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The Supreme Court Defines the Scope and Meaning of 'SLUSA'

March 3, 2014

On February 26, 2014, the Supreme Court issued an opinion addressing the meaning and scope of the Securities Litigation Uniform Standards Act (SLUSA). SLUSA is a federal statute adopted in 1998 that prohibited large securities class actions under state law including those 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). In the decision, the Court determined that SLUSA's inapplicability to "uncovered securities" remains even where "defendants falsely told the victims that the uncovered securities were backed by covered securities." More generally, the decision interprets SLUSA to mean that investors may institute large state law securities class actions where the fraudulent misrepresentation is not "material to a decision . . . to buy or sell a 'covered security.'" As the Supreme Court itself explained, "the basic consequence of our holding is that . . . it will permit victims of this (and similar) frauds to recover damages under state law." Additionally, the decision may provide greater opportunities for investors to allege state law securities class action claims against secondary actors, who have generally been shielded from federal securities liability by other Supreme Court holdings that restrict secondary or aiding and abetting liability claims under the federal securities laws.

The decision is captioned Chadbourne & Parke LLP v. Troice

The Securities Litigation Uniform Standards Act of 1998 is a law that prevents a "covered class action based upon the statutory or common law of any state . . . by any private party" concerning securities fraud allegations such as "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). By "covered security," SLUSA incorporates a definition from the Securities Act of 1933, referring to those securities "listed or authorized for listing on a national securities exchange." 15 U.S.C. § 77r(b)(1). SLUSA only applies to large class actions or those with more than 50 "persons or prospective class members." 15 U.S.C. § 78bb(f)(5). The issue before the Supreme Court concerned the meaning of the statutory phrase: "misrepresentation or omission of material fact in connection with the purchase or sale of a covered security." 

The securities at issue in the decision were certificates of deposit or CDs that were "debt assets that promised a fixed rate of return." The CDs were not "covered securities" within the meaning of SLUSA because they were "not traded nationally or listed on a regulated national exchange." The investor plaintiffs who brought the cases at issue in the decision, however, alleged that the fraud included misrepresentations that holdings in "covered" securities supported the "uncovered" CDs. Pursuant to SLUSA, the district court dismissed the cases at issue in the decision on grounds that the investors' state law fraud claims were "connected" to "transactions in covered securities." The Fifth Circuit reversed, reasoning that the "holdings in covered securities were too 'tangentially related' to the 'crux' of the fraud to trigger" SLUSA.        

The Supreme Court affirmed the Fifth Circuit ruling. In the decision, the Supreme Court characterized the issue as one concerning the breadth of SLUSA and whether the statute "extend[s] further than misrepresentations that are material to the purchase or sale of a covered security." The Supreme Court held that it does not, ruling that "[a] fraudulent misrepresentation or omission is not made 'in connection with' such a 'purchase or sale of a covered security' unless it is material to a decision by one or more individuals (other than the fraudster) to buy or sell a 'covered security.'"

The Supreme Court principally reasoned that SLUSA "focuses upon transactions in covered securities, not upon transactions in uncovered securities." Therefore, the meaning of "in connection with" under SLUSA must "insist[] upon a material connection with a transaction in a covered security." A "material connection," the Supreme Court amplified, is a connection that matters, meaning "where the misrepresentation makes a significant difference to someone's decision to purchase or sell a covered security, not to purchase or sell an uncovered security." In short, the decision underscores that securities fraud allegations directed to uncovered securities associated with covered securities will not be subject to SLUSA absent a showing of any material misrepresentation or omission as to the covered security.

In addition, the decision is significant because of the effect it may have on investors being able to sue secondary actors, such as accountants, brokers, lawyers, and advisers. The cases at issue in the decision involved investors suing "investment advisers" that provided "trust, insurance, accounting or reporting services" as well as law firms and insurance brokers. As the decision recounts, such "secondary actors" are generally shielded from private anti-fraud claims brought under Section 10(b) of the Securities Exchange Act of 1934 and the SEC's Rule 10b-5 promulgated thereunder. See e.g. Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 153, 155, 166 (2008) (private rights do not cover suits against "secondary actors" who had no "role in preparing or disseminating a stock issuer's fraudulent "financial statements"); Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 179 (1994) (private right does not extend to actions against "aiders and abettors" of securities fraud). Such restrictions may not exist under some state laws and, thus, a more narrow reading of SLUSA may allow greater opportunities for plaintiffs to sue "secondary actors" in state actions.

For more information, please contact the professional(s) listed below, or your regular Crowell & Moring contact.

Kathleen Taylor Sooy
Partner – Washington, D.C.
Phone: +1.202.624.2608