Argument preview: Justices tackle preclusion of state class actions involving securities
Allen Ferrell is the Greenfield Professor of Securities Law at Harvard Law School.
Chadbourne & Parke LLP v. Troice (consolidated with Willis of Colorado v. Troice and Proskauer Rose LLP v. Troice) involves state class action fraud litigation filed in the aftermath of Allen Stanford’s massive Ponzi scheme. According to the plaintiffs in this litigation, central to the scheme was the issuance of certificates of deposit by Stanford International Bank (chartered in Antigua) which falsely stated that the certificates were backed by safe, liquid investments (more specifically, supposedly backed by highly marketable securities issued by stable governments, strong multinational companies, and major international banks). Other misrepresentations allegedly occurred, including false representations concerning the staffing and regulation of Stanford International Bank. In typical Ponzi-scheme style, interest payments and redemptions were allegedly paid for by the sale of still more certificates of deposits.
The issue is whether this litigation can proceed in light of the Securities Litigation Uniform Standards Act (SLUSA), which precludes “covered class actions” in which a private party alleges “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” SLUSA’s “in connection with” language parallels the language used in Section 10(b) of the Exchange Act and Rule 10b-5. “Covered security,” in turn, is statutorily defined so as to basically capture nationally traded securities, such as NYSE-listed securities.
The Fifth Circuit held that the litigation did not fall under the purview of SLUSA. Perhaps most importantly, while the alleged misrepresentation concerning the safe, liquid investments falsely implied that Stanford International Bank had at least some “covered securities” (even though it in fact did not), the court concluded that this misrepresentation was a mere part of a much larger fraudulent scheme to defraud investors. And while it might be true that some investors sold a “covered security” to purchase the certificates of deposit, in the court’s view this alone is insufficient to establish the “in connection with” component of SLUSA.
The plaintiffs (respondents in the Supreme Court) have several arguments why SLUSA does not preclude their cause of action. At bottom, they argue that there is no misrepresentation “in connection” with a “covered security” for the simple reason that there were no “covered securities” at issue to begin with. Stanford International Bank did not in fact purchase any “covered securities” in connection with the sale of the certificates of deposit. Indeed, Mr. Stanford allegedly used a substantial portion of the funds for personal luxuries (and spent much of the rest to either continue the Ponzi scheme by paying interest and redemptions on the certificates of deposit or on various failed investments).
Nor was the misrepresentation at issue made to induce them, or anyone else, to purchase or sell a “covered security.” For one, certificates of deposits are not “covered securities.” The text of SLUSA limits its preclusive scope (as was intended) essentially to nationally traded securities, such as NYSE-listed securities – a concern not implicated, even indirectly, by the alleged Ponzi scheme at issue in the litigation. The alleged fraud at issue is therefore, the plaintiffs concluded, the proper subject for state law class action litigation.
The plaintiffs attempt to further buttress this argument by noting that the fraudulently sold certificates of deposit promised fixed rates of return — i.e., a return not tied to the investment holdings or assets held by Stanford International Bank. This fact, it is claimed, further breaks any “connection” between the misrepresentation concerning the assets held by Stanford International Bank and investors’ purchase of the certificates of deposit.
The defendants (petitioners in the Supreme Court) have a powerful set of counter-arguments. A fair reading of the allegations makes it difficult to avoid the conclusion that the alleged misrepresentation concerning the safe, liquid assets that Stanford International Bank supposedly had was of critical importance to would-be purchasers (or a “reasonable would-be investor”) of certificates of deposits issued by an Antigua chartered bank and offering attractive rates of return.
One could reasonably argue in response to this point that courts should not get into the thankless task of discerning what the true linchpin of the conduct alleged in a complaint – which misrepresentation or omission was the “really” important one according to some metric– when determining whether SLUSA applies. Such an approach would only encourage gamesmanship in the drafting of future complaints seeking to avoid the strictures of SLUSA. But such a criticism would also apply to the Fifth Circuit’s approach here, which held in favor of the plaintiffs.
This argument in response also leads one to the single most important argument that the defendants wish to press here: so long as there is “a” misrepresentation “in connection” with the purchase or sale of a covered security, then SLUSA applies. It does not matter how many other misrepresentations or omissions were also made or their relative importance. The subject matter of one particular alleged misrepresentation was covered securities. To further bolster their argument, the defendants can point to prior court decisions that broadly construed the “in connection” language. While powerful, one nagging question remains: does the misrepresentation that the certificates of deposits were backed by highly marketable securities issued by stable governments, strong multinational companies, and major international banks necessarily and inevitably mean that a “covered security” was involved?
Needless to say, both sides present policy arguments concerning the proper scope of SLUSA, the desirability of permitting state class actions, and the possibility that a narrow construction of SLUSA would allow future plaintiffs to evade the heightened requirements imposed on federal class actions in the Private Securities Litigation Reform Act . Without delving into the particulars of these arguments, it is worth noting that when the Supreme Court in Dabit interpreted SLUSA’s “in connection” language, it emphasized that it favored a broad construction of this language, a position motivated in part by policy reasons in favor of furthering SLUSA’s preclusive reach.
[Disclosure: The law firm of Goldstein & Russell, P.C., whose attorneys contribute to this blog in various capacities, serves as counsel to the respondents in the case. However, the author of this post is neither affiliated with the firm nor involved in the case.]
Recommended Citation: Allen Ferrell, Argument preview: Justices tackle preclusion of state class actions involving securities, SCOTUSblog (Oct. 7, 2013, 8:05 AM), http://www.scotusblog.com/2013/10/troice-preview/