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Mutual Fund Shareholders Cannot Avoid Reach of SLUSA, Sixth Circuit Says

Friday, September 9, 2011

Susan M. Greenwood | Bloomberg Law Atkinson v. Morgan Asset Management, Inc., No. 09-06265, 2011 BL 230130 (6th Cir. Sept. 8, 2011) Although a class of mutual fund shareholders (Plaintiffs) looked for loopholes in the Securities Litigation Uniform Standards Act of 1998 (SLUSA), the U.S. Court of Appeals for the Sixth Circuit held that their state law claims "'meet[] the relatively straightforward requirements'" for dismissal under SLUSA. Plaintiffs, the Court explained, were shareholders in mutual funds (Funds) issued by Morgan Keegan Select Fund, Inc. When their shares lost value in 2007 and 2008, Plaintiffs filed 13 state law claims alleging fraud by the Funds' officers and directors, advisers, distributor, auditor, and affiliated trust company (collectively, Defendants). After Defendants removed the action to federal court, the U.S. District Court for the Western District of Tennessee dismissed the action pursuant to SLUSA.

No Escape from SLUSA

Coming three years after the Private Securities Litigation Reform Act of 1995 (PSLRA), SLUSA addressed the trend of plaintiffs avoiding the PSLRA's stringent pleading requirements "by recasting their claims under state law and filing them in state court." As the Sixth Circuit explained, "Congress shut this state-law back door by enacting SLUSA." With limited exemptions, SLUSA precludes state court class actions on behalf of more than 50 class members that assert state law claims alleging "'an untrue statement or omission of a material fact in connection with the purchase or sale of'" a nationally listed security.

— Holders Need Not Apply for SLUSA Exemption

One specific exemption to SLUSA preclusion is the Delaware carve-out, which permits a class action involving '"the purchase or sale of securities by the issuer or an affiliate of the issuer exclusively from or to holders of equity securities of the issuer.'" According to the Sixth Circuit, however, the Delaware carve-out does not apply to shield Plaintiffs from SLUSA. As mutual fund holders, Plaintiffs' action did not involve either a purchase or a sale of a security. The Court rejected the contention that the Funds' "obligation to redeem Plaintiffs' shares amounts to an ongoing contract to purchase them." While some courts have accepted the acquisition of a contract to purchase—such as security options—as a purchase under SLUSA, the Sixth Circuit noted that Plaintiffs do not allege any misconduct in the acquisition of their Fund shares. Moreover, the Court said that there was "no authority for [Plaintiffs'] actual argument: that a fund's redemption obligation under an already-acquired contract to purchase amounts to an indefinitely extending 'purchase' under the carve-out." (emphasis in original). Unsuccessful with the plain language of the Delaware carve-out, Plaintiffs argued that even as holders of securities, their action "involves" the purchase or sale of securities. They relied on Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006), for the proposition that "SLUSA's bar on actions involving fraud 'in connection with the purchase or sale of a . . . security,'" includes holder claims. "In connection with" and "involves," Plaintiffs said, are synonymous so that as holder claims are included in the general SLUSA preclusion, they also are part of the Delaware carve-out. The Sixth Circuit disagreed, and credited Congress with the ability to choose the proper language to extend the Delaware carve-out to holders of securities. Moreover, it concluded that "Plaintiffs' construction of the carve-out invites us to pull the rug out from under Dabit's holding, creating an exemption for a large set of the very holder claims over which Dabit extended SLUSA's bar." The Sixth Circuit "decline[d] to extend the carve-out so far."

— Fraud by Any Other Name Is Still Fraud

Plaintiffs' state law claims alleged breach of contract, violations of the Maryland Securities Act, breach of fiduciary duty, negligence, and negligent misrepresentation. Each of these causes of action, indeed the complaint as a whole the Court said, reverberated with allegations that Defendants "misrepresented assets," "failed to disclose material information," and "employed false financial information." While Plaintiffs pointed to extracircuit case law to argue that "SLUSA bars only claims that require fraud as a necessary element," the Court was adamant that its own precedent ruled: [SLUSA] does not ask whether the complaint makes "material" or "dependent" allegations of misrepresentation in connection with buying or selling securities. It asks whether the complaint includes these types of allegations, pure and simple. (emphasis in original). The Court did acknowledge that it has not "addressed whether SLUSA precludes an entire action, as opposed to specific claims, if the complaint contains any covered allegations." However, it declined to answer that question, observing that "because all of Plaintiffs' claims include allegations of fraud, SLUSA damns each one."

— No Artful Amendment

Finally, the Sixth Circuit "agreed with the district court that fraud-based concepts invade each of Plaintiffs' claims, making efforts at artful amendment futile." Under Plaintiffs' rationale for amendment, the Court explained, a complaint could always be reworked to limit the number of class members to 49 or rewrite fraud-based allegations. SLUSA, however, does not permit a covered class action to be maintained "if it is based on allegations of fraud." Plaintiffs, the Sixth Circuit said, could have filed their initial action with less than 50 class members, but failing to do so, may not perpetually amend their complaint to avoid the strictures of SLUSA.
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