Supreme Court Rules that the Securities Litigation Uniform Standards Act Does Not Preempt State Law Claims

by Katten Muchin Rosenman LLP

This week, the US Supreme Court narrowed the scope of the preemption provisions of the Securities Litigation Uniform Standards Act (SLUSA), which bars certain state law-based securities class actions. As a result, securities fraud class claims against secondary actors, such as accountants, lawyers and investment advisers, which are barred under the federal securities laws, may proceed under state law.

The issue before the Court was the reach of the SLUSA statutory requirement that the state law class action concern “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security,” i.e., a security “listed or authorized for listing on a national securities exchange” (emphasis added). Before the Court were consolidated state law-based class actions brought against various law firms, investment advisers and insurance brokers, which allegedly aided or concealed Allen Stanford’s multibillion dollar Ponzi scheme involving the sale of certificates of deposits. The CDs issued by Stanford’s bank, Stanford International Bank, were admittedly uncovered securities, but the plaintiffs alleged that they were misled to believe the CDs were backed by covered securities, i.e., marketable stocks and bonds. 

The Court held, in a 7-2 decision, that under SLUSA the “fraudulent misrepresentation or omission is not made ‘on connection with’ . . . a ‘purchase of sale of a covered security’ unless it is material to a decision by one or more individuals (other than the fraudster) to buy or sell a ‘covered security.’” The plaintiffs had alleged that they were misled to believe that Stanford International Bank was using their investments to purchase marketable assets to ensure the liquidity of their CD investments, when in fact Stanford was using the funds to finance an opulent lifestyle, pay off other investors and make speculative real estate investments in the Caribbean. The Court found that these allegations were not enough to satisfy the requisite “in connection with” and “materiality” elements of SLUSA. The Court explained that the misrepresentations by Stanford (the fraudster) concerned his bank’s purchase (in truth, non-purchase) of publicly traded assets (covered securities), and did not concern the plaintiffs’ purchase of the CDs (uncovered securities). Justice Breyer, writing for the majority, emphasized that the Court’s interpretation of “in connection with” was consistent with SLUSA and other federal securities laws. 

The dissent disagreed, arguing that the majority’s narrow interpretation of the language of SLUSA was inconsistent with the Court’s prior precedent holding that the “in connection with” requirement is broadly construed and requires only that the fraud “coincide” with the covered security transaction. The dissent also raised a concern that the ruling would have an adverse effect on the market by limiting the Securities and Exchange Commission’s enforcement powers under § 10(b) of the Securities Exchange Act, which uses the same “in connection with” language as the SLUSA. The dissent also raised concerns that the ruling stripped “essential protections for our national securities market” and will drive up legal costs by exposing secondary actors to liability, which had been blocked by the Court’s prior decisions. The majority responded that neither the dissent nor the SEC could point to any prior SEC enforcement action that would have been barred based on the majority’s reading of SLUSA. Indeed, the SEC and Department of Justice had successfully prosecuted claims resulting in a prison sentencing for Stanford and a $6 billion forfeiture order.   

Chadbourne & Parke LLP v. Troice et al., No. 12-79 (US February 26, 2014).

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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