LITIGATION ALERT: The Fifth Circuit Court of Appeals Revives Securities Fraud Claims in Stanford Entities Securities Litigation
In response to a multitude of lawsuits involving investments in the alleged multi-billion dollar Ponzi scheme perpetrated by R. Allen Stanford, the Judicial Panel on Multidistrict Litigation consolidated nearly a hundred cases into a multi-district litigation known as In Re Stanford Entities Securities Litigation. The cases involve a variety of non-federal claims relating to investments in certificates of deposit. The targets include various third parties who allegedly facilitated the $8 Billion Ponzi scheme.
Finding that the investors' claims arose from misrepresentations or omissions made "in connection with a covered security," the district court dismissed three test cases and ostensibly closed the door on the investors. Specifically, the court held that the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") precluded Stanford investors from bringing class actions based on state or common law claims.
On appeal, the Fifth Circuit noted a split of authority among the federal circuit courts, but declined to follow those circuits that liberally interpret SLUSA's "in connection with a covered security" test. Namely, the Fifth Circuit held that the claims must have more than a tangential relationship to covered securities. Here, the court examined the certificates of deposits sold by Stanford and considered them too far removed from a transaction in a covered security.
The reversal re-opens the door for Stanford investors to pursue state law claims against banks, firms, and other institutions that may have played a role in Stanford's financial affairs. While many anticipate appeals to the United States Supreme Court, the
decision signals a retreat from securities litigation reform, and it will significantly impact the application of SLUSA in the Fifth Circuit.
I. Historical Backdrop.
By issuing the SLUSA ruling, the Fifth Circuit narrowly construed Congress' intent in enacting class action securities litigation reform. In 1995, because of perceived abuses of the class action vehicle in litigation involving nationally traded securities, Congress passed the Private Securities Litigation Reform Act ("PSLRA"). The reforms succeeded in limiting certain class actions, but the effort also had an unintended consequence: it prompted some members of the plaintiffs' bar to avoid federal court. Rather than confronting the restrictive conditions set forth by PSLRA, plaintiffs began filing class-action securities lawsuits under state law, often in state court.
To stem this shift from federal to state courts and to prevent certain state securities class action lawsuits from frustrating the objectives of PSLRA, Congress passed SLUSA. SLUSA provides, in relevant part, that:
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 . . . .
15 U.S.C. § 78bb(f)(1)–(f)(1)(A).
SLUSA further mandates that "[a]ny covered class action brought in any State court involving a covered security . . . shall be removable to the Federal district court for the district in which the action is pending" and subject to dismissal. Id. at § 78bb(f)(2).
II. The Cases on Appeal.
The Fifth Circuit opinion arose from a consolidated appeal of three Stanford-related class actions filed in both state and federal courts. All of the cases ended up in federal court.
- In Roland v. Green, the plaintiffs sued SEI Investments Company and the Stanford Trust Company, among others, alleging violations of Louisiana statutory and common law for their alleged role in the Stanford Ponzi scheme. Specifically, the Roland plaintiffs alleged that the defendants made misrepresentations to induce them to purchase Stanford's CDs.
- In Troice v. Willis of Colorado Inc., the plaintiffs brought claims against Stanford's insurance broker under the Texas Securities Act, as well as state law claims for aiding and abetting and civil conspiracy. The Willis plaintiffs alleged wrongful representations relating to the soundness of Stanford's CDs.
- Finally, in Troice v. Proskauer Rose, L.L.P., the plaintiffs brought aiding and abetting and conspiracy claims under Texas state law against a law firm that had represented Stanford.
In deciding whether SLUSA precluded the class actions, the district court addressed the central question of "whether the [plaintiffs allege] the use of misrepresentations, omissions, or deceptive devices in connection with the purchase or sale of a covered security." Although the district court concluded that Stanford's CDs did not qualify as "covered securities" under SLUSA, the district court did find that the CDs were allegedly invested in "covered securities." Because of this misrepresentation—as well as the plaintiffs' allegations that Stanford induced the investors to "roll over" covered securities into Stanford CDs—the district court found that the Stanford CDs fit within SLUSA's "in connection with" requirement. Based on these holdings, the district court dismissed the plaintiffs' claims as precluded by SLUSA.
III. The Fifth Circuit Reverses: SLUSA Does Not Preclude Plaintiffs' Claims
The main issue before the Fifth Circuit involved the interpretation of SLUSA's "in connection with" requirement, which is the subject of a split of authority among the circuits. After analyzing other circuits' definition of the requirement, the Fifth Circuit found persuasive and adopted the Ninth Circuit's test from Madden v. Cowen & Co., 576 F.3d 957 (9th Cir. 2009): "a misrepresentation is 'in connection with' the purchase or sale of securities if there is a relationship in which the fraud and the stock sale coincide or are more than tangentially related." Id. at 576 F.3d at 965–66.
1. The Roland Case and the Willis Cases.
In light of the Ninth Circuit's Madden test, the Fifth Circuit reversed the district court, holding that SLUSA precluded the Roland and Willis plaintiffs' claims because the Stanford CDs were not actually invested in "covered securities." Although Stanford had represented that the CDs were backed by SLUSA-covered securities, the Fifth Circuit found that such representation was "merely tangentially related to the 'heart,' 'crux,' or 'gravamen' of the defendants' fraud"—that being the representation "that the CDs were a safe and secure investment that was preferable to other investments for many reasons." Simply because Stanford marketed the CDs with vague references to Stanford's portfolio, which may have contained "covered securities," did not mean that the CDs met the "in connection with" requirement. Ultimately, the Fifth Circuit considered the relationship between the fraud and sales of covered securities as too tangential to fall within SLUSA preclusion.
2. The Proskauer Case.
Although the Proskauer plaintiffs did not explicitly allege misrepresentations against the defendant law firm, the Fifth Circuit found that it was "clear that there are misrepresentations involved." Specifically, Proskauer allegedly obstructed the SEC's oversight and investigation of Stanford's operations by telling the SEC that they could not investigate Stanford. This allegedly precluded the SEC from uncovering Stanford's fraud, thereby allowing Stanford to continue to harm the plaintiffs.
The Fifth Circuit found these alleged misrepresentations "one degree removed" from those at issue in the Roland and Willis cases. Accordingly, the Proskauer defendants' alleged misrepresentations were "not more than tangentially related to the purchase or sale of covered securities" and SLUSA preclusion did not apply.
IV. Conclusion.
Ultimately, the Fifth Circuit reversed and remanded Roland to state court, and reversed and remanded Proskauer and Willis to the district court. The Fifth Circuit's decision will likely allow Stanford investor groups to pursue state law claims against various third parties that may have played a role in Stanford's scheme. Beyond the immediate effect in Stanford-related litigation, the Fifth Circuit's decision will likely have a significant effect on the scope of SLUSA in the Fifth Circuit for years to come.
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This Litigation Alert is a summary of recent developments in the law and is provided for informational purposes only. It is not intended to constitute legal advice or to create an attorney-client relationship. Readers should obtain legal advice specific to their situation in connection with topics discussed.
Copyright © 2012 Kane Russell Coleman & Logan PC.All rights reserved.Unless otherwise indicated, the authors are not certified by the Texas Board of Legal Specialization.