The Sixth Circuit Court of Appeals affirmed the dismissal of a securities class action tied to the market crisis and brought against three mutual funds issued by Morgan Keegan Select Fund, Inc., an open-ended investment company. Atkinson v. Morgan Asset Management, Inc., No. 09-6265 (6th Cir. Sept. 8, 2011). The decision is based on the Securities Litigation Uniform Standards Act of 1998 or SLUSA.
Plaintiffs filed suit in state court against the funds’ advisers, officers, directors, distributor, auditor, and affiliated trust company. The complaints asserted thirteen state law claims for breach of contract, violations of the Maryland Securities Act, breach of fiduciary duty, negligence and negligent misrepresentation. The complaint centers on the claim that in 2007 and 2008 the defendants took unjustified risks in allocating fund assets which were concealed from the shareholders. If plaintiffs had known about the mismanagement, they would have redeemed their shares prior to the drop in value according to the complaint.
Defendants removed the state court action to federal court under SLUSA. Plaintiffs moved for remand. The district court concluded that SLUSA precludes the action and dismissed the action with prejudice.
SLUSA was enacted with the purpose of preventing class action plaintiffs from evading the requirements of the Private Securities Litigation Reform Act of 1995, or the PSLRA, by bringing the case in state rather than federal court. Accordingly, the Act precludes plaintiffs from filing a class action in state court if four elements are met: 1) the case consists of more than fifty prospective members; 2) it asserts state law claims; 3) it involves a nationally listed security; and 4) the complaint alleges “an untrue statement or omission of a material fact in connection with the purchase or sale of” that security. If these elements are met SLUSA authorizes the removal of the suit to federal court. A subsequent motion to remand raises a jurisdictional issue. Accordingly, if the court determines that the suit is precluded the proper course is to dismiss it.
Here plaintiffs claim that their suit is not precluded based on what is known as the Delaware carve-out. Under this section the action can go forward and is not precluded if it “involves . . .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.” In this case however plaintiffs are neither purchasers or sellers. Rather, they are “holders,” that is, they claim they did not sell but held their securities because of the acts of the defendants. While plaintiffs claim that the term purchase should be construed to include contracts to purchase securities, this argument would not save them the Court held. This is because in that instance the relevant purchase under the Delaware carve-out is the acquisition of their contract. Here the complaint does not allege any acquisition misconduct.
Likewise, plaintiffs’ supposition that their claims are based on state law and do not involve any “untrue statement or omission of a material fact” is inconsistent with the complaint, the Court concluded. It is true that SLUSA is only aimed at fraud based claims. The critical question here is whether “the complaint includes these types of allegations, pure and simple.” To make this determination the court must analyze the substance of the claims asserted in the complaint. Artful pleading will not save a complaint the Court cautioned. An analysis of the complaint in this case demonstrates that it is grounded in allegations of fraud. While the Court noted that it had not previously decided if SLUSA precludes only the fraud based claims or the entire complaint, that issue need not be resolved here since all of the allegations are tied to fraud.
Finally, the Court rejected plaintiffs’ suggestion that the action could be amended by reducing the number of plaintiffs or deleting the fraud claims. This point was not raised in the district court. Nevertheless, these modifications will not save this case the Court held because “SLUSA cannot be tricked.”
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Panelists: Christopher L. Garcia, Chief, Securities and Commodities fraud Task Force, Assistant U.S. Attorney, Southern District of New York; Daniel Hawke, Chief, Market Abuse Unit, Securities and Exchange Commission; Stuart Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association; Tammy Eisenberg, Chief Compliance Officer, General Counsel and Senior Vice President, DIAM U.S.A., Inc.
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