Chadbourne Decided (And Section 11 Is On Deck)

On the eve of the Halliburton oral argument, there have been two other developments in the U.S. Supreme Court related to securities litigation.

(1) Last week, in the Chadbourne & Parke LLP v. Troice case, the Court held that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) does not preclude state-law class actions unless the alleged misrepresentation “is material to a decision by one or more individuals (other than the fraudster) to buy or sell a ‘covered security.'” The Court went on to find that the state-law class action against the defendants should be allowed to proceed because the alleged ponzi scheme, in which high-interest certificates of deposit (not covered securities) were sold to investors who were falsely told that the proceeds would be invested in liquid securities (at least some of which would be covered securities), did not satisfy this test.

The 7-2 decision authored by Justice Breyer provides an interpretation of the phrase “in connection with the purchase or sale” of a security that is contained both in SLUSA and Section 10(b) of the Securities Exchange Act (the primary statutory basis for federal securities fraud claims). The Court presents the following key arguments in support of its interpretation. First, SLUSA’s language suggests that the requisite connection to the purchase or sale must “matter” and “[i]f the only party who decides to buy or sell a covered security as a result of a lie is the liar, that is not a connection that matters.” Second, “every securities case in which this Court has found a fraud to be ‘in connection with’ a purchase or sale of a security has involved victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition.” Finally, the Court’s reading of SLUSA is consistent with the Securities Exchange Act and the Securities Act because “[n]othing in [those] statutes suggests their object is to protect persons whose connection with the statutorily defined securities is more remote than words such as ‘buy,’ ‘sell,’ and the like, indicate.”

On its surface, of course, the decision is a victory for the plaintiffs’ bar because it narrows the scope of SLUSA preemption. But the split within the Court – Justices Kennedy and Alito filed a vigorous dissent arguing that the new test is inconsistent with the Court’s prior “broad construction” of the “in connection with” language – may be the result of two different forces at play. While the Court’s test narrows the scope of SLUSA preemption, it also appears to narrow the overall scope of Section 10(b), limiting how far the plaintiffs’ bar (and the SEC) can push the definition of a “securities fraud.” This result sheds some light on why, for example, Justice Thomas joins the majority in a short, separate concurrence that applauds the application of “a limiting principle to the phrase ‘in connection with'” – an outcome that no doubt appealed to a justice who has been in dissent in previous cases that arguably espoused a broader view of “in connection with” (e.g., O’Hagan).

(2) Apparently anxious to continue to delve into securities litigation issues, the Court also granted cert on Monday in the Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund case, which will be heard next term. At issue is the scope of Section 11 of the Securities Act, which provides a private remedy for a purchaser of securities issued under a registration statement filed with the SEC if the registration statement contains a material misstatement or omission.

The Court will consider the pleading standard for an allegedly false or misleading opinion (as opposed to statement of fact). While the Second, Third, and Ninth Circuits have held that under Section 11 a plaintiff must allege that the statement was both objectively and subjectively false – requiring allegations that the speaker’s actual opinion was different from the one expressed – in Omnicare the Sixth Circuit held that if a defendant “discloses information that includes a material misstatement [even if it is an opinion], that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity.” Stay tuned.