Supreme Court Rules in Favor of Stanford Fraud Victims’ Ability to Bring State Law Claims

When I covered Chadbourne & Parke LLP v. Troice during oral arguments in the Supreme Court, I promised I would update you when the High Court rendered its decision.     

Yesterday, the Supreme Court decided in a 7-2 decision whether investors in a 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 certain class action plaintiffs from bringing state law claims based on misrepresentations made “in connection with the purchase or sale of a covered security.”  SLUSA narrowly defines “covered security” as “[a security] listed, or authorized for listing, on a national securities exchange” such of which must be listed or authorized to be listed “at the time during which it is alleged that the misrepresentation, omission, or manipulative or deceptive conduct occurred.”

The class action at the center of this case concerned a Ponzi scheme by R. Allen Stanford involving certificates of deposits (“CDs”) sold to investors.  Part of the misrepresentations made to the investors were that the CDs were backed by a portfolio of marketable securities.  Recovery against Stanford has been unsuccessful, with investors receiving about a penny on the dollar for their losses, so the victims brought claims against various third-party entities alleging they 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 central question of the case was whether the purported securities-backed CDs sold to investors qualified the transactions as a covered security.  Plaintiffs argued that since SLUSA specifically exempted CDs from the definition of a covered security, they were not preempted from bringing state law claims.  Defendants, however, argued that since Stanford represented that the CDs were backed by marketable securities, a covered security under SLUSA, plaintiffs were barred from asserting state law claims. 

The test applied by the District Court, used in the Eleventh Circuit, 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.’”  Since the District Court determined that the investors were induced to purchase the CDs under the belief that they were backed by marketable securities, it denied plaintiffs’ state law claims. 

On appeal, the Fifth Circuit reversed the decision, rejecting the test applied in the Eleventh Circuit and instead adopting 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 upholding the Fifth Circuit’s decision, the Supreme Court relied on several factors.  First, the basic focus of SLUSA seeks to include transactions in covered securities, not upon transactions in uncovered securities.  Second, a natural reading of SLUSA’s language supports the interpretation that a connection between the representation and a sale matters where the misrepresentation makes a significant difference to someone’s decision to purchase or to sell a covered security, not to purchase or to sell an uncovered security.  The Supreme Court noted that the plaintiffs never alleged the defendants’ misrepresentations led anyone to buy or to sell (or to maintain positions in) covered securities.  Third, the Supreme Court found that prior case law supports its interpretation because every securities case brought before the Court where fraud was “in connection with” a purchase or sale of a security has involved a covered security as defined by SLUSA. 

In its fourth point, the Supreme Court pointed out that their interpretation of SLUSA was consistent with the underlying regulatory statutes: the Securities Exchange Act of 1934 and the Securities Act of 1933.  The opinion states, “[n]ot only language but also purpose suggests a statutory focus upon transactions involving the statutorily relevant securities” and nothing in those acts or SLUSA provides a reason for interpreting its language more broadly.  Writing for the majority, Justice Breyer went on to explain that “to interpret the necessary statutory “connection” more broadly…would interfere with state efforts to provide remedies for victims of ordinary state ­law frauds.”  For instance, the Court noted that a broader interpretation would allow SLUSA to prohibit a lawsuit brought by creditors of a small business that falsely represented it was creditworthy, in part because it owns or intends to own exchange-traded stock.

Finally, the majority rejected the dissent’s argument that the Court’s ruling would significantly curtail the SEC’s enforcement powers, especially since enforcement powers are enumerated in other statutes and the dissent could not point to one example of a federal securities action—public or private—that would now be impermissible under the Court’s decision.   

While the case did not consider the merits of the plaintiffs’ claims, it allows the victims to proceed in their fight to recovery for the billions lost in the Ponzi Scheme. 

*I owe credit to this prompt update to Gerhard Petzall, an attorney here in St. Louis who started his own firm in 1963.  Meeting him for the first time last night at a high school mock trial competition, we sparked up a conversation about securities law and how technology has changed the landscape of our profession and personal lives.  I had extreme admiration for the fact that Gerhard practiced during a time where information was not readily at your fingertips the way it is now.  I couldn't even imagine.  Gerhard read about the Supreme Court decision in the financial section of the newspaper.  I told him that I believed I sat near him for a reason because I had been following this case and had been waiting for the decision to be released.  Had he not mentioned it, I might not have gotten the news right away.  We had a good laugh and I promised him that I would make sure to give him credit when I wrote my article.  Since I keep my promises, thank you Gerhard! 

U.S. Supreme Court Upholds Narrow Grounds for Vacating an Arbitration Award in Sutter v. Oxford Health Plans

In today’s world, parties are often encouraged to settle legal disputes through means of alternative dispute resolution such as arbitration.  However, in order to prevent the losing party to an arbitration dispute from essentially requesting the court to re-try the case, the Federal Arbitration Act (“FAA”) provides very narrow grounds for vacatur of an arbitration award.  Section 10 of the FAA allows an arbitration award to be vacated when the award was procured by fraud or corruption, where the arbitrator was guilty of misconduct, misbehavior or evident partiality, or where the arbitrator exceeded his authority.

In Sutter v. Oxford Health Plans, Respondent John Sutter, a pediatrician, provided medical services to the members of Oxford Health Plans' (“Oxford”) network under a fee-for-services contract that required binding arbitration of contractual disputes.  However, when a contractual dispute arose, Sutter joined a class action with other physicians, alleging that Oxford failed to make full and timely payments.  The court granted Oxford’s motion to compel arbitration and referred the claims to arbitration.  The parties agreed that the arbitrator should decide whether the contact authorized class arbitration.  The arbitrator reasoned that the parties’ agreement barred the parties from bringing any civil action in court and thus, the intent of the clause was to “vest in the arbitration process everything that is prohibited from the court process.”  The arbitrator found that class actions are clearly the type of claim that could be brought in court absent the parties’ agreement and, therefore, the arbitration clause expressed the parties’ intent to provide for class arbitration.

Oxford filed a motion to vacate the arbitrator’s decision in federal court on the grounds that the arbitrator exceeded his powers under §10(a)(4) of the FAA.  The District Court of New Jersey denied the motion and the Court of Appeals for the Third Circuit affirmed.

While the arbitration was pending, the United States Supreme Court held in Stolt-Nielsen that "a party may not be compelled under the FAA to submit to class arbitration unless there is no contractual basis for concluding that the party agreed to do so." 559 U.S. at 684. The parties in Stolt-Nielsen had stipulated that they had never reached an agreement on class arbitration.  Therefore, the arbitrator had no basis for finding that the parties’ intended for the arbitration clause to include class arbitration.  The Supreme Court vacated the arbitrator’s decision pursuant to §10(a)(4) of the FAA because the arbitrator exceeded his powers.

In light of Stolt-Nielsen, Oxford requested that the arbitrator reconsider his decision allowing class arbitration. The arbitrator issued a new opinion finding that Stolt-Nielsen had no effect on the case because unlike Stolt-Nielsen, the parties disputed the meaning of their contract and agreed that the arbitrator should interpret that meaning.

Oxford filed another motion to vacate in federal court which the District Court of New Jersey again denied and the Court of Appeals for the Third Circuit affirmed.  The Third Circuit held that if the arbitrator makes a good faith attempt to interpret an agreement, “even serious errors of law or fact will not subject his award to vacatur.” 675 F.3d at 220.

On certiorari, the Supreme Court affirmed the decision of the Third Circuit reasoning that vacatur of an arbitrator’s decision only occurs in very limited circumstances. Justice Kagan’s opinion provided that allowing parties to take full legal and evidentiary appeals would cast arbitration as a “prelude to a more cumbersome and time-consuming judicial review process."  Thus, parties requesting vacatur where the arbitrator exceeds his powers under §10(a)(4) of the FAA bear a heavy burden and must show more than serious error.  The Court found that because the parties bargained for the arbitrator’s construction of the agreement, a decision that even arguably construes or applies the contract must be upheld even if the Court disagrees with the arbitrator’s interpretation.

Oxford argued, relying solely on Stolt-Nielsen, that the high burden of §10(a)(4) is overcome when an arbitrator imposes class arbitration without a sufficient contractual basis.  However, the Court disagreed with Oxford’s interpretation of Stolt-Nielsen and noted that the arbitral decision in Stolt-Nielsen lacked any contractual basis for class-actions because the parties entered into a stipulation that they had never reached an agreement on class arbitration.  Thus, the arbitrator’s decision could not have been based on the parties’ contractual intent.

In sum, the Court stated, “convincing a court of an arbitrator's error – even his grave error – is not enough. So long as the arbitrator was ‘arguably construing’ the contract…a court may not correct his mistakes under §10(a)(4). The potential for those mistakes is the price of agreeing to arbitration. As we have held before, we hold again: ‘It is the arbitrator's construction [of the contract] which was bargained for; and so far as the arbitrator's decision concerns construction of the contract, the courts have no business overruling him because their interpretation of the contract is different from his.”

The lesson to be learned from Oxford Health Plan is if a company wants to avoid class actions/arbitrations, its agreements should include an express class action waiver because an arbitrator’s construction of that agreement is given substantial deference.