SEC Amicus Brief Urges US Supreme Court Not to Review Unique Case Outside the Heartland of SLUSA Preclusion

At the request of the US Supreme Court, the SEC filed an amicus brief urging the Court not to review a case involving the question of whether the Securities Litigation Uniform Standards Act (SLUSA) precludes a class action alleging that plaintiffs purchased uncovered securities in reliance on misrepresentations that those securities were backed by investments in covered securities. Although the Fifth Circuit erred in its application of SLUSA’s preclusion provision, said the SEC brief, its decision does not conflict with any decision of another circuit.  This case, moreover, involves an unusual fact pattern, in which wrongdoers made misrepresentations about their own purchases of SLUSA-covered  securities in order to induce plaintiffs to purchase uncovered investment vehicles. A holding that SLUSA applies or does not apply in this setting would do little to guide lower courts in resolving the mine run of SLUSA controversies, stated the SEC. Thus, further review is not warranted and the Court should deny the petition for certiorari. US Supreme Court Dkt. Nos. 12-79, 12-86 and 12-88.

SLUSA precludes most state-law class actions in which the plaintiffs allege misrepresentations in connection with the purchase or sale of a covered security. The term “covered security” encompasses securities listed on a regulated national exchange.

The case arose from a multi-billion-dollar Ponzi scheme run by Allen Stanford and various entities that he controlled, including a bank which issued fixed-return certificates of deposit (CDs) that the bank falsely claimed were backed by safe, liquid investments.  In fact, the claimed investments did not exist, and the bank had to use new CD sales proceeds to make interest and redemption payments on pre-existing CDs.

After the fraud was discovered, two groups of Louisiana investors filed suits in state court against a number of Stanford companies and employees claiming violations of Louisiana law. The defendants removed the Louisiana cases to federal court, and all of the actions were ultimately transferred to the Northern District of Texas, which dismissed the complaints as precluded under SLUSA.  The district court held that, while the CDs themselves were not “covered securities,” the plaintiffs had nevertheless alleged misrepresentations made in connection with transactions in covered securities since the bank said that it invested its assets in highly marketable securities issued by stable governments and strong multinational companies. The district court found that the bank led the plaintiffs to believe that the CDs were backed, at least in part, by investments in SLUSA-covered securities.

The court of appeals reversed, deeming the references to the bank portfolio being backed by covered securities to be merely tangentially related to the heart the defendants’ fraud.  Misrepresentations about the investments were only one of a host of misrepresentations, reasoned the appeals court, which also observed that, because the CDs promised a fixed rate of return, they were not tied to the success of any of the bank’s purported investments in covered securities.

The SEC said that this case falls outside the heartland of SLUSA preclusion, but yet is covered by the plain terms of the statute. The scheme alleged here, said the SEC, is relatively far removed from the paradigmatic SLUSA-precluded case. At the core of SLUSA preclusion are cases in which the defendant misrepresents facts about a covered security in order to induce purchases or sales of that security, or to affect the market in that security. Here, the wrongdoers falsely claimed to be owners of covered securities in order to induce the fraud victims to purchase uncovered investment vehicles.  

The Fifth Circuit erred in assessing whether the alleged fraud was more than tangentially related to a purchase or sale of covered securities, said the SEC, by underestimating the role that the statements about the bank’s investment portfolio played in the Stanford Ponzi scheme. The crux of the fraud was to convince investors that the CDs were safe, liquid investments that would deliver high returns. The representation that the CDs would be backed by a well-diversified portfolio of highly marketable securities issued by stable national governments and strong multinational companies was important to the success of

that tactic, noted the SEC, and thus, the purported existence of covered securities transactions was far from tangential to the fraudulent scheme and the misrepresentations that supported it.

In the view of the SEC, the court of appeals incorrectly found that the importance of the statements about the bank’s transactions in covered securities was diminished by the existence of various other misrepresentations, such as that the CDs were protected by an insurance policy from Lloyd’s of London, allegedly made to convince investors that the CDs were a sound purchase. While those other misrepresentations could certainly have been relevant to a prospective purchaser, said the Commission, only the assertions about covered securities would have answered investors’ questions about  how the bank would be able to deliver the promised high returns on the CDs, questions that any reasonable investor would have asked before buying a financial instrument from a foreign bank.