United States: Second Circuit Narrows Scope Of SLUSA Preclusion

In In re Kingate Management Ltd. Litigation, No. 11-1397, 2015 U.S. App. LEXIS 6725 (2d Cir. Apr. 23, 2015), the United States Court of Appeals for the Second Circuit held that in order for the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), 15 U.S.C. § 78bb(f), to preclude state law claims that fall within the anti-falsity provisions of the Securities Act of 1933 and Securities Exchange Act of 1934, (1) the claims must allege that the defendant, not some third party, engaged in the requisite false conduct and (2) the allegation of false conduct must be necessary to liability under the state laws alleged. The Court also held that SLUSA does not require that an entire complaint be dismissed if only certain claims or parts of claims are precluded. Those claims which are not covered by SLUSA must be allowed to proceed. This decision clarifies the scope of SLUSA preclusion.

Plaintiffs were individuals and entities who purchased shares in Kingate Global Fund, Ltd. and/or Kingate Euro Fund, Ltd., and held those shares until Benard L. Madoff's Ponzi scheme was exposed in December 2008. Plaintiffs brought various state law class claims against defendants, persons and entities affiliated with the Funds. The Funds were feeder funds for Bernard L. Madoff Investment Securities LLC ("BMIS"), and delegated investment decisions and duties to Madoff and BMIS. BMIS provided statements to the Funds which purported to show purchases and sales of "covered securities."

Plaintiffs asserted twenty-eight state common law claims against defendants, which could be broken up into five categories: (1) fraudulent misrepresentations and omissions made in connection with the Funds' investment in covered securities and defendants' oversight of those investments; (2) negligent misrepresentations and omissions of the same sort; (3) aiding and abetting the intentional fraud of category 1; (4) breach of contractual, fiduciary, or tort-based duties owed to plaintiffs, resulting in the failure to detect Madoff and BMIS' fraud; and (5) compensation for fees paid to defendants by the Funds either because the defendants failed to perform the duties for which the fees were paid, or because the fees were based on improper calculations. Defendants moved to dismiss.

The United States District Court for the Southern District of New York granted the motion to dismiss, holding that the claims were precluded by SLUSA. SLUSA generally bars plaintiffs from bringing actions based on state common or statutory law on behalf of more than fifty people "in connection with the purchase or sale of a covered security." Though plaintiffs' shares of the Funds were not "covered securities" under SLUSA, plaintiffs' expectation that the Funds would invest in covered securities was sufficient to invoke SLUSA preclusion. The district court determined that all of the claims alleged were precluded because they included allegations of false conduct in connection with transactions in covered securities, and dismissed the complaint without leave to amend.

The Second Circuit reversed. The Court agreed with the district court's determination that SLUSA preclusion was properly implicated under the facts of the case. The Court held that the purchase of uncovered shares of the Funds with the expectation that the Funds, in turn, were investing in covered securities, was sufficient to satisfy the SLUSA requirement that the alleged falsity be "in connection with" the purchase or sale of a covered security.

The Second Circuit, however, rejected the district court's ruling that the complaint should be dismissed in its entirety because some allegations in the complaint involved material misstatements in connection with the purchase of a covered security. Instead, the Court held that courts must conduct a claim-by-claim analysis to determine whether (1) the defendant was involved in the allegedly misleading conduct and (2) the allegation is necessary to liability for the state law claims. Where a complaint includes an allegation of misrepresentation but that allegation either does not allege that the defendant engaged in misrepresentations or is not necessary for liability under the relevant state law, the claim is not precluded by SLUSA. The court reiterated that artful pleading cannot be used to avoid preclusion, and noted that SLUSA preclusion may apply even where no private right of action exists under the federal law. The Court also noted that district courts may look outside the allegations of a complaint to determine if certain status-based elements of SLUSA, such as the "covered" status of the relevant security, apply to the case at hand.

Applying this standard to the allegations in plaintiffs' complaint, the Court held that allegations related to defendants' claims for fraudulent misrepresentations and omissions, negligent misrepresentations and omissions, and aiding and abetting fraudulent misrepresentations were all precluded by SLUSA. Plainitffs' claims for breaches of various contractual, fiduciary, and tort-based duties, and claims based on the payment of fees to defendants, however, were not precluded. Although those claims involved allegations of false conduct, they did not allege that the defendants committed any of the alleged false conduct. Further, defendants' potential liability for those claims arose from breaches of duties and obligations to plaintiffs, and the payment of fees by plaintiffs to defendants, not from any alleged misstatements. As neither set of claims required any showing of false conduct on the part of the defendants, they were not precluded by SLUSA. The Court remanded, instructing the district court to determine which claims or portions of claims are, in fact, precluded by SLUSA, and ordering the Court to dismiss claims covered by SLUSA and proceed with the remainder.

The Second Circuit's decision here clarifies and narrows the scope of SLUSA preclusion. Defendants seeking to dismiss complaints on the ground of SLUSA preclusion must be able to demonstrate that all of the claims alleged implicate and are precluded by SLUSA. Claims that do not fall under SLUSA's ambit will no longer be dismissed alongside those that do.

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