The Securities Litigation Uniform Standards Act of 1998 does not preclude state law actions seeking to recover investments lost in Ponzi schemes, the U.S. Supreme Court held in a seven to two decision last week.
R. Allen Stanford and his Stanford Group Co. sold certificates of deposit in its Stanford International Bank promising a fixed rate of return. The plaintiffs claimed they expected the bank would use the money to buy highly lucrative assets; instead, Stanford and his associates spent the money to finance an elaborate lifestyle and repay old investors.
When the scam was uncovered, Stanford was convicted of mail fraud and wire fraud, among other federal charges; he was sentenced to prison and required to forfeit $6 billion. In addition, the Securities and Exchange Commission brought a civil suit against Stanford in which the court imposed a civil penalty of $6 billion.
Further, four civil class action suits were filed by private investors against investment advisors affiliated with Stanford, and others including law firms and insurance brokers, alleging that these groups helped Stanford and the Bank perpetrate the fraud, thereby violating Texas state law. A federal court overseeing the consolidated suits granted the defendants’ motion to dismiss, ruling the cases were precluded by the SLUSA. The Fifth U.S. Circuit Court of Appeals reversed and the Supreme Court granted certiorari.
In an opinion delivered by Justice Stephen Breyer, the Court affirmed that the class action plaintiffs could bring suit.
The majority focused on Section 78bb(f)(1) of the SLUSA, which forbids the bringing of large securities class actions by a private party based upon violations of state law where the plaintiffs allege “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.”
This provision simply did not apply to the litigation at hand, Justice Breyer wrote, because the plaintiffs claimed they purchased uncovered securities and the scope of the statutory language should not extend further – despite the fact that the defendants falsely told the victims that the uncovered securities were backed by covered securities.
The Court reached this conclusion for several reasons. First, the Act itself focuses upon transactions in covered securities (i.e., securities traded on a national exchange or those issued by investment companies), not upon transactions in uncovered securities. Second, the statutory language suggests a “connection that matters,” meaning that the alleged misrepresentation “makes a significant difference to someone’s decision to purchase or to sell a covered security, not to purchase or to sell an uncovered security, something about which [the SLUSA] expresses no concern.” Third, every prior securities case in which the Court found a fraud to be “in connection with” a purchase or sale of a security involved “[victims’] ownership interest in financial instruments that fall within the relevant statutory definition,” in contrast to this case, in which ownership was of securities outside the scope of the SLUSA. Fourth, the SLUSA must be read in conjunction with underlying regulatory statutes like the Securities Exchange Act of 1934 and the Securities Act of 1933, the purpose of which, again, “suggests a statutory focus upon transactions involving the statutorily relevant securities.” Finally, a broader interpretation of Section 78bb(f)(1) would interfere with state efforts to provide remedies for fraud victims, an intent at odds with the numerous provisions included in the SLUSA that purposefully maintain state authority.
As to the dissent’s contention that the opinion could significantly curtail the SEC’s enforcement powers, the majority held the case itself belied that argument. “That would be news to Allen Stanford, who was sentenced to 110 years in federal prison after a successful federal prosecution, and to Stanford International Bank, which was ordered to pay billions in federal fines, after the same,” Justice Breyer wrote. “Frauds like the one here – including this fraud itself – will continue to be within the reach of federal regulation because the authority of the SEC and Department of Justice extends to all ‘securities,’ not just to those traded on national exchanges.”
Justice Clarence Thomas filed a concurring opinion, while Justice Samuel Alito joined Justice Anthony Kennedy’s dissent.
Advocating for a broader reading of Section 78bb(f)(1), Justice Kennedy cautioned that the majority’s opinion would have a negative impact on the national securities markets, inhibit the SEC from policing fraud, and “subject many persons and entities whose profession it is to give advice, counsel, and assistance in investing in the securities markets to complex and costly state-law litigation based on allegations of aiding or participating in transactions that are in fact regulated by the federal securities laws.”
To read the Supreme Court’s opinion in Chadbourne and Parke v. Troice, click here.
Why it matters: The decision provides some clarity as to the meaning of the “in connection with” language of the SLUSA. In addition, while the decision is a victory for plaintiffs seeking to file state law fraud claims, the impact is limited to transactions that do not involve securities traded on a national exchange; SLUSA preclusion still applies to state law claims against third parties involving covered securities. Only time will tell whether the decision will lead to the proliferation of state-law class actions, as suggested by Justice Kennedy.