Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Tuesday, March 20, 2012

Fifth Circuit Finds SLUSA Does Not Preclude Stanford Investors' State Claims

The Fifth Circuit recently held that SLUSA did not preclude state law class actions seeking to recover damages for losses resulting from the Stanford ponzi scheme, because the purchase or sale of securities (or representations about the purchase or sale of securities) was "only tangentially related" to the ponzi scheme.  Roland v. Green (5th Cir. Mar. 19, 2012). (Download Roland.031912[1])

In that case Louisiana investors sued 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 the plaintiffs, the Antigua-based Stanford International Bank (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 allege that misrepresentations by SEI induced them to use their IRA funds to purchase the CDs, including that the CDs were a safe investment because SIB was "competent and efficient," that independent auditors "verified" the value of SIB's assets, and that SIB's assets were invested in a "well-diversified portfolio of highly marketable securities."  The defendants sought removal to district court on the basis of SLUSA preclusion.  (Roland was consolidated with two similar class actions.)

The district court, in holding that SLUSA precluded the class actions, acknowledged that the SIB CDs were not themselves "covered securities" under the statute, but determined that this did not end the inquiry.  It found that the requisite connection existed because (1) the plaintiffs' purchases of the CDs were allegedly induced by the representation that SIB invested in a portfolio of "covered securities" and (2) at least one plaintiff's purchases of the CDs were allegedly funded by sales of covered securities.

Though the question of the scope of the "in connection with" requirement under SLUSA was one of first impression in the Fifth Circuit, the appeals court noted that six circuits have addressed the issue.  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 this case, i.e., where the alleged fraud was centered around the purchase or sale of an uncovered security like the CDs in this case.  Accordingly, the court turned its attention to the "feeder fund" cases arising from the Madoff ponzi scheme and described three different approaches used by the courts: (1) whether the financial product purchased was a covered security (the product approach), (2) what was the separation between the investment in the financial product and the subsequent transactions in covered securities (the separation approach), (3) what were the purposes of the investment (the purposes approach).

Next, the Fifth Circuit returned to the "policy consideration" that the U.S. Supreme Court relied on in Dabit in determining the scope of the in connection with requirement and found persuasive Congress's explicit concern about the distinction between national, covered securities and other, uncovered securities.  "That SLUSA would be applied only to transactions involving national securitiess appears to be Congress's intent."  It also recognizes that "state common law breach of fiduciary duty actions provide an important remedy not available under federal law."  The court also acknowledged the concern expressed by some members of Congress who filed an amicus brief: "The interpretation of SLUSA and the 'in connection with' requirement adopted by the District Court ... could potentially subsume any consumer claims involving the exchange of money or alleging fraud against a bank, without regard to the product that was being peddled."

Ultimately, the Fifth Circuit concluded that the standards articulated by the Second and Eleventh Circuits were too stringent and adopted the Ninth Circuit test -- 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.

In applying the test, the Fifth Circuit agreed with the district court that the fact that the CDs were uncovered securities did not end the inquiry and that it must closely examine the schemes and purposes of the frauds alleged by the plaintiffs.  It disagreed with the district court, however, about the importance of the representation that SIB's assets were invested in marketable securities because that was only one of many representations made to induce plaintiffs to purchase the CDs.  Rather, the "heart, crux and gravamen" of the fraudulent scheme was the representation that the CDs were a "safe and secure" investment.  It also dismissed the significance placed by the district court on the fact that at least one plaintiff sold covered securities to finance the purchase of CDs, because the fraud did not depend upon the defendant convincing the victims to sell their covered securities.  Accordingly, in both instances, the representations were no more than "tangentially related" to the purchase or sale of covered securities.

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