By Rodney F. Tonkovic, J.D.
A petition for certiorari asks the Supreme Court to address whether the Ninth Circuit erred in adopting a narrow interpretation of the SLUSA's "in connection with" prong. In this case, the appellate court reversed a district court's ruling that the SLUSA precluded investors from pleading a state law claim and a federal securities claim based on the same conduct. The petitioner argues that the Ninth Circuit gave too narrow a reading to "in connection with," requiring that the alleged deception induce a specific transaction in a particular covered security. The petition urges the Court to take up the matter and resolve a circuit split between courts using this narrow interpretation and those reading the language more broadly to require a transaction just coinciding with a transaction in a covered security (Edward D. Jones & Co. v. Anderson, October 12, 2021).
"In connection with" requirements. At issue in this action is the interpretation of the SLUSA's prohibition of class actions premised on state law and alleging a material misrepresentation or omission "in connection with the purchase or sale of a covered security." This requirement was given a broad reading by the Court in 2006 in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, holding that it is enough that the fraud coincide with a securities transaction. In 2014, the Court affirmed the "coincide" requirement in Chadbourne & Parke LLP v. Troice while emphasizing that the SLUSA bar applies to misrepresentations with a material connection to the purchase of a covered security. In Troice the Court held that the plaintiffs had no ownership interest in the financial instruments at issue, so the claims involved uncovered securities and were not precluded by the SLUSA.
Transfer to fee-based accounts. The petitioner is Edward D. Jones & Co. (Edward Jones), a financial services firm headquartered in St. Louis, Missouri. The respondents are three "buy-and-hold" investors, meaning that they conduct little to no trading each year. This case arose from investors' decisions to transfer assets in their commission-based accounts into managed, fee-based advisory accounts. The accounts were transferred, and Edward Jones began to conduct trades on the investors' behalf.
The investors filed suit in the Eastern District of California alleging that the fee-based accounts were not suitable for buy-and-hold investors and resulted in significantly higher fees. Edward Jones, the investors alleged, incentivized its advisers to recommend fee-based accounts and generate higher fees, whether or not they were suitable; in fact, the advisers allegedly failed to conduct any suitability analysis at all. The complaint alleged violations of the antifraud provisions of the Exchange Act, plus claims under California and Missouri common law. In an unreported opinion, the district court dismissed the complaint with prejudice, ruling that the SLUSA precluded the investors from pleading a state law fiduciary duty claim and a federal securities claim based on the same conduct. The court explained that the plaintiffs characterized the lack of a suitability analysis as an omission for the federal fraud claim but not as an omission for the state law fiduciary duty claim.
The Ninth Circuit reversed, finding that the claims were not barred by the SLUSA. The court held that the alleged breach was not "in connection with" an investment decision involving a covered security because the investors did not allege that they would have purchased or sold different covered securities had the defendants conducted the suitability analysis. Rather, the plaintiffs paid a fee regardless of the transactions Edward Jones took on their behalf. According to the Ninth Circuit, Troice brought a more demanding implied materiality element into Dabit's "coincide" test. Here, the alleged deception was material to the decision to transfer accounts—the breach was complete when the accounts were transferred—but was not intrinsic to any investment decisions and was thus not materially connected to a securities transaction.
Circuit split. The petition asks the Court to resolve a circuit split as to whether Dabit's "coincide" standard was altered by Troice. According to Edward Jones, the Seventh and Eighth Circuits continue to apply the broader Dabit standard. On the other hand, the First, Third, and now Ninth Circuits apply Troice even when there is no dispute about whether the deception related to covered securities. These circuits read Troice broadly to hold that the "in connection with" requirement is satisfied only when the alleged deception induces an investment decision regarding a particular covered security. These divergent standards need to be resolved by the Court, the petition asserts.
Conflict with precedent. In addition, the Ninth Circuit's standard conflicts with Supreme Court precedent. The petition argues that the appellate court's definition of "in connection with" conflicts with SEC v. Zandford, U.S. v. O'Hagan, and Dabit. Building on the earlier cases, Dabit interprets the "in connection with" prong consistently with the language in Exchange Act Section 10(b) and Rule 10b-5, holding that it is sufficient that the alleged fraud coincide with a securities transaction, by the plaintiff or someone else. Later, the majority in Troice expressly rejected that that decision modified Dabit, but the Ninth Circuit, the petition urges, ignored the context of Troice—the distinction between covered and uncovered securities—to focus on the implied materiality element. In the present case, the petition stresses, there was no dispute over covered versus uncovered securities. And, moreover, there was no question that the investors had ownership interests in covered securities involved in transactions made to further the alleged scheme.
Important question. Finally, the petition argues that the Ninth Circuit's narrow interpretation is inconsistent with the SLUSA's language and objectives. Here, the petition again references Dabit, where the Court indicates that Congress must have been aware of the broad interpretation given to the phrase "in connection with" when that key phrase was imported into the SLUSA. To interpret "in connection with" as requiring a direct causal link contradicts the plain meaning of the phrase. The Ninth Circuit's interpretation also upsets the regulatory scheme governing the markets and securities industry by allowing securities claims framed under state law to proceed, the petition says, which undermines Congress’ intended reforms in the PSLRA and SLUSA.
The petition is No. 21-552.