In 1995, the Private Securities Litigation Reform Act (“PSLRA”) was passed to limit frivolous and unwarranted securities lawsuits.  15 U.S.C. §78u–4.  While private securities litigation is an indispensable tool in which defrauded investors can recover their losses, such litigation has led to nuisance filings, targeting of deep-pocket defendants, and vexatious discovery requests in attempts to, among other things, extort large settlements.  See Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006).  To combat these actions, the PSLRA changed the pleading requirements, discovery rules and class representation.  With the passage of the PSLRA, discovery is automatically stayed when a motion to dismiss is pending, forcing plaintiffs to acquire more proof of fraud before filing a lawsuit, or risk dismissal.

Fraud claims are typically brought pursuant to Section 10(b) of the Securities Exchange Act and Rule 10b-5 and, therefore, are brought in Federal courts and subject to the PSLRA.  Soon after the passage of the PSLRA, plaintiffs attempted to avoid the PSLRA’s stringent pleading requirements and procedural hurdles by seeking statutory or common law relief in state court.  In response, Congress enacted the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), to make federal law the principal vehicle for asserting class-action securities fraud claims, and to prevent avoidance of the PSLRA through state court litigation.  SLUSA preempts state-law class-action claims alleging that “the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.”  15 U.S.C.A. § 78bb.

The reach of preemption has been fairly broad, and has been given broad application in order to encompass new and evolving fraudulent schemes.  However, in February 2014, the Supreme Court limited SLUSA’s reach and explained that a fraudulent misrepresentation or omission is not made “in connection with” a purchase or sale of a covered security unless it is material to a decision to buy or sell a covered security.  Chadbourne & Parke LLP v. Troice, 134 S. Ct. 1058 (2014).  At issue in Chadbourne was whether SLUSA preempted claims involving “uncovered” securities where the defendants misrepresented that those “uncovered” securities were backed by “covered” securities.  The Court explained that since the plaintiff did not allege that the defendants’ misrepresentations led him to buy or sell a covered security, SLUSA did not apply.

On April 14, 2014, another key decision was rendered following the ruling in Chadbourne.  In In re Tremont Securities Law, State Law and Insurance Litigation, Case No. 08 Civ. 11117 pending in the Southern District of New York, the plaintiffs sought to have their original state law claims reinstated given the ruling in Chadbourne.  In Tremont, the plaintiffs purchased limited partnership interests, which were supposed to give the plaintiffs the ability to invest in securities managed by Bernard Madoff.  The Court explained that the plaintiffs did not buy an interest in covered securities but, rather, bought a limited partnership interest in funds, which are not covered securities, and there was not otherwise a sufficient connection between the material misrepresentations alleged and the transaction.  The Court went on to explain that “knowledge that the fund would buy covered securities for itself does not create the required ownership in covered securities.”  Accordingly, the Court held that the state-law claims were not precluded.

With these decisions, it is important to determine whether a transaction involves a “covered security” and whether SLUSA applies to prevent state court action.