An
important decision on the ability of Ponzi scheme victims to use class action
lawsuits to recoup their losses is expected from the U.S. Supreme Court. At the opening of the current term, the Court
heard oral argument in the case Proskauer
Rose, LLP v. Troice, a consolidated appeal of a decision by the U.S. Court
of Appeals for the Fifth Circuit involving claims by victims of the infamous
multi-billion dollar Ponzi scheme perpetrated by Allen Stanford.
In the Proskauer cases, the plaintiffs filed class action lawsuits in
Louisiana state court against various defendants, including brokerage firms,
insurance companies and law firms, for their alleged role in Stanford’s massive
Ponzi scheme. At the heart of his fraud,
Stanford arranged for affiliates to sell certificates of deposit issued by the
Stanford International Bank that were represented to pay above-market returns
and which were falsely characterized as being backed by safe, liquid
investments. According to an earlier lawsuit
filed by the SEC against Stanford, “[f]or almost 15 years, SIB represented that
it consistently earned high returns on its investment of CD sales proceeds. .
.In fact, however, SIB had to use new CD sales proceeds to make interest and
redemption payments on pre-existing CDs, because it did not have sufficient
assets, reserves and investments to cover its liabilities.”
The investors’ lawsuits against the
defendants alleged that, by their actions, the brokerage firm, insurers and law
firms aided and abetting Stanford’s Ponzi scheme and misrepresented the
validity of the CDs. The lawsuits were
filed in state court and alleged state-based claims, and the defendants removed
the cases to U.S. District Court on the basis of the Securities Litigation
Uniform Standards Act (“SLUSA”).
SLUSA was
enacted in the wake of the Private Securities Litigation Reform Act (“PSLRA”),
which Congress passed in response to the purported “rampant nuisance filings
[of securities litigation], targeting deep-pocket defendants [and] vexatious discovery
requests.” The PSLRA restricted
recoverable damages and attorneys’ fees and, importantly, imposed strict
pleading requirements on class action securities lawsuits. In order to avoid the PSLRA’s challenges,
plaintiffs began filing securities class action lawsuits in state courts,
alleging only state-based causes of action.
Congress responded to these efforts “to frustrate the objectives of the
PSLRA” by enacting SLUSA, which provides for removal and dismissal of a
state-based class action lawsuit that alleges a misrepresentation or omission
of material fact “in connection with” the purchase or sale of a covered
security.
At issue
before the Supreme Court in Proskauer
is the proper test to be used to determine the “in connection with” requirement
of SLUSA where the CDs, which were admittedly not covered securities, were
represented to be backed by fictitious securities. The Fifth Circuit identified the proper test
from the defendant-oriented perspective, and held that “fraud is ‘in connection
with’ the purchase or sale of securities if there is a relationship in which
the fraud and the stock sale coincide or are
more than tangentially related.” The
court determined that “the heart, crux and gravamen” of the scheme was the
representation that the CDs were a “safe and secure” investment because of its
backing by other securities. The court
held that the representations about the purchase or sale of securities were
only tangentially related to the fraudulent scheme, and thus were not “in
connection with” such transactions. As
such, the Fifth Circuit concluded that SLUSA did not apply, and the cases
should be remanded to the state court.
The U.S.
Supreme Court’s anticipated decision has the potential to broadly affect the
ability of Ponzi scheme victims to recoup their losses. Typically, the individuals who perpetrate the
fraudulent schemes have wasted the money entrusted to them, and the investors’
best chance to recover their losses is by establishing the liability of others
who aided and abetted the fraud, or otherwise made the scheme possible in
violation of state-law duties. Victims
of recent Ponzi schemes, including one that lead to the collapse of Peregrine
Financial Group and another perpetrated by Scott Rothstein in Miami, may be
directly impacted by the Court’s decision. If the Supreme Court reverses the Fifth
Circuit opinion, it will expand the reach of “in connection with” to imaginary
securities with the effect of radically curbing investors’ ability to recover
damages for losses suffered in Ponzi schemes.
