Federal securities law doesn’t preclude state law class actions

5th Circuit deepens circuit split on the breadth of SLUSA's preclusion provision

The 5th Circuit recently addressed an issue of first impression concerning the breadth of the preclusion provision of the Securities Litigation Uniform Standards Act (SLUSA), which prevents plaintiffs from filing state law class action lawsuits alleging fraud tied to nationally traded securities. The court’s decision in Roland v. Green deepened a split among the circuits, signaling possible future Supreme Court review of the issue.

The case stems from when the Securities and Exchange Commission (SEC) accused financier R. Allen Stanford of masterminding a $7 billion Ponzi scheme for two decades in February 2009. The agency claimed Stanford defrauded 30,000 investors in 113 countries by selling them high-yield certificates of deposit (CDs) and promising high returns.

Six months after the SEC announced its charges, Stanford’s investors filed a class action—Roland v. Green—against Stanford’s company and advisers for shirking securities laws. But in October 2011, a district court dismissed the suit, saying SLUSA preempted the plaintiffs’ state law claims because nationally traded securities backed the CDs allegedly tied to the fraud.

Two more investor lawsuits were consolidated with Roland v. Green before the 5th Circuit, which decided the case on March 19, just two weeks after a federal jury convicted Stanford on 13 of 14 counts of fraud. He is scheduled to be sentenced on June 14 and could face up to 230 years in prison.

SLUSA’s Story

In 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA), which aimed to halt perceived abuses of class actions involving nationally traded securities. “One of the core concerns was a perception that plaintiffs firms could file lawsuits against public companies any time there was a stock price drop based on pretty thin allegations of fraud and then use the discovery process to try to find a valid claim, or use the threat of costly discovery to try to coerce a settlement because the discovery in these types of cases can be voluminous,” says Haynes and Boone Partner Daniel Gold.

The PSLRA made it more difficult for plaintiffs to state a securities fraud claim in federal court by imposing heightened pleading requirements. In addition, it limited certain types of recoverable damages and attorneys’ fees, added a safe harbor for forward-looking statements to make it more difficult for plaintiffs to bring a claim based on growth projections or forecasts that ended up not being realized, and authorized courts to stay a case at the outset pending the resolution of a motion to dismiss. 

“An unintended consequence of [the PSLRA] was that it prompted some plaintiffs firms to just avoid the new law altogether by filing their cases under state law,” Gold says.

So in 1998, Congress passed SLUSA as an attempt to stop plaintiffs from circumventing the PSLRA. SLUSA’s preclusion provision stipulates that no state law class action can be maintained in either state or federal court by any private party alleging fraud in connection with the purchase or sale of a covered security [emphasis added]. SLUSA allows defendants to attempt to remove such class actions to federal court and then seek dismissal.

But courts have varied interpretations of the act’s language, particularly the preclusion provisions “in connection with” requirement, which the 5th Circuit  dissected in Roland v. Green.

Sheppard Mullin Partner John Stigi explains that the Roland v. Green plaintiffs “claim to have been defrauded to purchase CDs, which are not within the definition of a covered security, but which were in turn backed by covered securities,” or securities traded on a national exchange.

The district court determined that the CDs were “in connection with” covered securities for two reasons: First, the plaintiffs said they bought the CDs because Stanford’s company told them that covered securities backed the CDs, and second, some of the plaintiffs had sold covered securities in their retirement accounts in order to purchase the CDs. Those facts, in the court’s opinion, were enough to preclude the plaintiffs’ claims.

Significant Split

On appeal, the 5th Circuit examined other circuits’ interpretations of SLUSA’s “in connection with” requirement.

“The 11th Circuit has adopted what I would call the most stringent requirement and has found that in order for SLUSA to bar a state law claim, a fraudulent scheme must have depended on the purchase or sale of covered securities,” explains Neal Marder, a partner at Winston & Strawn. “The 9th Circuit’s test, compared to that, is much more watered down. It says SLUSA would apply if the fraud and the purchase or sales of securities were more than tangentially related.”

The 5th Circuit in Roland v. Green found that the 9th Circuit’s analysis was closer to congressional intent than the 11th Circuit’s. “The result of adopting this test should mean that it’s easier to find that SLUSA applies and bars state law claims, but when the 5th Circuit applied that test to the facts, it concluded that in this particular case, that test wasn’t met,” Marder says. “The misrepresentations were simply tangentially related to the fraud—they weren’t more than tangentially related. So it reversed the district court.”

Experts say the outcome of Roland v. Green could prompt the Supreme Court to review a case dealing with SLUSA’s problematic preclusion provision. “It’s clear the courts are struggling with how to apply this ‘in connection with’ standard,” Gold says.

Marder agrees. “The Supreme Court in the past few terms has been much more active in getting involved in securities cases and class actions,” he says. “This may very well provide the opportunity for the Supreme Court to intervene and decide in a more uniform way what ‘in connection with’ is intended to mean under SLUSA.”

Contributing Author

Ashley Post

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