A little over a year ago, the U.S. Supreme Court decided to tackle the issue of the scope of the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). SLUSA was passed in reaction to plaintiffs’ tactics in evading the strict standards enunciated in the Private Securities Litigation Reform Act (“PLSRA”). Instead of adhering to the PSLRA, plaintiffs’ lawyers attempted to skirt the legislation by filing securities actions in the guise of state law claims. This allowed what looked and felt like securities actions to be filed in state court, without the PSLRA’s stringent pleading standards and discovery limitations, for example. Enter SLUSA, which, among other things, called for class actions within its reach to allege “a misrepresentation or omission of a material fact in connection with the purchase or sale” of securities covered by the statute. 15 U.S.C. section 78bb(f)(1)(A) (emphasis added).
Earlier this month, the Supreme Court decided Chadbourne & Park v. Troice, No. 12-79. At issue in Chadbourne was what exactly SLUSA’s “in connection” language means. (See my post from Jan. 24, 2013.) The case consisted of three consolidated cases arising from the Standford Ponzi scheme. Plaintiffs had purchased certificates of deposit (“CDs”) from entities controlled by Stanford, and sued Stanford’s bank, its insurance brokers and its lawyers. The CDs at issue were not in and of themselves covered securities within the meaning of SLUSA. But the defendants argued that a representation that the CDs were backed by covered securities helped induce the plaintiffs’ purchase of CDs and that some buyers had sold covered securities to fund the purchase of CDs.
The district court agreed with defendants, and held that plaintiffs’ state law claims were preempted by SLUSA. The Fifth Circuit reversed, holding that state law claims are only precluded by SLUSA if “there is a relationship in which the fraud and the stock sale coincide or are more than tangentially related.”
The Supreme Court affirmed, articulating its own test. Justice Breyer wrote the decision for the majority, holding that “a fraudulent misrepresentation or omission is not made ‘in connection with’ … a ‘purchase or sale of a covered security’ unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a ‘covered security.”
In dissent, Justice Kennedy, joined by Justice Alito, argued that SLUSA must be read broadly to protect the securities markets as intended: The Court’s narrow reading of the statute will permit proliferation of state-law class actions, forcing defendants to defend against multiple suits in various state fora. This state-law litigation will drive up legal costs for market participants and the secondary actors, such as lawyers, accountants, brokers, and advisers, who seek to rely on the stability that results from a national securities market regulated by federal law….The purpose of the Act is to preclude just these suits.”
The obvious upshot of the decision is that plaintiffs will attempt to file more cases in state court in situations where the alleged fraud was not directly related to the sale of securities under SLUSA. This is not the first decision by the Court addressing the state-federal divide in the filing of class actions, as the Court has also decided two cases under the Class Action Fairness Act (“CAFA”) recently. (See my post from Jan, 17, 2014.) While these decisions on the whole do not favor state or federal court, continue to expect the Court to define the state-federal divide in coming Terms. The issue, whether it arises under SLUSA, CAFA or another statute or legal doctrine, remains one of the most important in class action law today.