In Chadbourne & Parke LLP v. Troice (U.S. Supreme Court February 26, 2014), the Supreme Court held that bank CD’s not traded on national securities exchange are not a “covered security” and therefore a class action based on fraud in connection with such CD’s can be brought in state court.
Allen Stanford and several of his companies ran a multi-billion-dollar Ponzi scheme. Stanford and his companies sold investors certificates of deposit in Stanford International Bank, an offshore bank chartered in Antigua. Those certificates “were debt assets that promised a fixed rate of return.” The investors alleged that they expected Stanford International Bank to use the money it received to buy highly marketable securities issued by stable governments and strong multinational companies. But instead, Stanford and his associates used the money provided by new investors to repay old investors, to finance an elaborate lifestyle, and to finance speculative real estate ventures. Stanford International Bank failed, and Allen Stanford was sentenced to 110 years in federal prison and required to forfeit $6 billion.
The Securities Litigation Uniform Standards Act of 1998 (the “Securities Litigation Act”) forbids bringing 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.” The Securities Litigation Act defines the term “covered security” narrowly to include only securities traded on a national securities exchange (or, here irrelevant, those issued by investment companies). The certificates of deposit offered by the bank were not traded on a national securities exchange.
The Securities Litigation Act, by the way, does not apply to class actions based on the law “of the State in which the issuer is incorporated.”
Investors who bought the bank’s certificates of deposit brought four class actions against two law firms as well as insurance brokers and investment advisers. Each complaint in one way or another alleged that the fraud included misrepresentations about the bank’s ownership of securities that constituted “covered securities” and that the bank’s purported ownership of these “covered” securities made investments in the certificates of deposit, which were uncovered securities, more secure.
The Fifth Circuit Court of Appeals held that the falsehoods about the bank’s holdings in covered securities were too “tangentially related” to the “crux” of the fraud to trigger the Securities Litigation Act.
The question presented to the Supreme Court was whether the Securities Litigation Act encompasses a class action in which the plaintiffs allege (1) that they “purchase[d]” uncovered securities (certificates of deposit that are not traded on any national exchange), but (2) that the defendants falsely told the victims that the uncovered securities were backed by covered securities.
The Supreme Court held that a fraudulent misrepresentation or omission is not made “in connection with” such a “purchase or sale of a covered security” unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a “covered security.” Thus, the Securities Litigation Act does not apply, and the investors were free to pursue the class action litigation.
The court acknowledged that its decision meant that a bank, chartered in Antigua and offering certificates of deposit not traded on a U. S. exchange, will not be able to claim the benefit of preclusion under the Litigation Act. But it stated that it was difficult to see why the federal securities laws would be—or should be—concerned with shielding such entities from lawsuits.
The court took pains to note that its holding does not limit the federal government’s authority to prosecute frauds like the one here.