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The Supreme Court Narrows SLUSA's Reach and Expands the Pool of Potential Defendants Subject to State Securities Law Class Actions

On February 26, 2014, the United States Supreme Court limited the reach of the Securities Litigation Uniform Standards Act of 1998 (SLUSA), thereby increasing the number of individuals and entities that may be surprised to find themselves defendants in state securities law class actions.  Specifically, in Chadbourne & Parke LLP v. Troice et al., 571 U.S. ___, Nos. 12-79, 12-86 and 12-88 (2014), the United States Supreme Court held that SLUSA does not preclude class actions brought under state securities laws based on purchases or sales of uncovered securities, even if the transaction or investment -- at some level -- may involve covered securities.  This means that managers, investment advisers, and professional advisors for funds selling uncovered securities (i.e., any security that is not sold on a national securities exchange or issued by an investment company) are potentially not covered by SLUSA's protection, even if those funds invest in covered securities.  The Court was able to reach its result through an application of the "in connection with" clause that the dissent argued was inconsistent with the previously expansive interpretation given that clause.  Please click on the link below for a more detailed discussion of Chadbourne and its potential impact.

SLUSA limits a plaintiff’s ability to bring a state-law-based class action lawsuit alleging a misrepresentation, material omission or deceptive practice “in connection with the purchase or sale of a covered security.”  15 U.S.C. §§ 78bb(f)(1)(A) & (B).  Under SLUSA, as under the Securities Act of 1933, a “covered security” is “[a security] listed, or authorized for listing, in a national securities exchange” or a security issued by an “investment company.”  15 U.S.C. §§ 77r(b)(1)- (2) & 78bb(f)(5)(e).

In Chadbourne, a case stemming from Allen Stanford’s multibillion-dollar Ponzi scheme, investors allegedly purchased an uncovered security, bank certificates of deposit (“CDs”), based on misrepresentations that the  CDs were, or would be, backed by investments in, among other assets, covered securities.  The Court noted that the law “defines ‘covered security’ narrowly.”  In a 7-2 opinion authored by Justice Breyer and joined by Chief Justice Roberts and Justices Scalia, Thomas, Ginsburg, Sotomayor and Kagan, the Court concluded that SLUSA does not preclude state-law-based actions filed against those who allegedly assisted in some of the fraudulent sales of Stanford International Bank CDs.  Thus, even though the defendant allegedly made false statements to the effect that the Bank held significant holdings of “highly marketable securities issued by stable governments [and] strong multinational companies,” the Court so held because the certificates of deposit at issue were undisputedly not covered securities under SLUSA. The Court reasoned that the securities laws are concerned with “transactions that lead to the taking or dissolving of ownership positions,” and under SLUSA, the only ownership positions that are subject to federal preclusion involve covered securities, not CDs or other uncovered securities.

In a brief concurring opinion, Justice Thomas recognized that Court was engaging in somewhat arbitrary line drawing, noting that the phrase “in connection with” is “essentially indeterminate because connections, like relations stop nowhere.”  Justice Thomas ultimately joined the majority because “the opinion of the Court resolves this case by applying a limiting principle to the phrase ‘in connection with’ that is consistent with the statutory framework and design” of the federal securities laws.

In a dissenting opinion, Justice Kennedy, joined by Justice Alito, pointed out that increased state-law litigation will put a “serious burden . . . on attorneys, accountants, brokers, and investment advisers nationwide; and that burden itself will make the national securities markets more costly and difficult to enter.”  The dissent feared that the majority’s holding “will permit a proliferation of state-law class actions” and “will drive up legal costs for market participants . . . who seek to rely on the stability that results from a national securities market regulated by federal law.”  The dissent also reasoned that the majority reversed direction from the Court’s previous holdings that construed “in connection with” broadly under both SLUSA and Section 10(b) of the Securities Exchange Act of 1934.  See, e.g., Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006); SEC v. Zandford, 535 U.S. 813 (2002).

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Joel D. Rothman

Special Counsel

Joel D. Rothman is an attorney who handles commercial, securities, insurance, and employment litigation matters for Mintz clients. Joel advises institutional investors on securities class actions, represents shareholders in merger disputes, and counsels insurers in coverage disputes.