Securities Regulation Daily Cert petition argues Ninth Circuit defied precedent in SLUSA ruling
Friday, October 4, 2019

Cert petition argues Ninth Circuit defied precedent in SLUSA ruling

By Rodney F. Tonkovic, J.D.

A petition for certiorari argues that the Ninth Circuit misapplied Supreme Court precedent on the SLUSA in a way that invites abusive litigation.

A petition for certiorari asks the Supreme Court to address the Ninth Circuit's narrow reading of the SLUSA's broad preemption provision. In a case where a trustee allegedly committed fraud when buying and selling securities for its own benefit, the Ninth Circuit said that the fraud could not be "in connection with" the purchase or sale of a security because the trustee's misconduct could only affect its own purchases. The petition asserts that the Ninth Circuit ignored and misused Court precedent and allowed a securities-fraud class-action suit to proceed under state law in direct contravention of the SLUSA's text. A response is due November 1, 2019 (The Northern Trust Corporation v. Banks, October 2, 2019).

Imprudent investments. The case was brought as a class action in federal court by the beneficiary of an irrevocable trust created under California law. The beneficiary asserted violations of state law involving breaches of fiduciary duty by Northern Trust Corporation based on its imprudent investments in affiliated funds over better-performing investments that were not affiliated with Northern. The district court dismissed the complaint without leave to amend as barred by the SLUSA. The court concluded that, because Northern was an agent of the trust's beneficiaries, the investments were made "in connection with" the purchase or sale of covered securities and featured material misrepresentations or omissions.

The Ninth Circuit reversed. The issue, one of first impression in the Ninth Circuit, was whether allegations concerning a trustee's imprudent investments constituted activity "in connection with" the purchase or sale of securities when those allegations are brought by the beneficiaries of an irrevocable trust. Crucial to the court's holding was the fact that beneficiaries who are not also trustees of an irrevocable trust cannot direct the actions of the trustee. In short, the only purchases or sales made in connection with Northern's alleged deceptive conduct were by Northern itself, not the plaintiff beneficiary—Northern, essentially, could only "deceive" itself.

Petition. In its petition for certiorari, Northern asks whether a trust beneficiary alleges misconduct "in connection with" the purchase or sale of a covered security when the beneficiary alleges that the trustee, for its own pecuniary gain, used trust assets to buy and sell the trustee’s own proprietary securities rather than competitors' securities. The Ninth Circuit, Northern contends, took an "impossibly narrow" view of Supreme Court precedent, creating an "arbitrary exception to SLUSA’s broad preclusive force." The holding is not only wrong, the petition continues, but also directly conflicts with rulings in other circuits.

Defiance of precedent. The petition remarks that, in what should have been an easy case, the Ninth Circuit elected to defy the Court's precedent—precedent involving facts "materially indistinguishable" from those in this case—in order to make a distinction between purchases and sales by a stockbroker, and purchases and sales by a trustee. SEC v. Zandford (2002) held that a broker made no affirmative misrepresentation to the plaintiffs when selling securities in a discretionary account and making personal use of the proceeds. In Zandford, then, the securities transactions and breaches of fiduciary duty coincided, and the "in connection with" requirement was thus satisfied. The Court said that it was of no consequence that the investment decisions were made without the knowledge or involvement of the principal.

In 2006, Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit held that Zandford, which concerned the scope of Rule 10b-5, also governs the SLUSA's scope. According to the petition, the Ninth Circuit based its deviation from this precedent on dicta in the Troice decision. That case, however, concerned statements about uncovered securities and thoroughly dissimilar facts, the petition avers. The Ninth Circuit further ignored Troice's statement that the opinion subjected to state-law liability only traders of securities not traded on U.S. national exchanges. Indeed, Troice specifically stated that it was not modifying Dabit. The petition argues that the respondent here states a classic securities law claim—trades made despite a conflict of interest—and the fact that Northern is a trustee should not exempt this case from the federal securities laws.

Circuit split. The Ninth Circuit's decision also squarely conflicts with rulings in the Sixth and Eighth Circuits. These cases had substantively identical facts, and the 2008 Eighth Circuit case turned upon the same question as this matter. In Siepel v. Bank of America, the Eighth Circuit found that the SLUSA barred a class action based on Dabit's holding that it is enough that the fraud alleged coincide with a securities transaction by the plaintiff or someone else. Rather than distinguishing these cases, the Ninth Circuit simply concluded that Troice implicitly abrogated them, but that case's narrow ruling cannot plausibly be read to overrule decisions like those from the Sixth and Eighth Circuits, the petition says.

This circuit split is an "engraved invitation to forum-shopping," the petition remarks. So long as a single class member lives in the Ninth Circuit, which is a near certainty in typical suits, litigants will flock to where a state-law claim is guaranteed to overcome a SLUSA preclusion defense. According to the petition, the Ninth Circuit's ruling will bring a windfall to plaintiffs’ lawyers, while harming financial institutions, trust beneficiaries, and the investing public. Moreover, the ruling will thwart the SEC's efforts to enforce the securities laws by allowing defendants to avoid liability under Section 10(b). The petition observes that this circumstance, at minimum, warrants an invitation for the Solicitor General to express his views.

The petition is No. 19-440.

Attorneys: Ian Heath Gershengorn (Jenner & Block LLP) for Northern Trust Corp. and Northern Trust Co.

Companies: Northern Trust Corp; Northern Trust Co.

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