U.S. Supreme Court: SLUSA Does Not Preempt Stanford Ponzi Scheme Victims’ State Law Claims

U.S. Supreme Court: SLUSA Does Not Preempt Stanford Ponzi Scheme Victims’ State Law Claims

 The state law fraud claims of certain victims of the Stanford Ponzi scheme against various law firms and brokerage firms are not precluded under the Securities Litigation Uniform Standards Act (“SLUSA”) and plaintiffs therefore may pursue their state law class actions against the defendants, according to a February 26, 2014 decision from the U.S. Supreme Court. The Court’s opinion in Chadbourne & Parke, LLC v. Troice can be found here [an enhanced version of this opinion is available to lexis.com subscribers].  

The Court rejected the defendants’ arguments that – even though the certificates of deposit the plaintiffs purchased from the Stanford International Bank were not “covered securities” under the statute – SLUSA nevertheless precluded the plaintiffs’ state court claims because the investors had been told the CD sales proceeds would be invested in securities of a type that would represent “covered securities”under SLUSA.

In an opinion written by Justice Stephen Breyer for a 7-2 majority (with Justices Kennedy and Alito dissenting), the Court held that SLUSA does not apply because “there is not the necessary ‘connection’ between the materiality of the misstatement and the statutorily required ‘purchase or sale of a covered security.’” The Court’s clarification of SLUSA’s scope could help eliminate confusion about SLUSA’s preclusive effects that has divided the lower courts. The Court’s ruling will permit at least some claimants to pursue state law claims that a broader reading of SLUSA would have precluded.


Congress enacted SLUSA in 1998 in order to prevent erstwhile securities law claimants from circumventing the restrictions of the Private Securities Litigation Reform Act (PSLRA) by filing their claims in state court under state law. As the Supreme Court said in 2006 in the Dabit case [enhanced version], “To stem the shift from Federal to State courts and to prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives of the [PSLRA], Congress enacted SLUSA.”

SLUSA precludes most state-law class actions involving a “misrepresentation” made “in connection with the purchase or sale of a covered security.” The lower courts have wrestled with the question of what it required in order to satisfy the “in connection with” requirement and trigger SLUSA preclusion.

In these cases arising out of the Stanford Ponzi scheme scandal, the investor plaintiffs contend they were misled to believe that the CDs in which they invested were backed by quality securities traded on major exchanges (though it later appeared that the CDs in fact had little or nothing behind them). The defendants – two law firms, an insurance brokerage firm and an investment firm — moved to dismiss the state law class actions that had been filed against them, arguing that, though CDs themselves were not “covered securities” within the meaning of SLUSA, the state court class action claims were nevertheless precluded under SLUSA because the plaintiffs claimed they were induced to purchase the securities by misrepresentation that the CDs were backed by SLUSA-covered securities.

The district court before which the cases were consolidated granted the defendants’ motions to dismiss and the plaintiffs appealed. In a March 19, 2012 opinion (here), a three-judge panel of the Fifth Circuit reversed the district court, specifically holding that the alleged purchases of covered securities that back the CDs were “only tangentially related to the fraudulent scheme” and therefore that SLUSA does not preclude the plaintiffs from using state class actions to pursue their claims.

The defendants filed a petition to the U.S. Supreme Court for a writ of certiorari. In its petition, the defendant Chadbourne & Parke law firm argued that split in authority among the various circuit courts has resulted in inconsistent interpretations and applications of SLUSA preclusion. The firm argued that the Fifth Circuit had adopted an interpretation of the “in connection with” standard that resulted in a determination that SLUSA preclusion did not apply, allowing the case against the firm to go forward, while at the same time rejected a conflicting standard prevailing in the Second, Sixth and Eleventh Circuits that would have resulted in the application of SLUSA preclusion here. The petitioners argued that the Circuit split not only threatened inconsistent outcomes among the Circuits, but it frustrated the very purposes for which Congress enacted SLUSA – that is to establish “national standards” for class actions “involving nationally traded securities.”

The Court’s Opinion      

In its opinion, the majority affirmed the Fifth Circuit and ruled that because “the plaintiffs do not allege that the defendants’ misrepresentations led anyone to buy or to sell (or to maintain positions in) covered securities,” SLUSA does not apply.

In reaching this conclusion, the Court emphasized that SLUSA’s focus is on transactions involving covered securities, not, as here, transactions in uncovered securities, noting that “an interpretation that insists upon a material connection with a transaction in a covered security is consistent with the Act’s basic focus.” The court added that the phrase “material fact in connection with the purchase or sale” “suggests a connection that matters. And for present purposes, a connection matters where the misrepresentation makes a significant difference to someone’s decision to purchase or to sell a covered security, not to purchase or sell an uncovered security, something about which the Act expresses no concern.”

The Court added that every securities case in which it had found a fraud to be “in connection with a purchase or sale of a security” has involved victims who made an investment decision involving “an ownership interest in the financial instruments that fall within the relevant definition.”

The Court also said that its interpretation of SLUSA’s “in connection with” language was consistent with the underlying regulatory statutes, the Securities Act of 1933 and the Securities Exchange Act of 1934. The Court said that both the language and purpose of these statutes “suggests a statutory focus upon transactions involving the statutorily relevant securities.” Nothing in the regulatory statutes “suggests their object is to protect persons whose connection with the statutorily defined securities is more remote than words such as ‘buy,’ ‘sell,’ and the like indicate.”

Justice Kennedy, in a dissenting opinion, argued that one of SLUSA’s purposes was to “protect those who advise, counsel or otherwise assist investors from abusive and multiplicitous class actions designed to extract settlements from defendants vulnerable to litigation costs.” The majority’s holding, Justice Kennedy said, “will subject many persons and entitles whose profession is to give advice, counsel, and assistance in investing in securities markets to complex and costly state-law litigation based on allegations of aiding and abetting or participating in transactions that are in fact regulated by the federal securities laws.”

In the majority opinion, Justice Breyer agreed that in passing the PSLRA and SLUSA “Congress sought to reduce frivolous suits and mitigate legal costs for firms and investment professionals that participate in the market for nationally traded securities, “ but he also said that “we fail to see how our decision today undermines that objective.” Justice Breyer added that “the only issuers, investment advisers, or accountants that today’s decision will continue to subject to state law jurisdiction are those who do not sell or participate in selling securities traded on U.S. national exchanges.”

On the other hand, Justice Breyer added, “to interpret the necessary statutory ‘connection’ more broadly than we do here would interfere with state efforts to provide remedies for victims of ordinary state-law fraud.”  The broader interpretation of SLUSA’s preclusive effect that the dissent urged would undermine these state-law goals: “Leaving aside whether this would work a significant expansion of the scope of liability under the federal securities laws, it unquestionably would limit the scope of protection under state laws that seek to provide remedies to victims of garden-variety fraud.”

Justice Breyer also rejected the dissent’s suggestion that the majority’s interpretation would inhibit the ability to governmental regulators to enforce the securities laws, noting that in connection with this very fraud, Allen Stanford had been successfully prosecuted criminally and had been held liable in a SEC enforcement action. The reach of underlying federal securities laws, unlike the SLUSA, are not restricted only to covered securities, and therefore the courts interpretation of the SLUSA’s “in connection with” requirement should not affect the regulators’ enforcement authority.


The Court’s decision is of interest if for no other reason than that it arises in the context of the high profile Stanford Ponzi scheme scandal, and involves two prestigious national law firms and a prominent brokerage firm. These factors ensure that this decision will receive a great deal of attention, regardless of the significance of the actual decision itself.

There likely will be some concerns that the Court’s decision could open up third-party advisors to state law aiding and abetting claims of a kind for which the advisors could not be held liable under federal law. While this concern arguably is well-founded, it should be noted that this expansion will only apply in cases involving the purchase or sale of noncovered securities – that is, securities that are not traded on a national exchange. In cases involving the purchase or sale of securities that trade on national exchanges, SLUSA’s preclusive effect will still apply and accordingly the third-party advisors could not be subjected to state law fraud claims.

At a minimum, the Court’s ruling should resolve the split that has emerged among the lower courts in their interpretation of the “in connection with” requirement. The resolution of this split should reduce the possibility of inconsistent outcomes in different cases based on nothing more than the judicial circuit in which the different cases were filed.

The Court’s ruling should also help to define the scope of SLUSA preclusion in more complex cases where the alleged fraudulent scheme involves a multi-layered transaction. These kinds of questions have become unfortunately uncommon in recent times: for example, the same kinds of questions arose in connection with the Madoff feeder funds suits. (The Court in those cases concluded that SLUSA preclusion applies.)

The Court’s ruling in this case is in a very real sense just the latest skirmish in the ongoing battle that the plaintiffs’ securities bar has been waging since Congress enacted the PSLRA. The plaintiffs’ bar has been trying to find ways to circumvent the procedural hurdles that Congress imposed for securities cases in the PSLRA. The plaintiffs’ lawyers’ first move was to try to file their cases in state court, under state law, rather than in federal court, rather than under federal law. To try to eliminate this effort to sidestep the PSLRA, Congress enacted SLUSA. This case raised the question of whether SLUSA’s preclusive effect will apply in claims against remote actors and transactions that do not directly involve covered securities.

This round, at least, seems to have gone to the plaintiffs’ bar, but the relief from SLUSA’s preclusive effect that this decision represents is limited – it will only help when the underlying transaction does not involve a security traded on a national exchange. On the other hand, it does clarify that when securities trading on national exchanges are not involved, the plaintiffs are free to pursue state law fraud claims. This may be particularly significant in cases to which SLUSA preclusion does not apply and in which the defendants are third party advisors of the type involved here; these defendants cannot be held liable for aiding and abetting under the federal securities laws, but at least where the underlying transaction involves noncovered securities, the defendants can at least be subjected to state law claims including where available aiding and abetting claims.

As interesting as this decision may be, it is not the main event during this Supreme Court term for those interested in the Court’s interpretation of the federal securities laws. The main event of course is the pending Halliburton case, in which the Court will take up the question of whether or not to dump the fraud on the market theory. Because the Halliburton case is scheduled to be argued next week, it is interesting to see whether the Court said anything in this decision that might shed some light on how the Court will view the Halliburton case.

Although it would be easy to read too much into it, the voting pattern on this case is interesting. It is not surprising that Justice Breyer wrote an opinion, on which he was joined by the other liberal-leaning Justices, that is favorable to plaintiffs. It is also not surprising that Justices Kennedy and Alito dissented based on a more defense oriented approach. What is interesting is that Chief Justice Roberts joined the majority, as did Justices Scalia and Thomas. (Justice Thomas also wrote a short concurring opinion.)  Roberts, you will recall, also joined the liberal Justices in the majority opinion in the Court’s 2013 decision in Amgen. Are Roberts’ tendencies with the more liberal Justices on securities cases?

There is little in the majority opinion itself that might shed on light the issues raised in Halliburton. It is perhaps noteworthy that Justice Breyer made a point of agreeing in his opinion with the dissent’s assertion that in its enactment of the PSLRA and of SLUSA, Congress “sought to reduce frivolous sutis and mitigate legal costs” from “abusive class actions.” But while this would seem to aid Halliburton in its argument that class action lawsuits should be restrained, it may also arguably aid the plaintiffs, as they can say that notwithstanding those purposes and all of the reforms that Congress has worked on the securities laws and on the securities litigation process, Congress chose not to address the “fraud on the market” theory.

In any event, as interesting as this case is, attention will quickly shift to next week’s oral argument in the Halliburton case. All part of the inexplicable fascination that the Court has had in recent years with taking up cases involving the federal securities laws.

Read a Mealey's Legal News item about this case

 Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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