The Securities Litigation Uniform Standards Act (SLUSA) was enacted in 1998 to curb the increase in filing of class action securities cases in state court to avoid recent heightened requirements imposed on such cases in federal court. Specifically, SLUSA precluded any “covered class action” based on state law that alleged a misrepresentation or omission of material fact “in connection with” the purchase or sale of a “covered security.” The Fifth Circuit Court of Appeals recently joined the split among circuit courts interpreting the “connection” requirement in this provision.

In Roland v. Green, __ F.3d __, 2012 WL 898557 (5th Cir. Mar. 23, 2012), a state court action was filed on behalf of a class of purchasers of certificates of deposit (CDs) from Stanford International Bank. The CDs themselves were not “covered securities” for purposes of SLUSA, but were purportedly backed in part by “covered securities.” The Fifth Circuit addressed whether the action was precluded under SLUSA as one alleging fraud “in connection with” a covered security. The court noted the split among at least six circuit courts, which have adopted standards ranging from fraud allegations that “necessarily involve” (Second Circuit), “depend on” (Sixth Circuit), “more than but for” (Seventh Circuit), “relate to” (Eighth Circuit), are “more than tangentially related to” (Ninth Circuit) or “are induced by” (Eleventh Circuit), transactions in covered securities.  

The Fifth Circuit sided with the Ninth Circuit’s “tangentially related” test, and held that the misrepresentations that the uncovered securities being purchased were backed by covered securities were not more than “tangentially related” to the alleged fraud. The court found that references to a portfolio of covered securities were just one of many misrepresentations with respect to the quality of the investments in the uncovered securities – with more prominent misrepresentations relating to the quality of management and liquidity of the uncovered security. Notably, the court distinguished the recent Madoff “feeder fund” cases in which investments were allegedly being made in “cursory pass-through vehicles” to invest in covered securities without “multiple layers of separation” between the covered and uncovered securities. As a result, the Fifth Circuit held that there was no preclusion under SLUSA and remanded the action to state court. On April 19, 2012, the Fifth Circuit denied a request to rehear the case en banc.  

For now, the applicable standard will depend on the circuit in which the case is brought. However, the Fifth Circuit’s detailed comparative analysis may influence other circuits to refine their own standard or illuminate the need for resolution of the circuit conflict.