The familiar “in connection with the purchase or sale” securities-litigation requirement may not be unlimited in its breadth, after all.

On February 26, the US Supreme Court pulled up short defendants in litigation by investors in the bank CDs at the heart of Allen Stanford’s Ponzi scheme.  In four separate class actions (two in USDC-NDTX and two removed from Louisiana state court, but consolidated by the JPMDL) investors brought state-law securities and related claims – apparently hoping to avoid stricter Federal-law pleading requirements, and limits on private “aider-and-abettor” liability.  Reversing roles, the law-firm and other secondary-actor defendants argued a broad, elastic interpretation of the “in-connection-with” element, hoping to pull the whole mess within less-elastic Federal-securities-laws.

The defendants argued that the state-law claims were barred by the Securities Litigation Uniform Standards Act of 1998, 15 U.S.C. § 78bb(f)(1)(A)(“SLUSA” or “Uniform Standards Act”).  The Uniform Standards Act followed the PSLRA and plugged a gap, by largely prohibiting state-law securities-fraud suits involving material misrepresentations or omission “in connection with” the purchase or sale of “covered securities.”  The investors bought Stanford Inv. Bank CDs – which are not “covered securities” – on the misrepresentation that the CDs, in turn, were backed by the Bank’s holdings of “covered securities,” (here, exchange-traded securities).

The Court held (7-2) that the misrepresentations were not “in connection with” the purchase or sale of “covered securities,” because there was no transaction in “covered securities.”  The Court affirmed the Fifth Circuit’s reversal of an earlier dismissal.  The investors will be able to pursue their claims against Stanford’s lawyers and insurers.

Dissenting, Justices Kennedy and Alito thought this primary-transaction sort of rationale a “new” departure from the Court’s prior approval of the federalization of second-step securities-fraud transactions, such as Zandford’s unauthorized sale of securities and second-step theft instead of the (mis)represented following securities purchase.  See SEC v. Zandford535 U.S. 813, 820 (2002).

So while Stanford’s Ponzi scheme still depended upon misrepresentations “in connection with” the purchase and sale of securities, they were not direct enough to be considered “in connection with” the somewhat more particular “purchase or sale of covered securities.”  Or as Justice Thomas pointed out, concurring:  The phrase “is essentially ‘indeterminate, because connections, like relations, ‘stop nowhere,’” and the majority drew its limiting principles from the structure of the Uniform Standards Act itself.

Without ever mentioning the word “penumbra.”

Chadbourne & Parke, LLP v. TroiceNo. 12-79 (U.S. February 26, 2014)(slip op).