Co-author: Frank Oliva

The Supreme Court recently granted certiorari to examine the “in connection with” requirement of the Securities Litigation Uniform Standards Act (“SLUSA”) in Chadbourne & Parke LLP v. Troice, No. 12-79.  SLUSA generally precludes state law securities class actions when there is a misrepresentation or omission “in connection with the purchase or sale of a covered security”:

No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal Court by any private party alleging a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.

In light of a seeming disagreement among the Circuits, this case could have a significant impact on which cases are precluded under SLUSA.

The case stems from a Ponzi scheme perpetrated by R. Allen Stanford, which unraveled in 2009.  Stanford purported to sell certificates of deposit (“CDs”) that generated above-market returns.  Purchasers of Stanford’s fraudulent CDs were led to believe that the CD’s were backed by SLUSA-covered securities.  The United States District Court for the Northern District of Texas held that the lawsuit was precluded by SLUSA.  The district court reasoned that the Supreme Court urged a broad interpretation of the “in connection with” requirement in order to further SLUSA’s goals, and that plaintiffs’ allegations sufficiently connected the fraud to transactions in covered securities, thus triggering the protections of SLUSA against class actions based on state law.

On appeal, the Fifth Circuit disagreed and held that SLUSA did not preclude various Stanford suits from moving forward because plaintiffs’ allegations were only “tangentially related” to securities trades covered by SLUSA.  The Fifth Circuit adopted the Ninth Circuit’s approach to determine whether allegations of fraud are sufficiently connected to covered securities to trigger SLUSA preclusion.  Under the Ninth Circuit standard, state law fraud allegations trigger the protections of SLUSA if they are more than tangentially related to real or purported transactions in covered securities.  The Fifth Circuit reasoned that the claim that the proceeds from the sale of CDs were invested in a portfolio including SLUSA-covered securities was but one of a host of misrepresentations made to plaintiffs in the attempt to lure them into buying the worthless CDs.  The real focus of the fraud, according to the court, was that the CDs were said to be a safe and secure investment.  In addition, the Fifth Circuit found that the sale of covered securities by plaintiffs to finance the purchase of CDs only created a tangential relationship between the fraud and covered securities because Stanford did not convince the victims to sell the securities.

While each case is arguably fact-specific, the Chadbourne case could potentially shed light on a legal standard that has proved slippery for the courts.