In its recent Chadbourne decision, the U.S. Supreme Court held that to be “in connection with” the purchase or sale of a security, an alleged securities fraud must involve “victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintaned an ownership interest in financial instruments that fall within the relevant statutory definition.” Whether that requirement is met, of course, depends heavily on the particular facts at issue.
In Hidalgo-Velez v. San Juan Asset Management, Inc., 2014 WL 3360698 (1st Cir. July 9, 2014) the court addressed whether SLUSA preemption, which applies only to cases involving the purchase or sale of securities traded on a national exchange (“covered securities”), could be invoked if the plaintiffs were investors in a fund that promised to invest at least 75% of its assets “in certain specialized notes offering exposure to North American and European bond indices.” As a threshold matter, the fund shares were not covered securities. The court found, however, that “the analysis does not invariably end there.” To the extent that “the primary intent or effect of purchasing an uncovered security is to take an ownership interest in a covered security,” the “in connection with” requirement could still be met.
The court held that in analyzing this issue, the “relevant questions include (but are not limited to) what the fund represents its primary purpose to be in soliciting investors and whether covered securities predominate in the promised mix of investments.” In the instant case, it was clear the fund was marketed “principally as a vehicle for exposure to uncovered securities” (i.e., the specialized notes). Accordingly, the “in connection with” requirement was not met and SLUSA preemption did not apply.
Holding: Judgment of dismissal vacated, reversal of order denying remand, and remittal of case with instructions to return it to state court.
Quote of note: “As pleaded, the plaintiffs’ case depends on averments that, in substance, the defendants made misrepresentations about uncovered securities (namely, those investments that were supposed to satisfy the 75% promise); that the plaintiffs purchased uncovered securities (shares in the Fund) based on those misrepresentations; and that their primary purpose in doing so was to acquire an interest in uncovered securities. Seen in this light, the connection between the misrepresentations alleged and any covered securities in the Fund’s portfolio is too tangential to justify bringing the SLUSA into play.”