Defrauded investors in a Ponzi scheme have a few choices
when the scheme goes bust. They can wait for a distribution from the insolvency
proceeding, or they can take matters into their own hands and form a class to
sue third parties for their damages. However, the Securities Litigation Uniform
Standards Act ("SLUSA") can impose a formidable barrier for those types of
class action suits.
SLUSA states, "No covered class action based upon the
statutory or common law of any State or subdivision thereof may be maintained
in any State or Federal court by any private party alleging a misrepresentation
or omission of a material fact in connection with the purchase or sale of a
covered security." 15 U.S.C. § 78bb(f)(1)(A).
The Supreme Court has agreed to hear an appeal in three
related cases in the Allen Stanford Ponzi scheme case on the significant
question of when SLUSA precludes investors' state law claims for relief against
The decision that the Supreme Court will review is the
Fifth Circuit's decision in Roland v.
Green, 675 F.3d 503 (5th Cir. 2012). The district court had before it three
state class actions to recover damages. In these suits, investors asserted a
range of claims under Texas and Louisiana law against a number of third party
defendants, including two law firms, Proskauer Rose and Chadbourne & Parke,
as well as an insurance brokerage, Willis of Colorado, Inc. These are the
parties that eventually petitioned the Supreme Court to hear the case.
In their complaints, the plaintiffs claimed that they
were misled into buying Stanford's International Bank's certificates of deposit
by several misrepresentations, including that SIB's assets were "invested in a
well-diversified portfolio of highly marketable securities issued by stable national
governments, strong multinational companies, and major international banks."
The plaintiffs alleged that law firms aided and abetted Stanford's fraud.
The defendants moved to dismiss under SLUSA, asserting
that the plaintiffs were claiming misrepresentations of material facts in
connection with the purchase of a "covered security." The district court agreed
Does "In Connection With" a "Covered Security" Mean?
The district court found that the SIB CDs themselves were
not "covered securities" within the meaning of SLUSA because SIB never
registered the CDs, nor were they traded on a national exchange. Nevertheless,
it held that the alleged misrepresentations were "in connection with" the
purchase of a "covered security," finding that:
The plaintiffs' "purchases of SIB CDs were
'induced' by the misrepresentation that SIB invested in a portfolio including
SLUSA-covered securities"; and
The plaintiffs' allegations "reasonably imply
that the Stanford scheme coincided with and depended upon the Plaintiffs' sale
of SLUSA-covered securities to finance SIB CD purchases."
On appeal, the Fifth Circuit reversed and reinstated the
plaintiffs' state law-based class action suits. Roland, 675 F.3d at 520. It reviewed the substantial conflicts in the
standards that the other courts of appeals had adopted on the issue of when a
misrepresentation is "in connection with the purchase or sale of a covered
security." The Fifth Circuit agreed with the standard that the Ninth Circuit
had adopted in Madden v. Cowen & Co.,
576 F.3d 957 (9th Cir. 2009): "Accordingly, if Appellants' allegations
regarding the fraud are more than tangentially related to (real or purported)
transactions in covered securities, then they are properly removable and also
precluded." Roland, at 520.
Applying that standard, the Fifth Circuit concluded that
the plaintiffs' "references to SIB's portfolio being backed by 'covered
securities' to be merely tangentially related to the 'heart,' 'crux,' or
'gravamen' of the defendants' fraud." Id.
at 521 (footnotes omitted). Rather, the court found that the "heart, crux, and
gravamen of their allegedly fraudulent scheme was representing to the
Appellants that the CDs were a 'safe and secure' investment that was preferable
to other investments for many reasons." Id.
Therefore, the Fifth Circuit rejected the district court's rationale that the
plaintiffs' purchases of SIB's CDs were induced by the misrepresentation that
SIB invested in a portfolio that included SLUSA-covered securities.
The district court had also concluded that the claimed
fraud was "in connection with" the sale of a security because to fund their
investments in SIB's fraudulent CDs, some plaintiffs had sold their existing,
unrelated securities. The Fifth Circuit also rejected that rationale, finding
that Stanford's scheme was focused not on persuading the plaintiffs to sell
their securities, but on selling the fraudulent CDs. Id. at 523.
Split in the Circuits
The standard adopted by the Fifth and Ninth Circuits - the
"more than tangentially related" test - is a narrow test, which results in the
dismissal of smaller group of these class action suits against third parties in
Ponzi scheme and other fraud cases.
On the other hand, the tests adopted by the Second, Sixth,
and Eleventh Circuits are broader and require the dismissal of a larger group
of these cases. Although these courts articulate their tests slightly
differently, each certainly would require the dismissal of the three cases in
Roland v. Green.
In Romano v.
Kazacos, 609 F.3d 512, 522 (2d Cir. 2010), the Second Circuit held that the
SLUSA requirement is met "where plaintiff's claims 'necessarily allege,'
'necessarily involve,' or 'rest on' the purchase or sale of securities." (This
was the test on which the district court relied in dismissing Roland v. Green.)
In Segal v. Fifth
Third Bank, N.A., 581 F.3d 305, 310 (6th Cir. 2009), the Sixth Circuit held
that SLUSA's "in connection with" requirement is satisfied when the fraud
"coincide[s] with" or "depend[s] upon" securities transactions. The Sixth
Circuit further held that SLUSA "does not ask whether the complaint makes
'material' or 'dependent' allegations of misrepresentations in connection with
buying or selling securities." Id. It
only "asks whether the complaint includes these types of allegations, pure and
simple." Id. at
In Instituto De
Prevision Militar v. Merrill Lynch, 546 F.3d 1340, 1349 (11th Cir. 2008),
the Eleventh Circuit held that a misrepresentation is made "in connection with"
a covered securities transaction so long as either an alleged misrepresentation
about a covered securities transaction "induced [plaintiff] to invest with
[defendant]," or the misrepresentation "coincided and depended upon the
purchase or sale of securities."
The Supreme Court's decision will likely turn on its
interpretation of its own precedent in SEC
v. Zandford, 535 U.S. 813, 824 (2002), and Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S.
In Zandford the
issue was when a misrepresentation is "in connection with" a securities sale,
as required to state a claim under § 10(b). The Court held that it is
sufficient if the misrepresentation "coincides" with the sale or purchase of a
covered security. However, the Court cautioned that "the statute must not be
construed so broadly as to convert every common-law fraud that happens to
involve [covered] securities into a violation of § 10(b)." 535 U.S. at 820.
In Dabit, the
Court addressed the SLUSA issue - when is a plaintiff's claim of a
misrepresentation "in connection with the purchase or sale" of a covered
security? In that case, the plaintiffs alleged in their state law fraud suit
that the defendants' misrepresentations induced them to hold their securities.
They had neither purchased nor sold a security as a consequence of the alleged
misrepresentations. The Supreme Court nevertheless held that SLUSA bars their
claims. It held that the SLUSA phrase "in connection with the purchase or sale
of a covered security" must be given the same "broad construction" as the
nearly identical "in connection with" language in § 10(b) itself, which
requires only that the "fraud alleged 'coincide' with a securities
transaction-whether by the plaintiff or by someone else." Dabit at 74, 85.
of the Outcome of Roland v. Green
The outcome of Roland
v. Green in the Supreme Court will directly impact the availability of
investors' remedies in many Ponzi scheme cases, where the perpetrator's promise
to invest in securities turns out to be wholly illusory. For example, as we
know, Bernard Madoff also falsely promised
securities investments. Madoff investors have the additional issue that many of
Madoff's victims invested not with him directly, but with feeder funds who in
turn invested with Madoff.
So, how will the Supreme Court resolve the conflict in
the circuits on this important issue?
Which test will it adopt?
Will Ponzi scheme victims be denied their
state law fraud claims that are based on false promises to invest in covered
Will their claims stand if they invested in
feeder funds that in turn invested with a schemer who falsely promises to
invest in covered securities?
This issue, along with other statutory and securities issues,
are covered in depth in chapter 10 of The
Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes (LexisNexis®
2012). Go to: www.theponzibook.com
for more information.
subscribers can access enhanced versions of the opinions and annotated versions
of the statutes cited in this article:
15 U.S.C. § 78bb
Roland v. Green, 675 F.3d 503 (5th Cir.
Madden v. Cowen & Co., 576 F.3d 957 (9th
Romano v. Kazacos, 609 F.3d 512 (2d Cir. 2010)
Segal v. Fifth Third Bank, N.A., 581
F.3d 305 (6th Cir. 2009)
Instituto De Prevision Militar v. Merrill Lynch,
546 F.3d 1340 (11th Cir. 2008)
SEC v. Zandford, 535 U.S. 813 (2002)
Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit,
547 U.S. 71 (2006)
Read additional articles at The Ponzi Scheme
Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal
Resource for Unraveling Ponzi Schemes (LexisNexis 2012), along with
Hon. Steven Rhodes. The Ponzi Book, recently reviewed by Commercial Crime International, is
available for purchase at www.lexisnexis.com/ponzibook, and more information about
the book can be found at www.theponzibook.com.
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