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!
