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October Term, 2013

February 26, 2014

Today the Supreme Court issued one decision, described below, of interest to the business community.

Securities Litigation Uniform Standards Act—Misrepresentations “In Connection With” Securities Transactions

Chadbourne & Parke LLP v. Troice, No. 12-79; Willis of Colorado Inc. v. Troice, No. 12-86; and Proskauer Rose LLP v. Troice, No. 12-88 (previously discussed in the January 22, 2013, Docket Report)

The Securities Litigation Uniform Standards Act (“SLUSA”) precludes the filing in either state or federal court of most class actions under state law that allege “a misrepresentation or omission of a material fact in connection with the purchase or sale of” securities covered by the statute. 15 U.S.C. § 78bb(f)(1)(A). The SLUSA defines “covered security” as any security “listed, or authorized for listing, on a national securities exchange.” Id. § 77r(b)(1). Today, in a 7-2 decision, the Supreme Court held that a misrepresentation satisfies the “in connection with” test only if the misrepresentation “is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a ‘covered security.’” Slip op. 8.

The Court’s opinion is of interest to businesses that purchase, sell, issue, or make representations concerning securities.

Respondents—plaintiffs in the district court—filed class actions relating to certificates of deposit that they purchased from Stanford International Bank, an entity controlled by R. Allen Stanford. Although the CDs themselves were not covered securities, respondents alleged that “their decision to purchase” the CDs was influenced by the Bank’s misrepresentations that the CDs were backed by covered securities and other assets. Slip op. 18. The district court concluded that those alleged misrepresentations were made “in connection with” the Bank’s supposed securities transactions. But the Fifth Circuit reversed, holding that “the falsehoods about the Bank’s holdings in covered securities were too ‘tangentially related’ to the ‘crux’ of the fraud to” fall within the scope of the SLUSA. Slip op. 8 (quoting Roland v. Green, 675 F.3d 503, 521 (5th Cir. 2012)).

In an opinion by Justice Breyer, the Supreme Court affirmed. The Court held that a misrepresentation concerns a “‘material fact in connection with the purchase or sale’” of a covered security only if it “makes a significant difference to [the] decision” of someone other than the entity making the misrepresentation “to purchase or to sell a covered security.” Slip op. 9. The Court reasoned that this interpretation finds support in the SLUSA’s focus on “transactions in covered securities” and in other provisions of the statute that “reflect[] congressional care” not to preclude suits under state law for “garden-variety fraud.” Slip op. 9, 13.

The Court rejected the suggestion of the United States—appearing as amicus curiae in support of the petitioners—that a narrow interpretation of the SLUSA would “limit the SEC’s enforcement capabilities” under Section 10(b) of the Securities Exchange Act of 1934, which “uses the phrase ‘in connection with the purchase or sale of any security’”—not only securities listed on a national exchange. Slip op. 15 (emphasis added). Specifically, the Court said that it could find no “SEC enforcement action brought during the past 80 years that [its] holding today would have prevented the SEC from bringing.” Id. And although the Court “conceded[]” that its decision leaves securities “issuers, investment advisers, [and] accountants” who “do not sell or participate in selling securities traded on U.S. national exchanges” exposed to liability under state law, the Court found it “difficult to see why the federal securities laws would be—or should be—concerned with shielding such entities from lawsuits.” Slip op. 12.

Justice Thomas concurred, stating that he believed that the Court was “applying a limiting principle to the phrase ‘in connection with’ that is ‘consistent with’” both the SLUSA and the Court’s “precedents.” Concurrence 2.

Justice Kennedy (joined by Justice Alito) dissented, arguing that the Court had previously given the SLUSA “a broad construction” and should continue to do so. Dissent 5 (internal quotation marks omitted). In particular, the dissent argued that the SLUSA barred the respondents’ claims because “the success of the fraud” directly turned on the [Bank’s] promise to trade in regulated securities.” Dissent 9. The dissent further suggested that the Court’s narrower construction of the phrase “in connection with” would prevent the SEC from bringing enforcement actions under the Securities Exchange Act against a “fraudster” who induces victims to purchase investments that are—unlike CDs—not a type of security. Dissent 16-17. And the dissent expressed concern that investors’ “confidence in the market” would “be severely undermined” if such frauds “are not within the reach of federal regulation.” Dissent 11.

Any questions about this case should be directed to Andrew Pincus (+1 202 263 3220) or Charles Rothfeld (+1 202 263 3233) in our Washington office.

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