The Securities Litigation Uniform Standards Act of 1998
or SLUSA was passed to prevent a class action plaintiff from circumventing the
stringent pleading requirements of the Private Securities Litigation Reform Act
by filing in state court. The Third, Sixth and Ninth Circuits have developed
different approaches to the application of SLUSA. The Seventh Circuit recently
disagreed with the approach of the Ninth Circuit, but concluded that under the
approach of the Sixth or one approaching that of the Third, an action brought
in state court centered on a claimed breach of fiduciary duty tangled with a
misrepresentation claim was properly dismissed under the Act. Brown v.
Calamos, No. 11-1785 (7th Cir. Decided Nov. 10, 2011).
Plaintiff brought a state court class action centered on
a claim that an investment adviser breached its fiduciary duty by redeeming
auction market preferred stock or AMPS to placate banks and brokers important
to other funds in the family. The suit was brought on behalf of the owners of
the common stock of Calamos Convertible Opportunities and Income Fund, a
closed-end investment fund. The defendants are the adviser, the fund and the
parent's board of trustees.
AMPS are preferred shares in the fund. They payed an
interest rate recomputed at short intervals at auctions. The auctions gave the
AMPS shareholders liquidity. The funds from the purchase of the preferred
shares are pooled with the money from the common shareholders. The AMPS were
essentially a kind of non-redeemable bond which gave the fund inexpensive
financing. When the auctions failed the AMPS shareholders demanded redemption.
The investment adviser redeemed the shares although there was no obligation.
This reduced the liquidity of the fund and its leverage. Additional money was
borrowed but at a higher interest rate.
The complaint claims that the redemption constituted a
breach of fiduciary duty and that it was undertaken to maintain relations with
investment bankers which were essential to other funds managed by the adviser.
It also contains a disclaimer which specifies that it does not contain a fraud
claim. Following removal the district court dismissed the case under SLUSA.
SLUSA prohibits securities class actions of more than 50
members based on state law alleging a misrepresentation or omission of a
material fact in connection with the purchase or sale of a covered security. A
covered security is one traded nationally and listed on a regulated national
exchange. Once a case is removed from state court the district court has two options.
First, if the case falls within the ambit of SLUSA the court must grant a
motion to dismiss. This is an adjudication on the merits. If however the suit
is not within the purview of the statute then it must be remanded to state
court. In that event the district court has no jurisdiction to hear the case.
Three approaches have evolved to the application of
SLUSA. Under the literalist approach of the Sixth Circuit if the complaint can
be interpreted as containing a misrepresentation and the other requirements of
the Act are met, it must be dismissed. The Third Circuit, in contrast, has
concluded that if a misrepresentation or material omission is not essential to
the success of the plaintiff's claim, it is not a bar to the suit. The Ninth
Circuit takes an intermediate approach which permits the complaint to be
dismissed but without prejudice. Plaintiffs can then file an amended complaint
in state court without the misrepresentation.
In this case the Seventh Circuit concluded that the suit
was properly dismissed. The approach of the Ninth Circuit is contrary to the
Act the Court found. The plaintiff here however "must lose even under a looser
approach than the Sixth Circuit's (not the Ninth Circuit's approach, however,
but one close to the Third Circuit's), whereby suit is barred by SLUSA only if
the allegations of the complaint make it likely that an issue of fraud will
arise in the court of the litigation - as in this case. The allegation of fraud
would be difficult and maybe impossible to disentangle from the charge of
breach of the duty of loyalty that the defendants owed their investors." Under
these circumstances, and despite the disclaimer in the complaint, the suit is
barred by SLUSA.
For more cutting edge commentary on developing
securities issues, visit SEC Actions, a blog by Thomas
more information about LexisNexis products and solutions connect with us
through our corporate site.