Yesterday, in a 7-2 decision with Justice Breyer writing for the majority, the Supreme Court issued a narrow interpretation of when the federal Securities Litigation Uniform Standards Act (“SLUSA”) preempts state-law securities class actions.
SLUSA precludes state-law class actions that allege “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)(A). In today’s decision, the Supreme Court determined that a misrepresentation is not considered “in connection with” a securities transaction “unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a ‘covered security.’” Chadbourne & Parke LLP v. Troice, 571 U.S. __, (2014) (slip op., at 8). The Court’s narrow interpretation limits SLUSA’s preclusion of state-law class actions.
The three cases consolidated for review arose out of a Ponzi scheme in which an individual and his companies allegedly induced the plaintiffs to purchase certificates of deposit, which are not covered securities under SLUSA, by representing that the certificates were backed by covered securities. The plaintiffs sought to recover damages for their losses through state-law class actions. The district court held that SLUSA precluded the plaintiffs’ state-law class claims because (1) the plaintiffs’ purchases were induced by a misrepresentation that the certificates of deposit were invested in a portfolio that included “covered securities”; and (2) one or more of the plaintiffs sold “covered securities” to purchase the certificates of deposit. The Fifth Circuit reversed that ruling, holding that a misrepresentation in connection with the purchase or sale of a covered security had to be more than tangentially related to transactions in covered securities. Roland v. Green, 675 F.3d 503, 519-20 (5th Cir. 2012).
The Supreme Court affirmed and clarified that SLUSA applies only to misrepresentations that are material to the purchase or sale of a covered security by one other than the person alleged to have committed fraud. Troice, 571 U.S. __, (2014) (slip op., at 9). The Court reasoned that “the phrase ‘material fact in connection with the purchase or sale’ suggests a connection that matters” (i.e., a connection such that the misrepresentation impacts a person’s decision to actually purchase or sell a covered security). Id. In dissent, Justice Kennedy warned that the Court’s narrow interpretation of SLUSA “will subject many persons and entities whose profession it is to give advice, counsel, and assistance in investing in the securities markets to complex and costly state-law litigation based on allegations of aiding or participating in transactions that are in fact regulated by the federal securities laws.” Troice, 571 U.S. __, (2014) (slip op., at 4) (Kennedy, J., dissenting).
The ruling will likely result in more securities class actions being allowed to be litigated in state court.