For Investors' Sake, Keep SLUSA Simple
Summary Judgment is American Lawyer senior writer Susan Beck's regular opinion column for the Litigation Daily.
Will the U.S. Supreme Court stop judges from getting too creative with the Securities Litigation Uniform Standards Act? Or, in simpler terms, will the court make it easier or harder for defrauded investors to recover some of their money?
On Monday the high court waded into the SLUSA debate in a case arising from R. Allen Stanford's Ponzi scheme. There, the U.S. Court of Appeals for the Fifth Circuit held last year that SLUSA didn't apply to bar claims brought by investors in worthless certificates of deposit issued by Stanford International Bank. That ruling contrasts with decisions from other circuits in which judges have used various theories to warp the plain meaning of the 1998 statute and dismiss similar investor fraud cases.
To step back, Congress passed SLUSA to stop plaintiffs from cleverly avoiding the more restrictive pleading standards of the federal securities laws by recasting their cases as state law class actions. SLUSA carved out a subset of cases that can't be brought as state law claims, but its reach was purposefully limited to cases alleging misrepresentations "in connection with the purchase or sale of a covered security." A covered security is generally defined as a security traded on a national exchange or a mutual fund. Congress made this distinction because it wanted to preserve some state law claims for investors.
In the Stanford case, the CDs that investors bought are not covered securities. There's no doubt about that. Still, the defendants argue that SLUSA applies because Stanford told investors he was using their money to buy covered securities, which he may or may not have done. The Fifth Circuit rejected that argument, concluding that the alleged fraud and the purported covered stock sales were only tangentially related. The reason the Stanford plaintiffs want to avoid the federal securities laws is that they're pursuing aiding and abetting claims against third parties, including two law firms that worked for Stanford — Chadbourne & Parke and Proskauer Rose. Thanks to some recent Supreme Court rulings, those types of claims can't be brought under the federal securities laws.
In contrast, other courts have been too easily persuaded to apply SLUSA in cases where investors didn't buy or sell a nationally traded security, but where those securities played some role in the alleged fraud. That's the scenario presented by a couple of cases out of the U.S. Court of Appeals for the Second Circuit arising from Bernard Madoff's Ponzi scheme. In a case decided last month, In re Herald, Primeo, and Thema, the Second Circuit dismissed claims brought by investors in a Madoff feeder fund on the grounds that the phony securities that Madoff pretended to buy would have been covered securities if they had existed. I call that a stretch.
Just last week, U.S. District Judge Alison Nathan in Manhattan cited Herald to dismiss a big chunk of investor claims against hedge fund manager Philip Falcone and Harbinger Capital Partners. Despite admissions of wrongdoing by Falcone and Harbinger in a related settlement with the Securities and Exchange Commission, Nathan seemed inclined to chuck the whole investor lawsuit, and she latched onto SLUSA to do it. (Nathan did, however, allow the plaintiffs to file an amended complaint to address Herald, which came out after briefing was complete.)
In Monday's Supreme Court oral arguments in the Stanford case, many of the justices voiced skepticism of an expansive reading of SLUSA. They pressed Paul Clement of Bancroft PLLC, who represents the defendants, about the limits of the law. Justice Elena Kagan asked if a dispute over a prenuptial agreement in which one party promised to sell stock to buy a house would be securities fraud under his theory. Justice Antonin Scalia focused on the intent and plain language of the law. "I had assumed that the purpose of the securities laws was to protect the purchasers and sellers of the covered securities," he said to Clement. "There is no purchaser or . . . seller of a covered security involved here."
Jacob Zamansky, who represents the plaintiffs in the Harbinger case, told me he's hopeful the justices will curtail these ambitious interpretations of SLUSA. "If the Supreme Court comes out against applying SLUSA to a case like this — where the relationship to covered securities is secondary, not primary — it would be hugely significant for investors, especially those who had stakes in feeder funds in Madoff and the like," he said.
I'm not taking a position on whether the defendants in the Stanford case should be held liable. That's for a court or possibly a jury to decide. But I wouldn't stop this lawsuit on SLUSA grounds before it reaches the merits. Over the past decade, the courts and Congress have done a lot of things to erode the rights of investors to pursue claims of securities fraud, especially against aiders and abettors. Here's a case where the court can preserve some state remedies for investors by not getting too fancy. Just give SLUSA its simplest and most straightforward interpretation, and give investors their day in court.