims fell within SLUSA’s scope.9
The Court, in a majority opinion written by Justice Breyer, rejected defendants’ broad interpretation of SLUSA. The Court looked to the language of SLUSA and found that, in order to fall within the statute’s scope, the misrepresentation at issue must occur “in connection with” a person’s decision to buy or sell a covered security.10 The Court held that plaintiffs’ belief that their investments in the CDs would be used to purchase covered securities and the proceeds from those covered securities would support the CDs’ returns was insufficient to bring the claims within SLUSA because the purchase being made in connection with the misrepresentation was of an non-covered security (the CDs), not a covered security.11 In making that distinction, the Court held that for there to be a “connection” the one allegedly defrauded must be the one who is buying or selling (or believes she is buying or selling) the covered security. The allegation that the alleged fraudster represented that he would be using the plaintiffs’ investment in non-covered securities to buy covered securities is not sufficient to fall within SLUSA.12 In addition to finding that the narrower interpretation of SLUSA was consistent with the statute’s language, the Court also concluded that a broader interpretation of “in connection with” would interfere with state efforts to provide remedies for ordinary state-law frauds.13 The Court described its decision as allowing “investors to obtain relief under state laws when the fraud bears so remote a connection to the national securities market that no person actually believed he was taking an ownership position in that market.”14
Implications and Significance
The primary consequence of the Court’s narrow interpretation of SLUSA is that defendants still cannot claim SLUSA protection for non-covered securities even if the defendants can establish a relationship between the non-covered securities and covered securities. Plaintiffs pursuing misrepresentation claims relating to non-covered securities may continue to bring class action claims under state law rather than being restricted to federal securities fraud claims. Examples of such non-covered securities are debt securities of non-listed issuers, including asset-backed and mortgage-backed securities, securities issued in private placements, and securities issued under the exemptions in Regulation D. And, because the SLUSA bar has been interpreted narrowly, advisors to issuers of such non-covered security still face class actions alleging state law misrepresentation claims against them under theories of secondary liability, such as aiding and abetting, which are not available under the federal securities fraud statutes. Defendants of this type who were hoping that the Supreme Court would expand SLUSA protection must continue to look to other avenues for defense.