Chadbourne and Parke LLP v. Troice (12-79); Willis of Colorado Inc. v. Troice (12-86); Proskauer Rose LLP v. Troice (12-88)

Issues 

The Supreme Court has consolidated for oral argument three Fifth Circuit cases that deal with the Securities Litigation Uniform Standards Act (SLUSA). These cases address a circuit split as to the standard for determining when an alleged misrepresentation is "material" enough to the purchase or sale of a covered security to satisfy the "in connection with" requirement and thus trigger SLUSA’s preclusive effect.

Oral argument: 
October 7, 2013

The Securities Litigation Uniform Standards Act (“SLUSA”) precludes certain state-law class actions when a “misrepresentation” is made “in connection with the purchase or sale of a covered security.” The Supreme Court will address a circuit split over the scope and meaning of this standard; in particular, at what point an alleged misrepresentation is sufficiently related to the sale or purchase of a covered security to satisfy the "in connection with" requirement. The Court has consolidated for oral argument three state law securities class actions from the Fifth Circuit Court of Appeals. The district court, adopting the Eleventh Circuit’s test, found that SLUSA precluded the plaintiffs' claims because misrepresentations were made in connection with the sale of SLUSA-covered securities. The Fifth Circuit, adopting the Ninth Circuit’s test, reversed and reinstated the plaintiffs' state law class-actions. The Court’s ruling will implicate the scope and application of SLUSA, SLUSA's impact on state-law class actions, and SLUSA's effect on U.S. securities markets.

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Questions as Framed for the Court by the Parties 

Chadbourne & Parke LLP V. Troice

The Securities Litigation Uniform Standards Act ("SLUSA") precludes most state-law class actions involving "a misrepresentation" made "in connection with the purchase or sale of a covered security." 15 U.S.C. § 78bb(f)(1)(A). The circuits, however, are divided over the standard for determining whether an alleged misrepresentation is sufficiently related to the purchase or sale of a covered security to satisfy the "in connection with" requirement. The Fifth Circuit in this case adopted the Ninth Circuit standard and held that the complaint here was not precluded by SLUSA, expressly rejecting conflicting Second, Sixth, and Eleventh Circuit standards for construing the "in connection with" requirement, all of which would result in SLUSA preclusion here. 

Additionally, and also in conflict with several other circuits, the Fifth Circuit held that SLUSA does not preclude actions alleging aiding and abetting of fraud in connection with SLUSA-covered security transactions when the aiders and abettors themselves did not make any representations concerning a SLUSA-covered security. 

The questions presented are: 

  1. Whether SLUSA precludes a state-law class action alleging a scheme of fraud that involves misrepresentations about transactions In SLUSA-covered securities. 
  2. Whether SLUSA precludes class actions asserting that defendants aided and abetted SLUSA-covered securities fraud when the defendants themselves did not make misrepresentations about the purchase or sale of SLUSA-covered securities. 

 

Willis of Colorado Inc. v. Troice

The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") precludes state law class actions that allege a misrepresentation or omission "in connection with" the purchase or sale of a covered security. 15 U.S.C. § 78bb(f)(1). The complaints at issue in this case plainly included such alleged misrepresentations. The district court, applying Eleventh Circuit precedent, recognized as much and dismissed the complaints. However, the Fifth Circuit disagreed and, purporting to apply the Ninth Circuit's test, found the fact that the complaints included alleged misrepresentations in connection with a covered security insufficient to invoke SLUSA because the complaints also included other misrepresentations that were not made "in connection with" a covered securities transaction. In doing so, the Fifth Circuit acknowledged that it was departing from the holding of the Eleventh Circuit and several other circuits. 

The question presented is whether a covered state law class action complaint that unquestionably alleges "a" misrepresentation "in connection with" the purchase or sale of a SLUSA-covered security nonetheless can escape the application of SLUSA by including other allegations that are farther removed from a covered securities transaction.

 

Proskauer Rose LLP v. Troice

  1. Does the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), 15 U.S.C. §§ 77p(b), 78bb(f)(1), prohibit private class actions based on state law only where the alleged purchase or sale of a covered security is "more than tangentially related" to the "heart, crux or gravamen" of the alleged fraud? 
  2. Does SLUSA preclude a class action in which the defendant is sued for aiding and abetting fraud, but a non-party, rather than the defendant, made the only alleged misrepresentation in connection with a covered securities transaction? 

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Facts

In 1995, Congress enacted the Private Securities Litigation Reform Act (“PSLRA”) to curtail abusive class action litigation involving nationally traded securities. See Roland v. Green, 675 F.3d 503, 507. PSLRA was designed to combat rampant “nuisance filings,” and imposed heightened pleading requirements on plaintiffs and mandated sanctions for frivolous litigation. See id.As a result, many plaintiffs began filing class action securities lawsuits in state court instead of federal court. See id.In response, Congress enacted the Securities Litigation Uniform Standards Act (“SLUSA”) to prevent certain state securities class action lawsuits from frustrating PSLRA’s objectives. See id. 

SLUSA’s key provision provides that "[n]o covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security." See id. (emphasis added);15 U.S.C. § 78bb(f)(1)(A). To enforce this provision, SLUSA mandates that any “covered class action brought in any State court involving a covered security . . . shall be removable to the Federal district court for the district in which the action is pending" and subject to dismissal. See id.; 15 U.S.C. § 78bb(f)(2). A “covered class action” is one in which damages are sought on behalf of more than fifty people, and a “covered security” is one nationally traded and listed on a regulated national exchange. Merrill Lynch v. Dabit, 548 U.S. 71, 83 (2006).

In February 2009, the Securities and Exchange Commission (“SEC”) sued Allen H. Stanford for allegedly perpetrating a $7 billion Ponzi scheme. See Roland v. Green, 675 F.3d 503, 508. Stanford executed his scheme through the Stanford International Bank (“SIB”), and with the help of various third parties. See id.The SEC alleged that through SIB, Stanford issued high-interest certificates of deposit (“CDs”) to private investors based on false assertions that the CDs were safely backed by securities and liquid investments. See id.The district court ordered that all lawsuits against SIB’s service providers or third parties be filed as ancillary proceedings to the SEC action. See id. at 508. 

On August 19, 2009, two separate groups of Louisiana investors led by James Roland and Leah Farr (“Roland plaintiffs”) brought suit in the 19th Judicial District Court, East Baton Rouge Parish against the SEI Investments Company ("SEI") and other third parties for their alleged role in the Stanford Ponzi scheme. See id. at 508. The Roland plaintiffs alleged that SEI led them to believe that their investments were at least partially backed by SLUSA-covered securities. Seeid. at 508-09. SEI removed the suit to the United States District Court for the Middle District of Louisiana on the basis that SLUSA precluded the state court from hearing the case. See id. at 509. The case was transferred to the Northern District of Texas, where the Roland and Farr lawsuits were consolidated under Roland v. Green. Seeid.

At the same time, a group of Latin American investors led by Respondent Samuel Troice filed two class actions in the Northern District of Texas against, respectively, SIB’s insurance brokers, Petitioner Willis of Colorado, Inc. (“Willis”), and SIB’s lawyers, Petitioners Proskauer Rose LLP (“Proskauer”) and Chadbourne & Parke LLP (“Chadbourne”). Id.Troice sued Willis under Texas law, alleging that Willis made various misrepresentations in connection with the Stanford Ponzi scheme. Id.Troice alleged civil conspiracy and aiding and abetting violations against Proskauer and Chadbourne, but not misrepresentation. See id.Invoking SLUSA, Willis, Proskauer, and Chadbourne moved to dismiss the suits. Id.

The district court used Roland v. Green as a vehicle to address the applicability of SLUSA preclusion to the Stanford litigation – specifically, whether the SIB CD’s were “covered securities” and whether plaintiffs had alleged misrepresentations “in connection with” their sale. See id. at 509-10. The court concluded that the SIB CD’s were not covered securities, but found that the Roland plaintiffs’ allegations reasonably implied that the Ponzi scheme coincided with the sale SLUSA-covered securities. See id. at 510. Accordingly, the court concluded that the Roland plaintiffs alleged facts connecting the SIB fraud to transactions involving covered securities, and thus, their claims were precluded by SLUSA. See id. at 510-11. In a separate order, the court found that SLUSA precluded Troice’s claims because they alleged misrepresentations in connection with the sale of covered securities. See id. at 511.

The Roland and Troice plaintiffs appealed to the Fifth Circuit Court of Appeals, which consolidated the three cases. See id. at 510. The Fifth Circuit reversed and reinstated the plaintiffs’ state law class-actions, rejecting the Eleventh Circuit test in Instituto De Prevision Militar v. Merrill Lynch, and adopting the Ninth Circuit test in Madden v. Cowen & Co. Roland, 675 F.3d at 513-514.

In July 2012, Willis, Proskauer, and Chadbourne each filed a petition for a writ of certiorari. Petition for Writ of Certiorari (Willis); Petition for Writ of Certiorari (Chadbourne); Petition for Writ of Certiorari (Proskauer). On January 18, 2013, the Supreme Court granted certiorari and consolidated the three cases to address a circuit split as to the scope of and meaning of the phrase “in connection with the purchase or sale of a covered security” for the sake of determining whether SLUSA precludes investors’ state law class actions.

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Discussion

This case will allow the Supreme Court to settle a circuit split over the scope and meaning of the phrase “in connection with the purchase or sale of a covered security” for the sake of determining whether SLUSA precludes investors’ state-law class actions. 

SLUSA’S EFFECT ON STATE-LAW CLASS ACTIONS 

Petitioners and supporting amici argue that affirming the Fifth Circuit’s interpretation of SLUSA would increase the number of abusive class action lawsuits. See Brief of Amicus Curiae SIFMA in Support of Petitioners at 11. The Securities Industry and Financial Markets Association (“SIFMA”) contends that SLUSA limits these potentially abusive class actions under state law, especially against third parties, by precluding any class action that contains an allegation of “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” See 15 U.S.C. § 78bb(f)(1); Brief of SIFMA at 11. Specifically, SIFMA claims that the Supreme Court has previously held that the “in connection” requirement is satisfied where the alleged fraud merely coincides with a covered securities transaction. See 15 U.S.C. § 78bb(f)(1); Brief of SIFMA at 11. Similarly, DRI—the Voice of the Defense Bar (“DRI”) argues that SLUSA’s “in connection” language is deliberately broad and intended to preclude a wide range of securities actions. See Brief of Amicus Curiae DRI in Support of Petitioners at 7.

Respondents and supporting amici argue that Petitioners’ interpretation of SLUSA would limit securities fraud victims’ ability to collectively seek redress. For example, sixteen law professors contend that adopting Petitioners’ reading of SLUSA would create a “legal no man’s zone” for many financial fraud class action lawsuits. See Brief of Sixteen Law Professors as Amici Curiae, in Support of Respondents at 17. Rather, Occupy the SEC (“Occupy”) argues that the Court should narrowly interpret SLUSA’s required connection with nationally-traded securities. See Brief of Occupy the SEC as Amicus Curiae, in Support of Respondents at 13. Under this scheme, the professors argue, defendants in state law class actions not involving nationally traded securities could show that the plaintiffs’ claims even tangentially touched SLUSA-covered securities. See Brief of Professors at 23. Then, the professors argue, the action could be removed to federal court where it would be dismissed pursuant to SLUSA. See Brief of Professors at 23. In the professors’ view, if the Court adopts Petitioners' position, then competent fraudsters could successfully escape liability and victims would be denied collective remedy in either state or federal court. See id. at 17, 22. Moreover, Occupy argues, Petitioners’ interpretation would “create a black hole in regulation” and could negatively impact victims of financial fraud, fraudulent mortgage deals, and traditional loans. See Brief of Occupy at 2-3.   

SLUSA’S EFFECT ON U.S. SECURITIES MARKETS 

Petitioners’ supporters argue that affirming the Fifth Circuit's decision would undermine SLUSA’s protections and decrease the "competitive edge" of American securities markets. See Brief of DRI at 20. Specifically, DRI claims that a lack of protection against abusive securities litigation has led to a decline in the securities markets’ competitive edge because of the expense of unwarranted or abusive litigation, thereby resulting in costly settlements. See Brief of DRI at 20. Similarly, SIFMA claims that an increase in class action lawsuits against third parties would undercut SLUSA’s protections and cause further decline of the American securities market. See Brief of SIFMA at 2. On a different note, the United States argues that the Fifth Circuit’s interpretation of SLUSA undermines the bill’s purpose of promoting confidence in American securities markets through regulations that have existed since 1933.See Brief of United States at 11.

Respondents and their supporters counter that the Fifth Circuit's decision in no way contravenes the purpose of SLUSA and therefore would not impact the bill's intended protection and promotion of the American securities market.  Examining the legislative history of SLUSA and its predecessor, sixteen law professors argue that Congress intended SLUSA to apply narrowly to cases involving nationally-traded securities and not to claims based on state law that only peripherally involve such securities.  See Brief of Professors at 15. Similarly, the Court-Appointed Receiver and Examiner posit that congressional reports demonstrate that Congress intentionally focused narrowly on nationally-traded securities and chose not to include a broader definition of “covered security.” See Brief of the Court-Appointed Receiver and the Court-Appointed Examiner as Amici Curiae, Supporting Respondents at 12-14.

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Analysis

The principal securities fraud statutes are Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5, which was adopted by the SEC under the authorization of Section 10(b). Brief for Respondents at 1; Brief for Petitioners, Chadbourne & Parke LLP at 2. Under 10b-5, the SEC has the authority to bring civil suits against securities fraud violators, the Department of Justice has the authority to bring criminal prosecutions, and private investors have a right of action to sue. 17 C.F.R. §240.10b-5; Brief for Respondents at 2; Brief for Petitioner, Chadbourne & Parke LLP at 2. 

However, to deter frivolous litigation by private parties, Congress enacted several measures that limit the claims that plaintiffs may bring under 10b-5. Brief for Petitioner, Willis of Colorado, Inc. at 2–3. Under the PSLRA, for example, Congress imposed heightened pleading standards on plaintiffs with federal securities fraud claims. 15 U.S.C. §78u-4(b); Brief for Respondents at 2; Brief for Petitioner, Proskauer Rose LLP at 3–4. In response to PSLRA’s federal restrictions, many plaintiffs brought their securities fraud class actions in state courts. Brief for Petitioner, Willis of Colorado, Inc. at 2–3; Brief for Respondents at 2. In response, Congress enacted SLUSA in 1998, which precludes plaintiffs from bringing a class or mass action lawsuit in state court alleging a “misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” 15 U.S.C. §78bb(f)(1); Brief for Petitioner, Proskauer Rose LLP at 3; Brief for Respondents at 2.

WERE THE FACTS SURROUNDING THE PONZI SCHEME MATERIAL AS UNDERSTOOD UNDER SLUSA?

Petitioners argue that the misrepresentations about SLUSA-covered securities were “material” to the fraudulent actions of the instant case. See Brief for Petitioner, Willis of Colorado, Inc. at 36–37. Petitioners contend that Respondents’ reading of SLUSA’s materiality requirement--that the misrepresentation must be “material” to the purchase or sale of a covered entity--is mistaken. See Reply Brief for Petitioner, Proskauer Rose LLP at 25. Instead, Petitioners cite Basic Inc. v. Levinson for the proposition that the Court treats “material” and “in connection with” separately. See id. Petitioners argue that SLUSA’s materiality requirement is met when the misrepresentations about the covered securities are “material” to the securities fraud. See id.

Petitioners argue that when SIB indicated the CDs were backed by “safe, liquid investments that were insured,” these misstatements were critical to the perpetuation of the Stanford Ponzi scheme. See Brief for Petitioner, Willis of Colorado, Inc. at 29. Without promises of diversified investments in SLUSA-covered securities, which would provide high returns and low risk, Respondents would not have chosen to invest in the SIB CDs. See id.

Respondents claim that the false representations made by SIB regarding its ownership or claim of intent to buy covered securities are not “material” to the purchase or sale of the covered securities, because such representations do not affect the actions of an investor in the covered securities market. See Brief of Respondents at 15–16. To support this proposition, Respondents also cite to Basic Inc. v. Levinson, in which the Supreme Court held that a statement is considered “material” if a reasonable investor would think of the statement to be significant in making his or her trading decision. See id. at 37. According to Respondents, Petitioners fail to offer any credible argument of how any statement by SIB could be material to its own purchase or sale of a covered security. See id. In fact, Respondents contend that the complaints merely establish SIB instructed its agents to “push” the non-covered assets. See id. at 20. Respondents assert that there is no evidence indicating SIB intended to deceive by its actions. See id. 

Moreover, both parties agree that SIB did buy some liquid assets, just fewer than it represented. See Brief of Respondents at 37. According to Respondents, such a misrepresentation does not implicate the kind of interests the securities laws are directed at, like public confidence in the market. See id.at 26. Additionally, Respondents argue that SLUSA does not apply in such a case where the fraud has a material effect on the party’s purchase of some other, non-covered asset. See id. at 38. Respondents agree with the Fifth Circuit’s holding that in such a case, SIB’s claim that it owned or would purchase liquid assets is only “tangentially related” to the purchase or sale of covered securities. See id. at 17. Therefore, Respondents assert that such a misrepresentation implicates ordinary state-law anti-fraud rules. See id. at 26. 

WAS THE ALLEGED MISREPRESENTATION ‘IN CONNECTION’ WITH THE PURCHASE OR SALE OF A COVERED SECURITY?

Petitioners state that the Supreme Court has consistently interpreted “in connection with” broadly and that the claims against petitioners fall within this broad interpretation. See Brief for Petitioner, Willis of Colorado, Inc. at 25. Petitioners refer to Merrill Lynch v. Dabit, where the Court stated that Congress “espoused a broad interpretation” of SLUSA. See id. (quoting Dabit, 547 U.S. at 85). The Court in Dabit found that the broad interpretation of SLUSA precluded plaintiffs’ claims from being brought in state court even though they did not actually buy or sell securities—plaintiffs were “holders” and had refrained from selling securities as a result of the fraud. See id. at 26. The Court found it was “enough that the fraud alleged ‘coincided’ with a securities transaction--whether by the plaintiff or someone else.” See id. at 27 (quoting Dabit, 547 U.S. at 85). Petitioners contend that Dabit only requires showing deception in connection with a security generally, not specifically identifiable deception tied to a singular individual. See id. 

Petitioners argue that Dabit also linked the interpretation of “in connection with” from SLUSA to the Court's interpretations of “in connection with” from Rule 10(b) and 10b-5. See Brief for Petitioner, Willis of Colorado, Inc. at 25. Petitioners cite to SEC v. Zandford for the statement that “in connection with” in Rule 10b-5 should be interpreted “flexibly, not technically and restrictively.” See id. at 25. Petitioners also refer to Superintendent of Insurance of the State of New York v. Bankers Life and Casualty Company, where the Court found that it was enough that the fraud was “touching” securities transactions when interpreting “in connection with” in the context of Rule 10b-5. See id. at 27–28. Petitioners also point to lower court decisions in the federal circuit which have interpreted “in connection with” broadly, so as to include, for example, instances in which there was only a representation about covered securities and not an actual transaction in those securities. See id. at 38–39. 

The Fifth Circuit interpreted SLUSA requirements to be satisfied only when a covered securities action is “more than tangentially related” to the “heart,” “crux,” or “gravamen” of the alleged fraud. See Brief for Petitioner, Proskauer Rose LLP at 10. Petitioners argue that the Fifth Circuit's approach in interpreting “in connection with” in SLUSA was flawed because it adopted words beyond SLUSA’s statutory text instead of restricting itself to the plain meaning of the text. See id.at 16–17. According to Petitioners, that approach relied upon ad hoc reasoning that prioritized result over process. See Brief for Petitioner, Chadbourne & Parke LLP at 40–41.

Respondents argue that where a party expresses intent to purchase covered securities, but instead transacts in non-covered assets through a false statement, the securities laws do not apply. See Brief of Respondents at 34. According to Respondents, such a misrepresentation is not made “in connection with” the purchase or sale of the covered security because certificates of deposits are non-covered assets. See id. at 17–18, 34. Respondents contend it is unlikely that the full force of the securities laws is triggered  every time a false statement is made “about” a securities transaction. See id. at 23. Moreover, Respondents state that the phrase “in connection with” is distinct from the word “connection,” and that this Court has interpreted that phrase to require that the fraud and the transaction “coincide” with one another. See id. at 35–36. 

Respondents contend that in this case, the fraud that induced the purchase of the certificates of deposits did not coincide with SIB’s alleged prior acquisition of the assets backing those certificates. See Brief of Respondents at 24. According to Respondents, at the time the petitioners bought the certificates of deposits, SIB claimed to have already owned those assets. See id. As such, Respondents argue that the sale of the non-covered product was complete before any later purchase or non-purchase of a covered security, thus making those transactions distinct. See id. at 34-35. To further support their claim, Respondents compare this case to United States v. O'Hagan, in which the Supreme Court found it critical that the fraudulent misappropriation made by the defendants could not be complete until they used the information to purchase the securities. See id. at 24. Therefore, Respondents assert that it is insufficient that the fraud and the later purchase of covered securities can be characterized as part of a common scheme for it to trigger SLUSA. See id. at 35.

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Conclusion

In this case, the Supreme Court will address a circuit split as to the standard for determining when an alleged misrepresentation is "material" enough to the purchase or sale of a covered security to satisfy the "in connection with" requirement of the Securities Litigation Uniform Standards Act. The Court's ruling will impact not only the victims of the Stanford Ponzi scheme but also the circumstances under which SLUSA can be triggered, private investors’ ability to bring state-law securities class actions, and SLUSA's effect on the U.S. securities markets.

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Acknowledgments 

Additional Resources