In Proctor v. Vishay Intertechnology Inc., 581 F.3d 305 (6^th Cir. 2009) and Segal v. Fifth Third Bank, N.A., No. 07-16527, 2009 WL 3260535 (9^th Cir. Oct. 9, 2009), two Federal Court of Appeals addressed the scope of the Securities Litigation Uniform Standards Act (the  “SLUSA”), each holding that the statute precludes class action law suits brought in state court.

The SLUSA sought to close the “federal flight” loophole created by the previous Private Securities Litigation Reform Act (the “PSLRA”).  The loophole refers to the use of state class action suits to avoid the stricter pleading requirements of the PSLRA.  To close that loophole, the SLUSA bars class actions based upon the statutory or common law of any state when a party alleges a misrepresentation or use of manipulative tactics in connection with the purchase or sale of a nationally listed security. 

In Segal, the beneficiary of certain trust accounts administered by Fifth Third Bank, N.A., filed a class action suit alleging breach of contractual and fiduciary duties.  The district court granted Fifth Third’s motion to dismiss for failure to state a claim under the SLUSA, concluding that the claims alleged prohibited misrepresentation or manipulation theories and could not, therefore, be filed in state court.  On appeal, the issue was whether the complaint alleged an “untrue statement” or a “material omission of fact” in connection with the sale of the nationally traded mutual funds. 

Despite the complaint expressly disclaiming that the state law allegations were based on misrepresentation or manipulation, the court held that such disclaimers were mere artful pleading.  The court concluded that in applying the SLUSA, courts should look to the overall substance of the complaint, and not resort to a formalistic search for the “magic” words (i.e. “untrue,” “deceptive,” “manipulation”, etc.).  Reasoning that to do otherwise would “frustrate the objectives” of PSLRA and SLUSA, the court further explained that the question under SLUSA was not whether the complaint used the “magic” words, but whether the complaint used the prohibited theories.  The court affirmed the district court’s decision but noted that Segal could have avoided the “unforgiving” operation of the SLUSA if he and other class members had filed the identical complaint individually. 

In Proctor, on the other hand, minority shareholders brought a derivative action against the corporation alleging corporate waste and breach of fiduciary duty in addition to a class action claim for breach of fiduciary duty in connection with a tender offer made by Vishay to its shareholders.  The defendants removed the action to federal court under the SLUSA.  The district court dismissed the class action claim on grounds that the claim was barred by the SLUSA.  The court sustained the remaining claims against the corporation and remanded the case back to state court. 

On appeal, the issue was whether the SLUSA required dismissal of all the claims under the SLUSA appearing in the same complaint as an entire precluded action.  In a matter of first impression for the Ninth Circuit, the court acknowledged a current circuit split on this issue.  This court joined the Second and Third Circuits, concluding that SLUSA precluded the class action, the statute did not bar the other claims, which could proceed in state court.  The court reasoned that the intent of the PRLSA, achieved through the SLUSA, was to reduce abusive litigation and that precluding otherwise valid claims would not serve this goal.  Indeed, the court noted, that to do otherwise may in fact reopen the “federal flight” loophole by forcing litigants to file two separate actions in state and federal court.

In Segal, where the complaint contained several claims incorporating prohibited theories under the SLUSA, as well as other non-prohibited theories that could be brought in state court, the court had no choice but to dismiss the entire action.  In Proctor, however, where the complaint carefully separated potentially SLUSA precluded federal claims from other non-precluded state claims, at least in the Second, Third and Ninth Circuits, those non-precluded state claims may proceed in state court. 

The practical import of theses recent appellate decisions is that a class action suit filed in state court arising out of a nationally listed security must be carefully pled so as to distinguish and separate theories of recovery that may be precluded under the SLUSA.  

The primary materials for this article may be found on the DU Corporate Governance website.