Supreme Court Maintains Viability of State Law Claims Related to Securities Transactions

by Ballard Spahr LLP
Contact

A recent Supreme Court opinion, Chadbourne & Parke LLP v. Troice, addresses the viability of class action state-law claims arising from fraudulent securities transactions. This was an opportunity for the Court to limit state-law liability, particularly for secondary actors, based on a federal securities litigation reform statute that precludes certain state court class action suits. In an opinion delivered by Justice Stephen Breyer, however, the Court read the statute narrowly, allowing potentially broad liability for securities fraud premised on state law.

The Securities Litigation Uniform Standards Act of 1998 (SLUSA) prohibits large securities class actions based upon state statutory or common law where the plaintiffs allege “misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” A “covered security” is defined (as relevant to the issues in Chadbourne) as only securities traded on a national exchange. (SLUSA was part of legislative reform to address perceived abuses in class action litigation involving nationally traded securities.) The issue in Chadbourne was whether the SLUSA prohibition applies in a case where the plaintiffs alleged that they purchased uncovered securities based on the defendants’ misrepresentations that these uncovered securities would be backed by covered securities.

Chadbourne involved the Ponzi scheme of Allen Stanford. Stanford and his companies sold plaintiffs certificates of deposits —“uncovered securities”—in Stanford International Bank. They did so based on misrepresentations that the bank would use the plaintiffs’ money to buy highly lucrative assets such as marketable securities, which would have been “covered securities.” In reality, however, Stanford misused the plaintiffs’ funds. He was convicted of numerous crimes, received a lengthy prison sentence, and was required to forfeit $6 billion; the U.S. Securities and Exchange Commission won an enforcement action against Stanford and his companies, resulting in a $6 million civil penalty.

The investors in Chadbourne filed class actions under state law against so-called secondary actors—investment advisers, service providers, insurance brokers, and two major law firms—alleging that they helped Stanford Bank perpetrate the fraud. If SLUSA applied to the misrepresentations to the plaintiffs, these actions would be precluded. At issue before the Supreme Court was the breadth of SLUSA’s phrase “misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security”— that is, whether it extends “further than misrepresentations that are material to the purchase or sale of a covered security.”

The Court held that a misrepresentation or omission is not in connection with a purchase or sale of a covered security “unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a ‘covered security.’” The Court provided several reasons for its interpretation:

  • SLUSA focuses on transactions in covered securities—that is, principally those traded on a national exchange—not uncovered securities.
  • A “natural reading” of SLUSA suggests “a connection that matters.” The Court explained that this is a connection where the misrepresentation makes a significant difference to an investor’s decision to buy or sell a covered security, not an uncovered one.
  • The Court’s precedents support its interpretation: every case where it found a fraud to be “in connection with” a purchase or sale of securities involved victims “who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition” (original emphasis).
  • The interpretation requiring securities transactions that lead to taking or dissolving an ownership interest is consistent with the underlying regulatory statutes (the Securities Exchange Act of 1934 and the Securities Act of 1933).
  • Interpreting SLUSA’s “connection” requirement more broadly “would interfere with state efforts to provide remedies for victims of ordinary state-law frauds.”

The Court rejected two principal arguments advanced by the defendants and the government. First, it disagreed with the contention that its precedents supported a broad interpretation of the language “in connection with.” The Court explained that all of the precedents concerned a false statement “that was ‘material’ to another individual’s decision to ‘purchase or s[ell]’ a statutorily defined ‘security’ or ‘covered security.’”

Second, responding particularly to the government’s concern that a narrow interpretation will curtail regulatory actions, the Court emphasized that its holding will not limit the SEC or U.S. Department of Justice in bringing enforcement proceedings or criminal charges. The Court stated: “When the fraudster peddles an uncovered security like the CDs here, the Federal Government will have the full scope of its usual powers to act.” The Court underscored that, while not constraining government enforcement, its holding “also preserve[s] the ability for investors to obtain relief under state laws when the fraud bears so remote a connection to the national securities market that no person actually believed he was taking an ownership position in that market.” (original emphasis)

Justice Anthony Kennedy, joined by Justice Samuel Alito, dissented. To the dissent, the “key question,” based on the Court’s precedents, “is whether the misrepresentation coincides with the purchase or sale of a covered security or the purchase or sale of the securities is what enables the fraud.” The dissent argued that Stanford’s actions came within this standard: “The fraudster in this litigation misrepresented that he would purchase nationally traded securities. That misrepresentation was made ‘in connection with the purchase or sale’ of the promised securities because it coincided with them.”

The dissent disagreed with the Court’s narrow reading of the “in connection with” requirement, asserting that the language—based on prior cases—should be given a broad construction. As a consequence, the dissent believed that the plaintiffs’ state-law cases should be precluded. The dissent also asserted that the Court’s interpretation introduces confusion into the securities laws and may (despite the Court’s contrary emphasis) “narrow[] and constrict[] essential protection for our national securities markets,” even inhibiting the SEC and litigants “from using federal law to police frauds and abuses” that harm the national securities markets.

Chadbourne clarifies that the door remains open, despite SLUSA, for disgruntled investors to bring class action state-law claims arising from securities fraud where the fraud involving the investor is deemed attenuated to national securities markets and the investor does not take a direct ownership position in securities on that market. In other words, if a plaintiff-investor alleges misrepresentations that are not material to a purchase-or-sale decision by the plaintiff of a national-market security, the plaintiff will be able to pursue state-law claims related to the fraud.

This may prove significant because fraudulent securities schemes often take many forms, and investors—such as those in Chadbourne—may assert that they were misled into acquiring or selling investments through circumstances that did not fall within Chadbourne’s narrow reading of the “in connection with”/“covered security” language. SLUSA will not stand in the way of class actions based on violations of state law brought on this basis.

The viability of state-law claims in the securities world is especially significant for secondary players in securities transactions—such as investment advisers, insurers, brokers, accountants and, of course, lawyers. Securities plaintiffs often assert that secondary actors (who are not secondarily liable in private federal suits under Section 10(b)) participated or enabled a fraudulent investment scheme, giving rise to common law claims sounding in fraud, breach of fiduciary duty, aiding and abetting, negligence and negligent misrepresentation, and the like, as well as state statutory claims.

Particularly where a substantial securities fraud occurs, and the fraudster may be judgment-proof, secondary actors are attractive targets to investor-plaintiffs. Where plaintiffs can portray the fraud affecting them as being remote from covered securities, Chadbourne allows plaintiffs to plead and prove claims against these defendants and avoid SLUSA preclusion.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Ballard Spahr LLP | Attorney Advertising

Written by:

Ballard Spahr LLP
Contact
more
less

Ballard Spahr LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!