The Securities Exchange Commission (SEC)
plays an active role in protecting the rights of investors. Its own
mission statement is:
The mission of the Securities and
Exchange Commission is to protect investors; maintain fair, orderly, and
efficient markets; and facilitate capital formation.
Yet, in the high-profile Ponzi scheme
case of R. Allen Stanford and Stanford Financial Bank, the SEC is finding
itself aligned both for and against efforts to recover funds for the
benefit of the defrauded victims. Positions taken by the SEC in two
different pending litigation matters in the Stanford case may have polar
opposite effects on the financial outcome for defrauded investors.
One case, SEC v. SIPC, now pending in
the Circuit Court for the District of Columbia, involves a battle between
the SEC and the Securities Investor Protection Corporation (SIPC) over
whether the defrauded victims are “customers” under the Securities
Investor Protection Act (SIPA) and therefore entitled to payment from SIPC.
This is the first time that the SEC has ever commenced an action seeking
SIPC coverage for investors. The lower court found that the Stanford
investors are not entitled to SIPC coverage, but the SEC continues to
champion the cause of the investors in the Circuit Court seeking SIPC
coverage for them.
The other case, Chadbourne & Park LLP
v. Troice et al., involves an appeal to the U.S. Supreme Court over
the issue of whether Securities Litigation Uniform Standards Act of 1998 (SLUSA)
bars lawsuits by a class of victims against third parties to recover their
losses from alleged wrongdoers. The Fifth Circuit held that the claims
against two law firms, an insurance brokerage firm and a financial
services firm could proceed despite SLUSA. The U.S. Government, on behalf
of the SEC and other agencies, filed an amicus brief with the Supreme
Court arguing that the investor claims should be barred under SLUSA. If
the Government’s position prevails, defrauded victims will be denied
recovery on their claims.
In what would be a worst case scenario
for the investors, the SEC will lose in SEC v. SIPC so that investors will
be denied “customer” status and protection, and the Government’s position
in the Chadbourne & Park case will prevail, denying investors the
ability to use self-help to sue alleged wrongdoers.
At a quick glance, it seems that the SEC
is on the wrong side of the SLUSA fight in Chadbourne & Park, given
the potentially adverse consequences for investors if the SEC’s position
is adopted. But perhaps the issue has more do with the way that the
applicable statutes are written and interpreted than with any intent on
the part of the SEC.
In Chadbourne & Park, the
principal question to be considered by the Supreme Court is:
Does the Securities Litigation Uniform
Standards Act of 1998 (“SLUSA”), 15 U.S.C. 77p(b), 78bb(f)(1), prohibit
private class actions based on state law only where the alleged purchase
or sale of a covered security is “more than tangentially related” to the
“heart, crux or gravamen” of the alleged fraud?
SLUSA prohibits a state law class action
alleging a purchase or sale of a covered security “in connection with” an
untrue statement or omission of material fact. A “covered class action” is
a lawsuit in which damages are sought on behalf of more than 50 people,
and a “covered security” is a nationally traded security that is listed on
a regulated national exchange. So the question remaining is: What does “in
connection with” mean?
The target defendants in the litigation
at issue argue that “in connection with” covers the following two factual
scenarios that touch “covered securities” in the Stanford case: (1) that
Stanford lied to purchasers of CDs and told them that the CDs were backed
by investments in stocks; and (2) that some of the CD purchasers must have
liquidated stocks in order to purchase the CDs.
The Fifth Circuit did not agree that
either of these two scenarios were sufficient to bar claims under SLUSA,
holding that the purchase or sale of a covered security must be more than
tangentially related “to the ‘heart,’ ‘crux,’ or ‘gravamen’ of the
defendants’ fraud.” The Fifth Circuit held that the claims against the
defendants could proceed.
The Government, on the other hand, has
taken the position in its amicus brief to the Supreme Court that the
relevant language of SLUSA was taken from the Securities Exchange Act of
1934 and should be read consistently with similar language in Section
10(b) of the Act. In urging a broad reading of the words “in connection
with,” the Government contends that:
[A] broad reading is essential to the
achievement of Congress’s purpose in enacting both Section 10(b) and
SLUSA. Under Section 10(b), it enhances the SEC’s ability to protect the
securities markets against a variety of different forms of fraud. Under
SLUSA, it furthers Congress’s objective of preventing the use of
state-law class actions to circumvent the restrictions by the PSLRA
[Private Securities Litigation Reform Act] and by this Court’s decisions
constraining private securities-fraud suits.
In an amicus brief taking the contrary
position, 16 law professors directly challenge the concept of broadening
the application of SLUSA to include the certificates of deposit purchased
by the Stanford investors. They note that the certificates of deposit are
not themselves covered securities and argue that therefore SLUSA should be
“interpreted in a way that does not preclude investors from using state
courts to pursue claims seeking traditional state law remedies for acts
that do not involve covered securities within the meaning of the federal
securities laws.”
To stress their position that SLUSA
should not apply to non-covered bank-issued securities that may be
potentially backed by covered securities, the 16 law professors float the
following hypothetical class action claims, among others, that they
contend would improperly be prohibited under SLUSA if interpreted that
broadly:
-“A car dealer who lies to customers
about the terms of a car loan, where the car loans are securitized in a
pool and interests in the pool are sold off as covered securities.”
-“A credit card company that securitizes
credit card balances fails to pay appropriate wages to telephone operators
and answering card holder questions, and the operators file a state class
action alleging violations of state wage and hour laws.”
-“A nationally-traded securities
clearing firm engages in sex discrimination in compensating clerical
workers for work done in the securities office, and the workers file a sex
discrimination class action law suit.”
In summary, where the Supreme Court
draws the lines on the application of SLUSA could have a significant
impact on a variety of state law claims that may or may not have much to
do with securities. The SEC stands behind a broad reading of SLUSA under
the pretense of protecting the securities market, but its position appears
to have the consequence of harming, not helping, defrauded victims by
blocking state law damage claims.
The issues are undoubtedly complicated,
and there are a variety of competing considerations. From the investors’
perspective, however, they can just add this to the list of roadblocks to
getting their money back.
Originally posted on
www.theponzischemeblog.com on October 24, 2013.
*Kathy Bazoian Phelps is a partner at Diamond McCarthy, LLP, Los
Angeles, and the co-author of The Ponzi Book: A Legal Resource for
Unraveling Ponzi Schemes. She frequently represents receivers and
trustees. |