Introduction

On January 20, 2009, the United States Court of Appeals for the Third Circuit announced its decision in White v. Lord Abbett & Co. LLC (In re Lord AbbettMutual Funds Fee Litigation),1 holding that the presence of one or more claims preempted by the Securities Litigation Uniform Standards Act (“SLUSA”) did not automatically require dismissal of the entire securities class action. After examining statutory language, legislative intent and relevant case law, the court held that Congress did not intend that all claims must be dismissed when an action includes some claims that cannot be maintained under SLUSA. The court held that dismissing state claims preempted under SLUSA, while allowing the non-offending federal claims to proceed, is consistent with SLUSA’s purposes of preventing abuses in private securities fraud and promoting a uniform federal standard governing all nationally-traded securities.

Background

In 1995, Congress adopted the Private Securities Litigation Reform Act (“PSLRA”) to combat the perceived abuses of meritless class action suits that targeted corporate defendants.2 The legislation consisted of procedural reforms, including heightened pleading standards, limitations on damage, sanctions for frivolous litigation, and a “loser pays” fee-shifting regime designed to deter filing of frivolous class actions. However, to evade these federal restrictions, plaintiffs’ attorneys began filing securities class actions in state court, under state securities laws.

In an attempt to remedy the “federal flight” loophole, in 1998, Congress enacted the Securities Litigation Uniform Standards Act to create “national standards for securities class action lawsuits involving nationally traded securities.”3 In doing so, federal law, not state law, became the exclusive vehicle to assert securities class action fraud claims, and the federal courts became the exclusive venue for such suits. Under SLUSA, any “covered class action”4 alleging a misrepresentation of a material fact “in connection with” the purchase or sale of a security based on state law, is preempted by federal law and faces subsequent dismissal in federal court. The Supreme Court’s unanimous decision in Merrill Lynch, Pierce, Fenner& Smith, Inc. v. Dabit (Dabit II)5 clarified that SLUSA preempts a broad array of state-law class actions claims, regardless of whether the plaintiff is a purchaser, seller, or holder of a covered security, or someone else. If a plaintiff files a “covered class action” in state court, the case should be dismissed or removed to federal court by the defendant. Once removed to federal court, the state law claims preempted under SLUSA will be dismissed, but it is an open question as to what happened to the remaining claims that do not trigger preemption. The decision in In re Abbett addresses whether the remaining viable claims will proceed in federal court or whether the entire action must be dismissed automatically once one of the claims is found to be preempted under SLUSA.

District Court’s Decision

In In re Lord Abbett Mut. Funds Fee Litig., six shareholders sued a fund management company and its partners, directors, and others in a class action that contained ten claims for relief under both state and federal law.The district court initially dismissed the complaint reasoning that the state law claims were preempted by SLUSA and the federal securities claim, under Section 36(b) of the Investment Company Act of 1940, failed to state a claim on other grounds, but granted leave to amend the federal securities claim. Defendants then argued that because plaintiffs had joined their Section 36(b) class claim to their preempted state-law class claim, SLUSA required dismissal of the entire case, not just the state law claims. Agreeing, the district court concluded that SLUSA’s statutory language required dismissal of the entire “covered class action” rather than individual “claims” including the plaintiffs federal § 36(b) claim.6 The district court vacated its order granting leave to amend and dismissed the class action complaint with prejudice.

Third Circuit’s Decision to Reverse

Judge Roth, writing for a panel that included Judges Sloviter and Barry, vacated the district court’s order dismissing the entire class action on grounds that it was preempted by SLUSA and remanded the case for further proceedings consistent with the court of appeals’ opinion.

According to the Third Circuit, the plain language of SLUSA does not indicate whether Congress intended for an entire action to be dismissed when a complaint contains some claims that are precluded under SLUSA and other claims that are not. The defendants argued that Congress intentionally used the term “action” and not “claim” so SLUSA would pre-empt entire actions that include offending state law claims. The court also recognized that it had suggested, in Rowinski v. Salomon Smith Barney Inc., that SLUSA “preempts entire actions rather than particular claims.”7 However, the panel distinguished Rowinski, which incorporated pre-empted state-law allegations into every count of the complaint, from In re Lord Abbett, where the complaint contained independent federal claims.

The Third Circuit noted that the only other appeals court decision on point, the Second Circuit’s decision in Dabit v. Merill Lynch, Pierce, Fenner & Smith, Inc. (Dabit I),8 was consistent with its holding here. Dabit I similarly reasoned that SLUSA does not require dismissal of an entire action when the action only includes some preempted state-law class action claims. Then in Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit (Dabit II),9 the Supreme Court reversed Dabit I on other grounds. Although Dabit I was reversed on separate grounds, the defendants in In re Lord Abbett contended Dabit II weakened the Second Circuit’s view that SLUSA does not require dismissal of an entire class action when only some claims are prohibited. Ultimately, the court concluded Dabit II did not compel it to hold that SLUSA required the dismissal of an entire action; rather, Dabit II determined that “holder actions”10 were not excluded from SLUSA’s sweep.

The Third Circuit reasoned that requiring the dismissal of valid federal claims which are not preempted by statute would not further SLUSA’s purposes and is not supported in the plain language of the statute or legislative history. Further, it is likely that plaintiffs will simply file one or more separate actions to avoid having all of their claims dismissed. This result will burden the court with wasteful and duplicative litigation. Thus, the court concluded that “SLUSA does not mandate dismissal of an action in its entirety where the action includes only some pre-empted claims.”

Looking Forward

The Third Circuit determined that Congress did not intend to preempt federal claims and state-law claims that were not specifically covered by SLUSA’s preemptive scope. It remains to be seen if other courts will agree with the Third Circuit’s interpretation and whether the Supreme Court will rule on yet another issue involving SLUSA.

1 No. 07-1112, 2009 U.S. App. LEXIS 893 (3d Cir. Jan. 20, 2009).

2 These so called “strike suits” were filed with the hope that corporate defendants would settle when faced with costly litigation despite the fact that the plaintiffs’ claims lacked merit.

3 H.R. Conf. Rep. No. 105-108, at 2 (1998).

4 A “covered class action” is a lawsuit that’s filed on behalf of more than fifty members.

5 See 547 U.S. 71 (2006) (settling a dispute among the appellate circuit courts and holding that SLUSA preempts state securities fraud holding claims in addition to claims brought by purchasers and sellers).

6 SLUSA provides, “No covered class action based upon statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court...” and SLUSA defines “covered class actions” as a “single lawsuit” or group of lawsuits.”

7 398 F.3d 294, 305 (3d Cir. 2005).

8 395 F.3d 25 (2d Cir. 2005).

9 547 U.S. 71 (2006).

10 Holding claims are a subset of state-law class actions claims based on the fact that investors held on to over-valued securities as a result of broker fraud or misrepresentation.