This article discusses the appeal ― to be argued in October 2013 ― in which the Supreme Court will consider whether the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) precludes investors’ state law class actions against third-party actors, where the complaints alleged a scheme of fraudulent misrepresentation about transactions in connection with SLUSA covered securities. The defendants seek reversal of a Fifth Circuit decision that declined to apply SLUSA’s preclusion provision, which essentially permitted the litigation against the defendants to proceed in federal court.
The underlying litigation involved the highly publicized $7 billion financial Ponzi scheme perpetrated by R. Allen Stanford. As a consequence of the alleged fraud, investors who purchased CDs from Stanford’s bank sued various law firms, insurance, and financial service companies in four state and federal securities fraud class actions. These consolidated appeals will garner extensive media attention, arising from the central colorful character of R. Allen Stanford, the extent of the fraud he perpetrated, and the ways in which Stanford personally dissipated nearly $7 billion dollars of his investors’ assets.
The cases before the Supreme Court, however, are not about Stanford or the primary defrauders, who now are in jail. In addition, the various Stanford entities are insolvent and in receivership. Instead, these appeals implicate the very important question of the ability of plaintiffs to seek recovery in class action litigation against third-parties whose actions arguably were peripheral to the original fraud.
The Court will address this question through a rather unglamorous exercise in statutory construction of the SLUSA statute, in the context of a complicated statutory scheme of securities laws. No doubt the Court’s starting point will be its recent Dabit opinion, coupled with commentary on the lower federal court’s subsequent interpretation of Dabit and SLUSA’s “in connection with” language. The Court will have to resolve the conflict on the circuits concerning whether the SLUSA language requires a broad or narrow reading to allow SLUSA preclusion to apply and require dismissal of the lawsuits.
The nub of the litigation centers on the statutory construction of SLUSA’s preclusion provision, especially the “in connection with” language. The leading Supreme Court decision construing SLUSA’s “in connection with” requirement held that “it is enough that the fraud alleged ‘coincide’ with a securities transaction ― whether by the plaintiff or someone else. In addition, the Court in Dabit endorsed a broad reading of SLUSA, in light of the reasons for its enactment.
The federal circuits are split concerning construction and application of SLUSA’s “in connection with” language and the Court’s interpretation in Dabit. The Second and Eleventh Circuits adopted the Dabit test asking whether the fraud and stock sale “coincide.” The Ninth Circuit rejected this formulation and added the requirement that the fraud and stock sale must be “more than tangentially related” and go to the heart or crux of the fraud. In absence of its own precedent, the Fifth Circuit followed the Ninth Circuit’s test.
The Court’s resolution of SLUSA’s reach entails a great deal at stake for potential third-party defendants such as the law firms, insurance companies, and other potential corporate defendants. These entities rely on SLUSA’s preclusion provision to insulate them from vexatious securities class action litigation based on state law claims. Consequently, a number of these groups have aligned as amici in support of the Defendants. In addition, potential third-party defendants fear that if the Court affirms the Fifth Circuit’s decision, this will encourage future plaintiffs to engage in artful pleading to intentionally evade SLUSA’s preclusion provision.
The plaintiffs contend that reversal of the Fifth Circuit’s decision will open to the door to SLUSA preclusion of an array of other financial and credit transactions, “or indeed transactions of any kind.” This would accomplish a radical expansion of federal regulatory authority over security fraud claims, with a concomitant diminishment of traditional state police and regulatory authority over garden-variety fraud claims. It also would frustrate the ability of large numbers of defrauded investors to seek relief through the class action mechanism.
It remains to be seen whether the Supreme Court decides these appeals based on narrow statutory construction grounds, or whether the Court decides to frame the issues in the context of broader federalism and policy concerns. If so, the Court’s conservative wing will be confronted with an interesting ideological tension between antipathy towards class litigation, pitted against a similar aversion towards expanding federal regulatory power.
Linda S. Mullenix, The $7 Billion Stanford Ponzi Scheme: Class Litigation Against Third Party Actors Under the Securities Litigation Uniform Standards Act, 41 Preview of United States Supreme Court Cases 33 (October 7, 2013).