The Supreme Court’s February 26, 2014 decision in Chadbourne & Parke LLP v. Troice, et al., has eliminated a potential protection for secondary actors (such as investment advisors, law firms or insurance brokerages) that allegedly assist a fraudster in a Ponzi scheme.
Reviewing four consolidated class actions by victims of Allen Stanford’s Ponzi scheme, the Court narrowly interpreted the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) to apply only to frauds directly connected to purchases of securities “traded nationally or listed on a regulated national exchange,” known as “covered securities.” SLUSA preempts state or common law based class actions relating to “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” Stated another way, when SLUSA preemption is found, secondary actors are protected from state law based class action suits. The question before the court was just how “connected” to the covered securities did the misrepresentation or omission need to be for SLUSA protection to apply.
The answer, and crux of the Courts decision is that a fraudulent misrepresentation or omission 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 individual (other than the fraudster) to buy a covered security. In the case of Stanford’s Ponzi scheme, the uncovered securities sold to investors were represented to be (of course, falsely) backed partially by covered securities. The Court found that this was too tenuous a connection for SLUSA to apply.
A vigorous dissent by Justice Kennedy (joined by Justice Alito) predicts the narrow interpretation will have two primary consequences – first, that the SEC and litigants will have more difficulty utilizing federal law in obtaining relief from fraudsters; and second, that those whose profession it is to give advice and assistance in investing in the securities market will be subject to “complex and costly state-law litigation based on allegations of aiding or participating in transactions that are in fact regulated by federal securities law.”
While it is still too early to assess the ramifications of the Supreme Court’s decision, what is known now is that the litigation landscape has changed. Previously, this area of law afforded secondary actors a degree of protection due to the variety of interpretations of SLUSA preemption. The Second Circuit had previously suggested a test that had been used by some courts to broadly interpret SLUSA preemption. The Third Circuit, on the other hand, has suggested a narrower reading of SLUSA preemption. Now, however, the Supreme Court’s guidance eliminates many of the ambiguities in this complex area of law in favor of disallowing SLUSA preemption – and a degree of protection that secondary actors had previously relied upon is lost.