In a legal environment that seems to be growing increasingly difficult for Ponzi scheme victims to recover their losses, the United States Supreme Court gave a group of defrauded investors some welcome news. The Court issued its decision in Chadbourne & Park LLP v. Troice et al., 2014 U.S. LEXIS 1644 (Feb. 26, 2014) in a 7 -2 vote, allowing lawsuits by a class of victims of R. Allen Stanford and Stanford Financial against two law firms, an insurance brokerage firm and a financial services firm to proceed [an enhanced version of this opinion is available to lexis.com subscribers].
The case involved an appeal over the issue of whether the Securities Litigation Uniform Standards Act of 1998 (SLUSA) bars the investors’ lawsuits which allege that some of the defendants misrepresented that certificates of deposits sold by Stanford were safe investments and that the law firms helped Stanford evade regulatory oversight.
The SEC and the Obama administration had filed amicus briefs in support of the defendants’ positions, supporting the application of SLUSA to bar the victims’ claims. The Ponzi Scheme Blog in October 2013 questioned why the SEC would be supportive of a position that would deny recovery to Ponzi scheme victims. The Supreme Court’s recent ruling pretty handily shut down the government’s position in the Stanford case.
SLUSA is a federal law that bars class-action lawsuits related to securities fraud that are brought under state law. In Troice, the Court summarized the issues and its conclusion as follows:
The question before us is whether the Litigation Act encompasses a class action in which the plaintiffs allege (1) that they "purchase[d]" uncovered securities (certificates of deposit that are not traded on any national exchange), but (2) that the defendants falsely told the victims that the uncovered securities were backed by covered securities. We note that the plaintiffs do not allege that the defendants' misrepresentations led anyone to buy or to sell (or to maintain positions in) covered securities. Under these circumstances, we conclude the Act does not apply.
Boiled down to its simplest form, the main questions considered by the Court were:
-Are the Stanford CDs “covered securities”?
-What do the words “in connection with” mean under SLUSA?
If the CDs were not “covered securities” or if they were but the alleged purchase or sale of a covered security was not “in connection with” an untrue statement or omission of material fact, then the cases could proceed under SLUSA.
Is a CD a security and, if so, is it a “covered security”?
The Court found that the Stanford CDs did not fall within SLUSA’s definition of a “covered security”:
The law defines ‘covered security’ narrowly. It is a security that “satisfies the standards for a covered security specified in paragraph (1) or (2) of section 18(b) of the Securities Act of 1933.” §78bb(f)(5)(E). And the relevant paragraphs of §18(b) of the 1933 Act define a “covered security” as "[a security] listed, or authorized for listing, on a national securities exchange. . . The Litigation Act also specifies that a "covered security" must be listed or authorized for listing on a national exchange "at the time during which it is alleged that the misrepresentation, omission, or manipulative or deceptive conduct occurred." §78bb(f)(5)(E).
The Court did not challenge or dispute the notion that the CDs are “securities” – noting that the SEC brought an action against Stanford on that basis – but concluded that the CDs were not “covered securities.”
In other words, if there is no “covered security,” there is no protection for the defendants under SLUSA. And even if the transaction related to a covered security, the Court noted that the connection only matters if the decision to buy or sell a security is by someone other than the fraudster:
A fraudulent misrepresentation or omission is not made “in connection with” such 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.”
The Court noted, “If the only party who decides to buy or sell a covered security as a result of a lie is the liar, that is not a ‘connection’ that matters.”
Majority’s Strong Criticism of the Dissent
The majority opinion disagreed with the two dissenting justices (Justices Kennedy and Alito) on the subject of whether the ruling would have the impact on the securities market threatened by the dissent. Among other things, the dissent argued, "The 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 majority responded to the dissent’s concerns about the protection of the securities market:
Lingering Questions About Application of SLUSA in Fraud Cases
The Troice opinion gives the Stanford victims the opportunity to pursue recourse against alleged wrongdoers – a good thing in the face of minimal recoveries coming out of the Stanford receivership to date. Of course, the defendants in the litigation have stated their intention to file motions to dismiss in the remanded cases on other grounds, so it remains to be seen what actually recovery will ultimately be obtained for the victims through these class actions.
So while the result appears to be the right one in this case, it does cause one to question the value of SLUSA in other fraud cases. Does this opinion put form over substance, giving relief to the Stanford investors simply because CDs were involved? What about the Madoff victims? They, like the Stanford victims, bought into a fraud and didn’t actually acquire securities – whether “covered” or uncovered – yet Madoff class actions have been barred by SLUSA. See Trezziova v. Kohn (In re Herald, Primeo, and Thema), 730 F.3d 112 (2d Cir. 2013) (“[W]e agree with the district court that the fact that Madoff Securities may not have actually executed their pretended securities trades does not take this case outside the ambit of SLUSA”) [enhanced version]; see, also, Select, L.P. v. Tremont Group Holdings, Inc., 2013 U.S. Dist. LEXIS 125550 (S.D.N.Y. Sept. 3, 2013) [enhanced version].
Worse yet for Madoff victims, the findings in Troice could have adverse consequences for them in a context other than SLUSA. The Madoff trustee is currently appealing an adverse ruling under Bankruptcy Code section 546(e) which bars certain of his claims to recover fraudulent transfers on transactions relating to securities. If these federal statutes apply whether or not securities were actually purchased, Troice may add insult to injury to the Madoff victims.
Is it fair to give relief to one set of victims but not the other? Both cases involved massive Ponzi schemes in which victims invested in phony securities and lost their money. What is the difference? Should SLUSA apply where victims thought they were buying covered securities but in fact were buying nothing at all?
Read additional articles at The Ponzi Scheme Blog
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 the ABI Journal and 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.
Kathy is also the author of is Ponzi-Proof Your Investments: An Investor’s Guide to Avoiding Ponzi Schemes and Other Fraudulent Scams. For more information, or to purchase the book, click here.
Watch Kathy’s interview on The Not So Legal Show.
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