"SLUSA in the Age of Madoff"

by Skadden, Arps, Slate, Meagher & Flom LLP
Contact

Litigation arising out of Bernard Madoff's Ponzi scheme has generated multiple legal developments, including new case law regarding the Securities Litigation Uniform Standards Act of 1998 (SLUSA). SLUSA provides a powerful legal defense in securities class actions, often enabling defendants to secure dismissal at the outset of the case.

Congress enacted SLUSA to prevent plaintiffs from maintaining securities class actions under state law in order to circumvent stringent pleading requirements applicable to claims of federal securities fraud. To that end, SLUSA provides in pertinent part:

No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging … a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security[.]

An issue that frequently arises under SLUSA is whether a state law claim satisfies the statute's "in connection with" requirement. In other words, does the claim allege a misrepresentation "in connection with" the purchase or sale of a covered security (one that is traded or registered for trading on a national exchange)? In the seminal case Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, the U.S. Supreme Court construed the requirement broadly, finding that the requisite connection exists when a claim alleges a misrepresentation that "'coincide[s]' with a securities transaction — whether by the plaintiff or by someone else."

Dabit, however, left open the question — which has loomed large in Madoff cases — of whether "someone else" means "anyone else." Before his arrest, Madoff's clients principally were hedge funds that authorized Madoff to buy and sell "covered securities" on their behalf. The plaintiffs in the Madoff cases, however, typically have not been Madoff's former hedge fund clients. Rather, they principally have been investors in those funds (feeder funds) and, consequently, had only indirect exposure to Madoff's investment strategy, which they obtained by acquiring restricted securities issued by the funds in private placement transactions. In many of the cases, the plaintiffs alleged state law claims asserting that they were induced to invest in feeder funds by misrepresentations made by the funds' managers and others regarding the legitimacy of Madoff's operations and investment strategy. In response to threshold motions made by defendants seeking dismissal of those claims, plaintiffs argued in part that their purchases of uncovered hedge fund securities were removed from — and, therefore, not "in connection with" — Madoff's purported investments in covered securities on behalf of the funds.

While lower courts were grappling with this issue, the Supreme Court rendered its decision in Chadbourne & Parke LLP v. Troice, a case stemming from the Stanford Ponzi scheme. In that decision, the Court held that the "someone else" referenced in the Dabit opinion did not mean anyone else but, rather, only persons other than the fraudster who bought or sold covered securities. The Second Circuit then applied Troice to rule that the requirements of SLUSA may be satisfied when the "someone else" induced to engage in a challenged securities transaction is an indirect purchaser of covered securities — namely, an investor in hedge funds managed by Madoff. In re Herald, Primeo & Thema.

Herald is one of a number of significant SLUSA rulings handed down in Madoff-related litigation, which also include the following:

  • A large group of plaintiff investors cannot necessarily avoid SLUSA preclusion by filing several related lawsuits, each naming fewer than 50 plaintiffs, in different courthouses located in the same state. If and when those cases are transferred to a single judge and are coordinated in any way, they become "covered class actions" for purposes of SLUSA. Spectrum Select II, L.P. v. Tremont Group Holdings, Inc.
  • To satisfy the "alleging … a misrepresentation" prong of SLUSA, the alleged misrepresentation or other "false conduct" must be made or committed by a named defendant (not an unnamed third party), and proof of such conduct must be "essential to the success of the state law claim" — although not necessarily an essential element of the claim. In re Kingate Mgmt. Ltd. Litigation.
  • A state law claim alleging a false promise to engage in covered securities transactions may be precluded under SLUSA even if no such transactions are actually executed. In re Herald.
  • SLUSA preclusion must be determined on a claim-by-claim basis. When only one of several state law claims alleged in the complaint is subject to SLUSA, only that claim can and must be dismissed pursuant to the statute, and the balance of the action may proceed. In re Kingate.

Although many questions arising under SLUSA have been addressed in Madoff litigation, several remain unresolved. For example, after Kingate, the law awaits further development on the question of when an alleged misrepresentation will be deemed essential to the success of a state law claim, but not an essential element of the claim. Another issue, which also surfaced in Kingate, is whether SLUSA preclusion of state law claims brought by foreign investors amounts to an impermissible extraterritorial application of the statute. The district court in Kingate answered this question in the negative, and the Second Circuit affirmed on this point sub silentio. We expect to see further litigation on this issue, particularly in cases brought by investors in offshore hedge funds contemplating transactions in covered securities. In the meantime, litigation in the aftermath of the Madoff debacle has clarified the scope of SLUSA and strengthened the defense by expanding its application to putative class securities claims alleged under state law.

Download PDF

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.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP
Contact
more
less

Skadden, Arps, Slate, Meagher & Flom 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.
Custom Email Digest
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.