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SLUSA Precludes Only Claims Arising out of Defendant's False Conduct: Second Circuit
Practical Law Legal Update 7-610-4347 (Approx. 3 pages)
SLUSA Precludes Only Claims Arising out of Defendant's False Conduct: Second Circuit
by Practical Law Litigation
| Published on 28 Apr 2015 • USA (National/Federal) |
In In re Kingate Mgmt. Ltd. Litig., the US Court of Appeals for the Second Circuit clarified the scope of the Securities Litigation Uniform Standards Act of 1998 (SLUSA), holding that it precludes only claims predicated on false conduct by the defendant.
On April 23, 2015, in In re Kingate Mgmt. Ltd. Litig., the US Court of Appeals for the Second Circuit clarified the scope of the Securities Litigation Uniform Standards Act of 1998 (SLUSA), holding that it precludes only claims predicated on false conduct by the defendant (No. 11-1397, (2d Cir. Apr. 23, 2015)).
Investors in offshore feeder funds that were part of the Bernard Madoff Ponzi scheme brought state-law class action claims against the funds' managers, auditors, consultant, and administrator for fraud, negligent misrepresentation, negligence, breach of contract, breach of fiduciary duties, constructive trust, mutual mistake, and unjust enrichment.
Defendants moved to dismiss on the ground that the investors' claims were precluded by SLUSA, which bars plaintiffs from bringing state-law class actions alleging false conduct in connection with certain types of securities. The US District Court for the Southern District of New York granted the motion and dismissed the plaintiffs' claims. Plaintiffs appealed.
The Second Circuit identified three relationships a court must consider in determining whether a state‐law class action suit falls within the scope of SLUSA's prohibitions:
- The relationship of the transaction in covered securities to the alleged false conduct.
- The relationship of the alleged false conduct to the state law theory of liability.
- The relationship of the defendant to the alleged false conduct.
Concerning the first relationship, the court, relying on In re Herald, 753 F.3d 110 (2d Cir.2014), held that it is sufficient for the alleged false conduct to have occurred in connection with the indirect purchase of "covered securities." Here, although the plaintiffs purchased something other than covered securities, they knew that the funds in which they invested would use their investments to purchase covered securities.
Concerning the second and third relationships, the Second Circuit held that SLUSA precludes only state law claims where the allegations of false conduct are necessary (legally or factually) to establish the defendant's liability. A claim that includes peripheral or inessential allegations of false conduct does not fall within SLUSA's scope.
In stating this standard, the court noted two caveats:
- In determining whether SLUSA applies, courts must consider the substance of the plaintiffs' claims, not the language of the complaint. Plaintiffs, therefore, may not evade SLUSA by camouflaging allegations that involve falsity in connection with transactions in covered securities as something else (for example, claims for breach of a contractual obligation for good faith and fair dealing) or omitting pertinent facts (for example, that a security was listed on a national exchange).
- While SLUSA applies only to allegations of conduct by the defendant that would violate the anti-falsity provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, SLUSA may apply even though there is no private claim for that violation under the 1933 and 1934 Acts.
Here, only some of the plaintiffs' claims alleged conduct by defendants prohibited by anti-falsity provisions of federal securities statutes. SLUSA precluded those claims, but not the remaining claims. The Second Circuit therefore vacated the district court's judgment dismissing the plaintiffs' claims and instructed the district court to dismiss the precluded claims and proceed with the remaining claims.