U.S. Supreme Court Debates Coverage of the Securities Litigation Uniform Standards Act

The U.S. Supreme Court recently debated whether investors in a consolidated class action suit were precluded by the Securities Litigation Uniform Standards Act (“SLUSA”) from bringing state law causes of action against law firms and other third party entities for their alleged roles in the $7 billion R. Allen Stanford Ponzi scheme. SLUSA bars plaintiffs from bringing state law claims based on misrepresentations made “in connection with the purchase or sale of a covered security.” 

The Ponzi scheme at the center of the allegations involved over 21,000 investors who bought certificates of deposit from R. Allen Stanford’s bank in Antigua. Stanford promised a risk-free investment with above-market rates of return and said the CDs were backed by portfolios of liquid securities.  However, there were no securities and the money went to fund a string of failed businesses, bribe regulators, and support Stanford’s lavish lifestyle. R. Allen Stanford was convicted and sentenced to 110 years in prison in March of 2012.  The receiver, who was court appointed in 2009 to recover money from Stanford’s failed companies to return to investors, recently began mailing checks ranging from $2.81 to $110,000 to hundreds of investors.  That amounts to approximately $55 million of the $6 billion lost from the scheme – less than a penny on the dollar.

The complaints filed by investors alleged that various third party entities made misrepresentations concerning the safety of the investments and that Stanford’s attorneys conspired with and aided and abetted Stanford in violating the securities laws by lying to the SEC and assisting Stanford to evade regulatory oversight.

The District Court examined whether a covered security was applicable in the case because although the CD was not a covered security, the marketable securities purportedly backing the CD’s were a covered security.  During this analysis, the District Court used the Eleventh Circuit’s approach, which asks “whether a group of plaintiffs premise their claim on either ‘fraud that induced [the plaintiffs] to invest with [the defendants] … or a fraudulent scheme that coincided and depended upon the purchase or sale of securities.’” The District Court determined that the belief that the CD’s were backed by marketable securities induced the investors to purchase the CD’s.  Therefore, the District Court dismissed the investors’ claims.

On appeal, the Fifth Circuit reversed the decision, rejecting the test applied in the Eleventh Circuit and adopted the Ninth Circuit test: “A misrepresentation is ‘in connection with’ the purchase or sale of a security if there is a relationship in which the fraud and the stock sale coincide or are more than tangentially related.”  The Fifth Circuit relied on public policy considerations that requires interpretation of the “in connection with” element in a manner not to preclude group claims simply because the issuer advertises that it owns covered securities in its portfolio. 

In order to resolve the circuit split on the interpretation of SLUSA’s “in connection with” requirement, the Supreme Court granted certiorari. The issues considered by the highest court were the following: (1) whether the Securities Litigation Uniform Standards Act (SLUSA) precludes a state-law class action alleging a scheme of fraud that involves misrepresentations about transactions in SLUSA-covered securities; and (2) whether SLUSA precludes class actions asserting that defendants aided and abetted SLUSA-covered securities fraud when the defendants themselves did not make misrepresentations about the purchase or sale of SLUSA-covered securities.

Plaintiffs hinge part of their argument on the fact certificates of deposits were specifically excluded from Congress’s definition of “covered security” and request the Court uphold the 5^th Circuit’s ruling.  The defendants claimed that the application of federal law should be broad and because Stanford made the promise to back the CD’s with securities, the SLUSA effectively blocks the state causes of action.

During oral arguments, the nine justices gave no clear indication on how they will rule.  However, Justice Scalia’s questions and comments suggested he felt the suits could go forward because he read the statutory language “in connection with the purchase or sale of a covered security.”  Justice Alito, on the other hand, read “in connection with” broadly.  Stay tuned for and update when the court releases its ruling.