On September 14, 2018, the United States Court of Appeal for the Ninth Circuit affirmed the District Court’s dismissal of class claims brought by a financial advisor on behalf of itself and shareholders of a bond fund (the “Fund”) against defendants an investment company and its board, on the basis that the claims were barred by the Securities Litigation Uniform Standards Act (“SLUSA”). Northstar Fin. Advisors v. Schwab Invs., No. 16-15303 (9th Cir. Sept. 14, 2018). Plaintiff alleged that defendants made certain investments in the Fund that deviated from the investment policies and objectives that resulted in negative returns for the Fund. Based on those deviations, plaintiff asserted claims of breaches of fiduciary duty, contract, and covenant of good faith and fair dealing against defendants. The Ninth Circuit affirmed the District Court’s dismissal, agreeing with the District Court that the claims were preempted by SLUSA because the essence of plaintiff’s allegations related to misstatements or omissions in connection with a sale of a security, and that plaintiff could not “avoid preclusion through artful pleading that removes the covered words . . . but leaves in the covered concepts.”
Plaintiff’s state law claims were based on defendants’ alleged deviation from the Fund’s investment objectives in two ways. First, although the Fund was to track the Lehman Brothers U.S. Aggregate Bonds Index (the “Index”), beginning around August 2007, the Fund allegedly began investing in high risk non-U.S. agency collateralized mortgage obligations (CMOs) that were not part of the Index and were substantially riskier than other securities that comprised the Index. Second, although the Fund’s objectives prohibited it from investing more than 25% of the Fund’s assets in any one industry, the Fund invested more than 25% of its assets in non-agency mortgage-backed securities and CMOs. Plaintiff alleged that these deviations resulted in negative returns for the shareholders of two classes: (i) shareholders who purchased shares prior to August 2007 and continued to hold those shares (the “Pre-Breach Period”), and (ii) shareholders who purchased shares between August 2007 and February 2009 (the “Breach Period”). When opposing defendants’ motion to dismiss, plaintiff had argued that it removed from its amended complaint phrases such as “misrepresentation,” “inform,” and “relied on,” and that it had thus removed its causes of actions from SLUSA’s purview. The District Court rejected that argument, stating that SLUSA could not be reduced to such a formalistic interpretation of certain “magic words.”
In affirming the District Court’s decision, the Court stated that “SLUSA’s preclusion of a cause of action does not turn on the name or title given to a claim by the plaintiff,” but “on the gravamen or essence of the claim.” The Court held that both the Pre-Breach and Breach class claims depended on allegations of misrepresentations or omissions related to the sale of securities. The Pre-Breach class claims of breaches of contract and fiduciary duty rested entirely on allegations that defendants failed to inform the shareholders of the deviations from the investment objectives (i.e., omissions) and that defendants repeated statements regarding the Fund’s objectives despite the deviations (i.e., misrepresentations). Similarly, the Breach class claims were predicated on the continuation of the same alleged breaches and thus dependent on the existence of alleged omissions or misrepresentations. Because plaintiff’s claims were based solely on alleged misrepresentations or omissions of a material fact regarding the investment objectives and the actual investments, the claims were barred by SLUSA.
Although the Court affirmed the District Court’s dismissal of all of plaintiff’s claims, it ruled that the dismissal should have been under Rule 12(b)(1) and not Rule 12(b)(6) because SLUSA deprives the district court of jurisdiction to hear state law claims on a class-wide basis. The Court also ruled that the dismissal should have been without prejudice. Accordingly, the Court remanded the case to the district court to give plaintiff an opportunity to amend its complaint.