State Claims Against Hedge Funds Survive SLUSA Challenge

By N. Peter Rasmussen, J.D.

The Securities Litigation Uniform Standards Act did not preempt state claims against the directors and administrators of two defunct hedge funds (Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities, LLC, SD NY 05 Civ. 9016). The shares issued by the British Virgin Island-based funds were clearly not "covered securities" under the Uniform Standards Act. According to the fund defendants, however, the Uniform Standards Act preempted the state claims because a portion of the funds' portfolios included, or purported to include, covered securities.

Judge Shira Scheindlin of the Southern District of New York wrote that only the alleged misrepresentations by the defendants were relevant to SLUSA preemption analysis. She concluded that the alleged misstatements concerned only the valuation of the funds and were not made in connection with the purchase or sale of covered securities.

Judge Scheindlin recognized that the Supreme Court interpreted the "in connection with" requirement rather broadly in the 2006 Merrill Lynch v. Dabit case (SLUSA preempted "holder" claims as well as those by buyers and sellers if the fraud "coincided" with a scheme involving covered securities). However, she concluded that such an application of SLUSA to this case "stretches the statute beyond its plain meaning." Congress, and not the courts, should decide whether the statute applied to statements made in connection with the purchase or sale of shares of unregistered hedge funds.

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