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From Securities Regulation Daily, February 26, 2014

Supreme Court rejects broad interpretation of SLUSA in Stanford Ponzi scheme case

By Jim Hamilton, J.D., LL.M.

The U.S. Supreme Court ruled that the Securities Litigation Uniform Standards Act did not preclude a state-law class action based on misrepresentations concerning uncovered certificates of deposit that were said to be backed up by covered securities. SLUSA precludes most state-law class actions in which the plaintiffs allege misrepresentations in connection with the purchase or sale of a covered security. The term “covered security” encompasses securities listed on a regulated national exchange (Chadbourne & Parke, LLP v. Troice, February 26, 2014, Breyer, S.).

Writing for the Court, Justice Breyer said that SLUSA did not apply to the purchase of certificates of deposit that were not traded on any national exchange, but which the defendants falsely represented as backed by covered securities. The Court noted that the investors did not allege that the defendants’ misrepresentations led anyone to buy or to sell covered securities. The basic consequence of the Court’s holding is that, without limiting the federal government’s prosecution power in any significant way, the ruling will permit victims of this type of fraud and similar frauds to recover damages under state law. Justice Thomas filed a concurring opinion. Justice Kennedy dissented, joined by Justice Alito. 

Background. The case arose from a multi-billion-dollar Ponzi scheme run by Allen Stanford and various entities that he controlled, including a bank that issued fixed-return certificates of deposit (CDs) that the bank falsely claimed were backed by safe, liquid investments. In fact, the claimed investments did not exist, and the bank had to use new CD sales proceeds to make interest and redemption payments on pre-existing CDs.

Procedural history. After the fraud was discovered, two groups of Louisiana investors filed suits in state court against a number of Stanford companies and employees claiming violations of Louisiana law. The defendants removed the Louisiana cases to federal court, and all of the actions were ultimately transferred to the Northern District of Texas, which dismissed the complaints as precluded under SLUSA.  The district court held that, while the CDs themselves were not “covered securities,” the plaintiffs had nevertheless alleged misrepresentations made in connection with transactions in covered securities: namely, that the bank said that it invested its assets in highly marketable securities issued by stable governments and strong multinational companies. The district court found that the bank led the plaintiffs to believe that the CDs were backed, at least in part, by investments in SLUSA-covered securities.

The Fifth Circuit reversed, deeming the references to the bank portfolio being backed by covered securities to be merely tangentially related to the heart of the defendants’ fraud.  Misrepresentations about the investments were only one of a host of misrepresentations, reasoned the appeals court, which also observed that, because the CDs promised a fixed rate of return, they were not tied to the success of any of the bank’s purported investments in covered securities.

SLUSA scope. The Supreme Court said that several factors supported the conclusion that the reach of SLUSA’s phrase “misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security” does not extend further than misrepresentations that are material to the decision by one or more individuals (other than the fraudster) to purchase or sell a covered security. The Act focuses upon transactions in covered securities, noted the Court, not upon transactions in uncovered securities. The Court reasoned that an interpretation that insists upon a material connection with a transaction in a covered security is consistent with the Act’s basic focus.

Moreover, the Court read SLUSA in light of and consistent with the underlying regulatory statutes: the Securities Exchange Act and the Securities Act. The regulatory statutes refer to persons engaged in securities transactions that lead to the taking or dissolving of ownership positions. In addition, they make it illegal to deceive a person when he or she is doing so. Both language and purpose suggest a statutory focus upon transactions involving the statutorily relevant securities, said the Court. Nothing in the regulatory statutes suggests that their object is to protect persons whose connection with the statutorily defined securities is more remote than words such as “buy” and “sell” indicate, reasoned the Court, nor does anything in SLUSA provide a reason for interpreting its similar language more broadly.

Addressing the dissenting opinion, the majority conceded that its decision means that a bank, chartered in Antigua whose sole product was a fixed-rate debt instrument not traded on a U.S. exchange, would not be able to claim the benefit of preclusion under SLUSA. According to the majority, the federal securities laws should not be concerned with shielding such entities from lawsuits.

The case is Nos. 12–79, 12–86, and 12–88.

Attorneys: Walter Dellinger (O'Melveny & Myers LLP) for Chadbourne & Parke LLP. Thomas C. Goldstein (Goldstein & Russell, P.C.) for Samuel Troice, et al.

Companies: Stanford International Bank; Chadbourne & Parke LLP; Willis of Colorado Incorporated; Proskauer Rose LLP

MainStory: TopStory FraudManipulation

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