In Roland v. Green, 2012 WL 898557 (5th Cir. Mar. 19, 2012), the United States Court of Appeals for the Fifth Circuit held that in order for a plaintiff’s state law class action lawsuit alleging fraud to be properly removable to federal court and precluded under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), the allegations of the fraudulent activity must be more than “tangentially related” to transactions in “covered securities.” In so doing, the Fifth Circuit adopted the Ninth Circuit’s test regarding the scope of the “in connection with” language under SLUSA, declining to follow what it perceived to be more stringent tests applied by other circuits. In light of the clear circuit-split, this issue appears ripe for review by the United States Supreme Court.
In February 2009, the Securities and Exchange Commission brought suit against the Stanford Group Company, along with various other Stanford corporate entities, including the Antigua-based Stanford International Bank (“SIB”), for allegedly perpetrating a massive Ponzi scheme. When the Ponzi scheme collapsed two groups of Louisiana investors filed separate lawsuits against the SEI Investments Company (“SEI”), the Stanford Trust Company, the Trust’s employees and the Trust’s investment advisers alleging violations of Louisiana law. According to plaintiffs, SIB sold CDs to the Trust, which served as the custodian for individual IRA purchases of the CDs. The Trust, in turn, contracted with SEI to administer the Trust, making SEI responsible for reporting the value of the CDs. Plaintiffs alleged that misrepresentations by SEI induced them to use their IRA funds to purchase the CDs.
Defendants sought removal to federal court and dismissal of the case under SLUSA. The preclusion provision of SLUSA provides that “[n]o 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)(A) (emphasis added).
The United States District Court for the Northern District of Texas held that the plaintiffs’ claims were precluded under SLUSA because even though SIB’s CDs were not themselves covered securities, they were purportedly backed by “covered securities.” (Roland was consolidated with two similar class actions.) Plaintiffs appealed.
The Fifth Circuit recognized that the appropriate inquiry under SLUSA was whether the alleged fraudulent scheme was “in connection with” a transaction in a covered security. Because the scope of the SLUSA “in connection with” language was one of first impression for the court, it looked to Supreme Court precedent, Congressional intent and rulings by six other circuits to formulate its standard. The Fifth Circuit initially found the decisions from the Second, Ninth and Eleventh Circuits most useful because they attempted to give dimension to what is sufficiently connected/coincidental to a transaction in covered securities to trigger SLUSA preclusion. However, because each of these Circuits stated the requisite connection in a slightly different formulation, the Fifth Circuit looked to cases where the facts were closer to the allegations in the instant case.
Ultimately, the Fifth Circuit concluded that the standards articulated by the Second and Eleventh Circuits were too stringent, and instead adopted the Ninth Circuit’s test from Madden v. Cowen & Co., 576 F.3d 957 (9th Cir. 2009), which provides that 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.” Thus, if the allegations regarding fraud are more than tangentially related to (real or purported) transactions in covered securities, then they are properly removable and precluded under SLUSA.
In application and upon close examination of the “schemes and purposes of the frauds” alleged by Plaintiffs, the Fifth Circuit held that the references to SIB’s portfolio being backed by “covered securities” to be merely tangentially related to the “heart,” “crux,” or “gravamen” of the defendants’ fraud. The Fifth Circuit held that the gravamen of defendants’ allegedly fraudulent scheme was representing to the Plaintiffs that the CDs were a “safe and secure” investment that was preferable to other investments for many reasons. That the CDs were marketed with some vague references to SIB’s portfolio containing instruments that might be SLUSA-covered securities was tangential to the schemes allegedly advanced by the defendants. Thus, SLUSA did not preclude plaintiffs from using their state class actions to pursue recovery.
This decision reflects a complicated, multi-faceted circuit-split on an important aspect of federal securities law, suggesting that the issue is ripe for review by the Supreme Court.