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From Securities Regulation Daily, September 16, 2013

SLUSA ensnares Madoff victims’ class action against banks

By Anne Sherry, J.D.

A Second Circuit panel today affirmed the Southern District of New York’s dismissal of a class action brought by victims of Bernard Madoff against JPMorgan Chase & Co. and the Bank of New York Mellon Corporation (BNY). The panel agreed with the district court that SLUSA precluded the class action, even though the investments that the plaintiff class purchased were not “covered securities” as defined in the statute, because the alleged misconduct was “in connection with” Madoff’s Ponzi scheme involving covered securities. The opinion was authored by Jed Rakoff of the Southern District of New York, sitting by designation (Trezziova v. Kohn, September 16, 2013, Rakoff, J.).

Allegations. The plaintiffs alleged fraud in connection with certain Madoff feeder funds. In particular, Neville Seymour Davis, the lead plaintiff for the class of investors in Thema International Fund plc, alleged that Thema represented that it selected investment vehicles carefully but, in fact, failed to do so and simply funneled investments to Madoff in exchange for fees. He brought claims against Thema and certain of its principals and third-party advisors; members of the Madoff family; and JPMorgan and BNY, which held Madoff’s accounts. Davis argued that JPMorgan had actual knowledge that Madoff’s company was violating its fiduciary duties and committing fraud but kept quiet and kept funneling money to Madoff. Similarly, according to the complaints, BNY knew that it was substantially assisting in the fraud but ignored the evidence of fraud and failed to disclose it.

Covered securities. The district court dismissed the claims as precluded by SLUSA and preempted by New York’s Martin Act. Stressing Congress’ purpose to negate the artful pleading that was an unintended consequence of the PSLRA, the Second Circuit panel on appeal noted that SLUSA is broadly worded to preclude any state securities fraud action brought on behalf of more than 50 persons in connection with a covered security. The parties conceded that the foreign feeder funds are not “covered securities,” but the district court found that, as Madoff’s trading strategy used covered securities, and all of the claims of misconduct arose “in connection with” that fraud, SLUSA applied.

Affirmance. The appeals court was unswayed by the plaintiffs’ contention that Madoff’s “downstream” transactions in covered securities did not subject their “uncovered” interests to SLUSA preclusion. This argument ignores that, on the face of the complaints, the banks’ liability is predicated not on their relationship with the plaintiffs or their investment in the feeder funds but rather on the banks’ relationship with and alleged assistance to the Madoff Ponzi scheme. This scheme “indisputably engaged in purported investments in covered securities on U.S. exchanges,” the panel noted, and SLUSA precluded the class action.

The panel also agreed with the district court that the allegations were precluded by SLUSA, despite not being styled as securities fraud claims. The complaints charge that JPMorgan and BNY were complicit in Madoff’s fraud, more than meeting SLUSA’s requirement that the complaint allege a “misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.”

Claims against other defendants. In a non-precedential summary order filed simultaneously with its opinion as to the banks, the court affirmed the district court’s dismissal of the claims against all other defendant-appellees on procedural grounds.

The case is No. 12-156-cv.

Attorneys: Timothy Joseph Burke (Stull, Stull & Brody) for Dana Trezziova. Albert Y. Chang (Bottini & Bottini Inc.) for Neville Seymour Davis. Nathan Daniel Adler (Neuberger, Quinn, Gielen, Rubin & Gibber, P.A.) for Sonja Kohn.

Companies: Bank of New York Mellon Corporation; JPMorgan Chase & Co.; Thema International Fund plc

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