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Securities Law Commentary
Fisher v. Kanas Continues Line of Cases That Puts Limit on the Right to Initiate Class Action Suits
Fisher v. Kanas
Posted: 08/23/2007
By: Josh Lawler, Esq.
Introduction
This case is a continuation of a line of jurisprudence that seeks to impose a strict limitation on the right of stockholders to initiate class action law suits in state courts.
Detailed Commentary
When the District Court for the Eastern District Court of New York ordered the dismissal of this class action law suit on the finding that it falls under the SLUSA (Securities Litigation Uniform Standards Act of 1998) provisions on removal and preemption, such judicial directive is but an illustration of what the Supreme Court had declared in a previous case [Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 126 S.Ct. 1503, 1512, 164 L.Ed.2d 179 (2006)] to be a “broad construction” of this statute—a construction that strengthens the legislative policy of preventing “plaintiffs from filing class action lawsuits in State courts under more lenient State statutes.” [Lander v. Hartford Life & Annuity Life Ins. Co., 251 F.3d 101, 107-08 (2d Cir.2001)].
The rule therefore that was so strictly applied in this case, following the precedents laid down in the Dabit case and in Ring v. AXA Fin., Inc., 483 F.3d 95, 98-99 (2d Cir.2007) can be summarized this way: a state class action suit that satisfies the SLUSA criteria may caused to be removed by the defendant in the federal district court, and the district court must order its dismissal. Conversely, a case that does not fulfill such criteria must be remanded to state court, since the federal court is the exclusive venue for a class action which alleges fraud in the sale of a covered security.
SLUSA [§ 101(b)(1)(A, B), 15 U.S.C.A. § 78bb(f)] prohibits the filing of a covered class action based upon the statutory or common law of any State before federal and state courts where the party alleges misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security; or that the defendant used or employed any manipulative or deceptive device in connection with the purchase or sale of a covered security.
“A covered class action is a lawsuit in which damages are sought on behalf of more than [fifty] people,” while a “covered security is one traded nationally and listed on a regulated national exchange.”(Dabit case).
The complaint asserted that the class the plaintiff sought to represent in this lawsuit comprised of company stockholders who received misleading proxy statements which claimed that the compensation agreements with defendant company executives were standard. These proxy statements were allegedly materially false for failure on the part of defendants to reveal the true amount of this executive compensation package.
Had they been informed of the true value involved in such package, the plaintiff claimed, the stockholders would not have elected the defendants as directors, and the compensation would not have been granted. Plaintiff added that the stock holders were deprived of their “full equity interest” as a result of the “egregious sum of money paid to defendants.”
Defendants had the case removed to the district court on the ground that based on SLUSA, the case which was a covered class action suit, was barred from being filed in a state court for alleging a misrepresentation in connection with the purchase or sale of a covered security. Thereafter, plaintiff filed a motion to remand for the reason that since the district court had previously ruled in a prior case which asserted basically the same allegations that it did not have jurisdiction over the plaintiff’s claim of breach of fiduciary duty, the case should be remanded to the state court.
According to the defendants, the plaintiff’s allegation that the misrepresentations resulted in the stockholders receiving less cash and stock for their shares, brought this action within the purview of the SLUSA. Defendants argued that, pursuant to the SLUSA, the action was removable to the district court and subject to dismissal. Plaintiff however countered that SLUSA did not apply because the action did not involve the purchase and sale of securities.
COURT DISMISSED SUIT SINCE IT FELL WITHIN SLUSA’S PROVISIONS
Four Requirements for Dismiss under SLUSA
In ruling against plaintiff, the district court had the occasion to apply the tenets laid down in Felton v. Morgan Stanley Dean Witter & Co., 429 F.Supp.2d 684, 690-91 (S.D.N.Y.2006) which enumerated the four conditions that must be satisfied for SLUSA’s provisions on removal and preemption to apply, thus: (1) the suit must be a “covered class action;” (2) the action must be based on state or local law; (3) the action must involve a “covered security;” and (4) the defendant must have misrepresented or omitted a material fact or employed a manipulative device or contrivance “in connection with the purchase and sale” of the security.
The Action Involved a Covered Security
Applying these conditions to this case, the court noted that the plaintiff had admitted that: the suit was a covered class action; was based on state law, and involved a covered security. But in an obvious effort to bring this case out of the coverage of SLUSA, plaintiff argued that the case had to be remanded to state court because it did not involve the purchase or sale of a covered security. Therefore, in view of the supposed absence of the fourth condition enumerated above, the SLUSA provision on preemption was not applicable.
SLUSA Applies to Stockholders, Not Just Sellers and Buyers
It was at this point when the district court brought in the “broad construction” policy of Congress in the application of this statute: in brushing aside these arguments of plaintiff, the district court invoked the Supreme Court’s determination in the Dabit case that merely holding a security, rather than purchasing or selling, would be enough to bring an action within the coverage of the SLUSA.
In manifestly expanding the coverage of the statute, the district court, just like in the Dabit and Felton cases, as well as in the case of In re Salomon Smith Barney Mut. Fund Fees Litig., [441 F.Supp.2d 579, 604 (S.D.N.Y.2006) (citing 126 S.Ct. at 1513)] gave an added meaning to the fourth condition stated above, as it referred to the previous rulings, notably in the Dabit case, that “SLUSA’s operative language must be read broadly to sweep in not only purchasers and sellers of securities but also holders of securities.”
As if this justification of its own ruling was not enough, the district court even cited a summary order of the Second Circuit in Leykin v. AT & T Corp. [No. 06-1583, 216 Fed.Appx. 14, 2007 U.S.App. LEXIS 2378 (2d Cir. Jan. 30, 2007)] where similar issues were addressed. According to the district court, the Leykin case saw the plaintiff alleging that defendants breaching their fiduciary duties and committing fraud by engaging in a secret scheme to convert proprietary technology and making misleading claims in proxy statements. It was the assertion of plaintiffs that defendants’ misrepresentations and scheme resulted in a decline in stock prices. The Second Circuit held that plaintiffs’ allegation of common law fraud and breach of fiduciary duty toward the stockholders brought the case within the coverage of the SLUSA, since the “alleged misrepresentations and omissions in the proxy statements were ‘n connection with the purchase or sale of a covered security’.”
What this line of cases markedly does is to provide a stern warning against plaintiffs’ institution of suits in groups of under 50 individuals who allege state common law violations in a calculated strategy to evade preemption of their case under SLUSA, since such scheme will easily be detected by courts which will not hesitate to make a finding of preemption. The district court even went to the extent of boldly re-stating the declaration made in the Dabit case that SLUSA “denies the plaintiffs the right to use the class action device to vindicate certain claims.”
As a bit of consolation, though, a statement was made that the statute does not necessarily deny any individual plaintiff, or any group of fewer than 50 plaintiffs, the right to seek judicial relief through state law for a cause of action that may validly arise.
The author, Josh Lawler, Esq., is a partner of Zuber & Taillieu LLP, specializing in corporate and securities transactions.
Securities Law Summary
Read the related Securities Law summary: NY District Court Dismisses Class Action Suit in Fisher v. Kanas
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