Chadbourne & Parke LLP v. Troice: State Law Securities Class Actions Based on Fraudulent Sale of CDs Not Barred by the Securities Litigation Uniform Standards Act

In Chadbourne & Parke LLP v. Troice, 134 S. Ct. 1058, 1059 (2014), the Supreme Court affirmed the Fifth Circuit’s ruling reversing the district court’s dismissal of four class action suits for securities fraud under the Securities Litigation Uniform Standards Act of 1988 (the “SLUSA”).

According to the allegations in the complaint, Plaintiffs were private investors who purchased certificates of deposit (“CDs”) from Stanford International Bank (the “Bank”) on the promise that the CDs were backed by other securities held by the Bank (“Plaintiffs”). The CDs themselves were not covered securities under the SLUSA but some of the investments made by the funds from the CDs were. Plaintiffs were allegedly told that the investments were safer than government issued CDs and that the Bank only invested CD sale proceeds in safe, secure assets. Plaintiffs asserted that they purchased the CDs based on these promises but Stanford instead used the funds from new investors for personal ends and to pay off old investors. 

Four separate state law class action suits were filed, two in Louisiana and two in Texas, against individuals and firms affiliated with Stanford (collectively, “Defendants”). Plaintiffs alleged that Defendants helped Stanford make false representations about the backing of the CDs with covered securities. The lawsuits were eventually removed to federal court and consolidated in the Northern District of Texas.  The District Court dismissed the claims, finding that they fell within the SLUSA.  

The SLUSA “forbids the bringing of large securities class actions based upon the statutory or common law of any State in which the plaintiffs allege a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” 15 U.S.C. §78bb(f)(1). A covered security is defined, in relevant part, as “securities traded on a national exchange.” §§ 78bb(f)(5)(E), 77r(b)(1). 

The District Court found that all four cases involved alleged misrepresentations in connection with covered securities and were, therefore, preempted by SLUSA. The Fifth Circuit, however, disagreed, finding that the alleged fraud was not “in connection with” covered securities. Defendants appealed to the Supreme Court. 

The CDs themselves were not securities covered by the SLUSA.  As a result, the Supreme Court considered whether the SLUSA extended to uncovered securities purchased with the promise that they were backed by covered securities. The Court held that a fraudulent misrepresentation was not made “in connection with” a purchase of a covered security “unless it was material to a decision by one or more individuals (other than the fraudster) to buy or sell a covered security.”

The majority concluded that the fraud was not “in connection with” any transaction in covered securities. First, the SLUSA focused specifically on transactions in covered securities, not uncovered. Second, the SLUSA’s “in connection with” requirement called for a fact that affected someone’s (other than the fraudster) decision to buy or sell a covered security. Third, prior case law was solely concerned with transactions in covered securities. Fourth, this interpretation helped ensure an honest securities market. And fifth, a broader interpretation of the rule would swallow many facets of state securities law and enforcement. 

Accordingly, the Court affirmed the Fifth Circuit’s judgment and found that SLUSA did not preclude the plaintiffs' state-law class actions.

The primary materials for this post are available on the DU Corporate Governance website.

Thomas Walton