Second Circuit Clarifies Scope of SLUSA Preclusion

by Sheppard Mullin Richter & Hampton LLP
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In Trezziova v. Kohn (In re Herald, Primeo & Thema Sec. Litig.), No. 12-156-cv, 2013 U.S. App. LEXIS 19132 (2d Cir. Sept. 16, 2013), the United States Court of Appeals for the Second Circuit affirmed the dismissal of state law class action claims alleging, among other claims, that defendants had aided and abetted Bernard Madoff Investment Securities’ (“BMIS”) Ponzi scheme.  Plaintiffs were investors in the defendant investment companies and funds, which had, in turn, invested large sums of money in BMIS.  The Court held the claims were precluded by the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), 15 U.S.C. § 78bb(f), even though plaintiffs did not actually purchase any “covered securities” under SLUSA and did not style their claims as securities fraud allegations.  The fact that plaintiffs’ allegations centered on purported sales of covered securities by BMIS was sufficient to trigger SLUSA.

Plaintiffs brought various state law claims against defendants JPMorgan Chase & Co. and Bank of New York Mellon, both of which had provided banking services to BMIS.  Plaintiffs alleged that the banks had known about BMIS’ securities fraud, chosen not to report the fraud, and instead assisted BMIS in the commission of the fraud.  The claims, which included claims for civil conspiracy, aiding and abetting, conversion, breaches of fiduciary duty and unjust enrichment, were all purported state law claims.  Defendants moved to dismiss.

The United States District Court for the Southern District of New York granted the motion to dismiss, holding that the claims were precluded by SLUSA.  SLUSA generally bars plaintiffs from bringing actions based on state common or statutory law on behalf of more than fifty people “in connection with the purchase or sale of a covered security.”  SLUSA adopts the definition of “covered security” in the Securities Act of 1933 as one that is “listed, or authorized for listing, on [the national exchanges]” or one that is “issued by an investment company that is registered . . . under the Investment Company Act of 1940.”  Though plaintiffs’ claims sprung from their investments in what were actually “foreign feeder funds” and not “covered securities,” the court held that SLUSA nevertheless applied because BMIS’ investment strategy involved the purported purchase and sale of “covered securities.”  Since plaintiffs’ claims were “integrally tied” to BMIS’ fraud, the district court held they were precluded under SLUSA.

The Second Circuit affirmed, agreeing with the district court on two key issues.  First, the Court affirmed the district court’s holding that the fact that BMIS had only pretended to execute trades of covered securities, and had actually invested plaintiffs’ money in foreign feeder funds, did not prevent plaintiffs’ claims from being precluded by SLUSA.  Defendants’ potential liability, the Court observed, hinged not on the investment in the feeder funds, but on defendants’ alleged assistance of BMIS’ Ponzi scheme, which involved purported investments in “covered securities.”  Next, the Court affirmed that plaintiffs’ allegations were precluded by SLUSA even though plaintiffs had not framed their allegations as securities fraud claims.  The Court noted that SLUSA requires it to look past the pleadings to the realities of the underlying claims.  SLUSA does not allow plaintiffs to avoid preclusion merely by omitting references to federal securities laws.  Because the complaints essentially alleged defendants were complicit in BMIS’ securities fraud, and were thus integrally tied to that securities fraud, the allegations were “more than sufficient” to trigger SLUSA preclusion.

The Second Circuit’s decision here clarifies the scope of actions that fall within the ambit of, and may be precluded by, SLUSA.  Plaintiffs attempting to bring securities fraud class actions will not be able to avoid SLUSA preclusion by alleging only state law claims.  This decision brings courts closer to effectuating the purpose of SLUSA, and requiring plaintiffs bringing securities fraud class actions to comply with the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995.

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.

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