In a 7-2 decision released on Wednesday, February 26, 2014, the U.S. Supreme Court held that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) did not foreclose state-law class actions alleging that the defendants made misrepresentations about "uncovered" securities that were supposedly backed by "covered" securities. In Chadbourne & Parke LLP v. Troice, 571 U.S. ___ (2014), the U.S. Supreme Court determined that SLUSA applies to claims based on misrepresentations that were material to a decision by someone other than the fraudster to buy or sell "covered" securities.
Several groups of plaintiffs filed state-law class actions arising out of a Ponzi scheme run by Allen Stanford and several of his companies. Among the named defendants were two law firms. The plaintiffs alleged that these law firms helped Stanford and one of his companies perpetrate the Ponzi scheme or conceal it from regulators. In particular, the plaintiffs alleged that the law firms falsely represented that the uncovered securities (in the form of certificates of deposit) the plaintiffs were purchasing would be backed by covered securities.
The district court dismissed the actions under SLUSA, 15 U.S.C. § 78bb(f)(1), which forbids any "covered class action based upon the statutory or common law of any State" alleging "a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security." SLUSA defines a "covered security" as one listed or authorized for listing on a national securities exchange. The Court of Appeals for the Fifth Circuit reversed, holding that the alleged falsehoods about the uncovered securities were too tangentially related to the covered securities to require dismissal under SLUSA.
The U.S. Supreme Court affirmed the decision of the Court of Appeals. The Supreme Court concluded that a misrepresentation is not made "in connection with" a purchase or sale of a covered security unless it is material to a decision by one or more victims to buy or sell the covered security. The Supreme Court emphasized that:
- SLUSA focuses on transactions in covered securities, not uncovered securities.
- The misrepresentation must make a difference to someone other than the fraudster when deciding whether to buy or sell a covered security.
- Prior cases construing the phrase "in connection with" involved victims who maintained, changed, or attempted to change their ownership interest.
- The Securities Act of 1933 and the Securities Exchange Act of 1934 are not designed to protect persons whose connection with the securities at issue is more remote than words such as "buy" and "sell" indicate.
- Interpreting the necessary "connection" more broadly would interfere with state efforts to provide remedies for victims of ordinary state-law frauds.
The Supreme Court rejected the argument of the government and the dissenters that narrowly interpreting the phrase "in connection with" would limit federal enforcement capabilities. The majority noted that the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) had already prevailed in enforcement actions against Stanford and related companies. The majority further noted that the authority of the SEC and the DOJ extends to all "securities," not just those traded on national exchanges. The majority argued not only that the dissent failed to point to any examples of federal securities actions that would be disallowed as a result of Wednesday's ruling, but also that federal law does not recognize a private right of action for investors vis-à-vis "secondary actors" or "aiders and abettors" of securities fraud.
Chadbourne holds that SLUSA does not preclude state-law claims involving misrepresentations that were not material to the victim's decision to buy or sell "covered" securities. Litigating securities class actions in state court can be advantageous to a plaintiff, including when the plaintiff is freed from the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 (PSLRA). Still, because many securities class actions focus on publicly-traded companies whose securities are listed on national exchanges, SLUSA, the PSLRA, and federal case law limiting claims against "secondary actors" or "aiders and abettors" will continue to be important tools for the defense. In addition, the majority in Chadbourne attempted to couch the ruling in terms that will not radically affect the SEC's enforcement powers.