Blocking the Work-Around: SLUSA’s Preemption of State Law Securities Class Actions

BACKGROUND

Due to an increasing volume of private securities fraud litigation being filed in the 1980’s and early 1990’s, Congress feared that plaintiffs were bringing abusive securities claims. Despite little chance of winning on the merits, these plaintiffs would often force defendants to settle due to the expensive nature of discovery in securities litigation. In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”). The Act raised the barrier for private federal securities fraud litigation, putting in place stringent new pleading standards for these lawsuits. Under the PSLRA, plaintiffs would need to provide evidence of fraud before any pretrial discovery took place.  In an effort to circumvent the new federal PSLRA standards, plaintiffs began bringing more securities fraud claims under state law.

To prevent these plaintiffs from avoiding the new pleading standards, Congress then passed the Securities Litigation Uniform Standards Act (“SLUSA”) in 1998. SLUSA precludes claimants from filing class actions that (1) consist of more than fifty prospective members; (2) assert state law claims; (3) involve a nationally listed security; and (4) allege a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security. The result is that private federal securities fraud claims can be pursued as a state law individual action or a federal securities fraud class action, but a plaintiff cannot pursue such claims as a state law class action.

However, Congress did not explicitly define which claims include misrepresentation or omission of material fact. In particular, it is unclear whether claims for breach of contract and breach of fiduciary duties, which are typically brought as state law claims, are treated as alleging misrepresentation or omission of material fact.

THE ISSUE

Does SLUSA preempt class action claims alleging a state law breach of contract and/or fiduciary duty in connection with the purchase or sale of a covered security?

THE SPLIT

The stances taken by the circuits do not fit into a simple binary. Each circuit with precedent on the issue has taken the approach that there are times that SLUSA does preempt these claims, but other times it does not. However, the circuits can be divided into three categories as to where the line has been drawn on preemption.

Sixth Circuit

            The Sixth Circuit has taken a literalist approach to this issue, where the court asks whether the complaint includes allegations of misrepresentation or omission. However, the Sixth Circuit has also instructed district courts to dismiss claims where the plaintiff has omitted allegations of misrepresentation or omission through artful pleading. So under Sixth Circuit precedent, any explicit or implicit allegation of misrepresentation or omission of material fact in a state law class action claim in connection with the purchase or sale of a covered security is sufficient to be preempted by SLUSA.

            In Segal v. Fifth Third Bank, N.A., the plaintiff brought state law class action claims for breach of fiduciary and breach of contract. The plaintiffs accused Fifth Third Bank of investing fiduciary assets in proprietary Fifth Third mutual funds rather than superior funds operated by the Bank’s competitors and providing standardized, largely automated management of the assets after promising individualized management. In the Amended Complaint, the plaintiff stated: “None of the causes of action stated herein are based upon any misrepresentation or failure to disclose material facts of plaintiff.” However, the Sixth Circuit upheld dismissal of the complaint, stating that SLUSA’s preemption does not depend on whether the complaint makes material or dependent allegations of misrepresentation, but “whether the complaint includes these types of allegations, pure and simple.” Additionally, the court made it clear that the question of preemption is dependent on “whether the complaint covers the prohibited theories, no matter what words are used (or disclaimed) in explaining them.”

Second, Third, and Ninth Circuits

            Under the precedent of the Second, Third, and Ninth Circuits, a class action claim for breach of contract and/or fiduciary duty is barred by SLUSA only if the claim requires proof of a misrepresentation or omission of material fact. These courts look to whether any misrepresentation or omission serves as the factual predicate of the state law claim.

            In Freeman Investments, L.P. v. Pacific Line Ins. Co., the plaintiffs alleged the defendant had breached their contracts and its duty of good faith and fair dealing by charging policyholders an excessive “cost of insurance.” The district court dismissed the complaint since it included allegations of systematic concealment and deceit involving hidden fees. However, the Ninth Circuit reversed the dismissal, holding that SLUSA preemption should depend on what the plaintiffs would be required to show to prove their claim. For the claims brought forth by the plaintiffs here, they need not show that the defendant misrepresented the cost of insurance or omitted critical details—they only need to persuade the court that their reading of the contract terms is the proper interpretation. A similar approach was taken by the Second Circuit in In re Kingate Management Ltd. Litigation and the Third Circuit in LaSala v. Bordier et Cie.

Seventh Circuit

            Lastly, the Seventh Circuit decided two cases in 2017, Goldberg v. Bank of America, N.A. and Holtz v. JPMorgan Chase Bank, N.A., where the court took a different approach than any other circuit. The court held that if a claim could be pursued under federal securities law, then it is preempted by SLUSA even if it also could be pursued under state contract or fiduciary law. The court elaborated that allowing plaintiffs to work around securities law by bringing state law contract or fiduciary duty claims would render SLUSA ineffectual. This approach has been the subject of significant criticism from commentators, as well as Judge Hamilton’s dissent in Goldberg, for taking SLUSA’s statutory purpose too far.

LOOKING FORWARD

            In his dissent in Goldberg, Judge Hamilton articulates his belief that only the Supreme Court can settle the circuit split on SLUSA preemption. While the Court may certainly choose to take a case to interpret SLUSA in a way that would resolve the differences between the circuits, the split may more effectively be resolved where it began—Congress. While relying on Congress to act may not be the most reliable option, a section defining the scope of SLUSA preemption could work its way into a much larger bill. After all, securities litigation is on the rise again, and Congress may be interested in helping to clarify an ambiguity that may affect many of these lawsuits.

Joining Forces: Whether § 2 of the VRA Permits Aggregation to Create Majority-Minority Coalition Districts

BACKGROUND

Section 2 of the Voting Rights Act of 1965 prohibits voting practices or procedures that discriminate on the basis of race, color, or membership in one of the language minority groups identified in the VRA. In 1982, Congress amended § 2 to allow a plaintiff to establish a violation of the Section if the evidence established by a “totality of the circumstance of the local election process” that the standard, practice or procedure being challenged had the result of denying a racial or language minority an equal opportunity to participate in the political process and to elect representatives of their choice. In effect, this empowered voters to challenge district lines drawn to either dilute or pack minority voters to decrease their influence on the political process.

In its first case following the passage of the 1982 amendments, the Supreme Court explained in Thornburg v. Gingles that the “essence of the Section 2 claim is that a certain electoral law, practice, or structure interacts with social and historical conditions to cause an inequality in the opportunities enjoyed by black and white voters to elect their preferred representatives.”

The Court in Gingles held the following:

  • That the use of multimember districts generally will not impede the ability of minority voters to elect representatives unless: (1) the minority group is sufficiently large and geographically compact to constitute a majority in a single-member district; (2) the minority group is politically cohesive; and (3) the white majority group votes sufficiently as a bloc to enable it to usually defeat the minority’s preferred candidate.
  • That a showing that a significant number of minority group members usually vote for the same candidates is one way of proving the requisite political cohesiveness.
  • A white bloc vote that normally will defeat the combined strength of minority support plus white “crossover” votes rises to the level of legally significant white bloc voting.
  • That the “clearly erroneous test” of Rule 52(a) of the Federal Rules of Civil Procedure is the appropriate standard of appellate review for a finding of vote dilution.

Despite these findings, the Court did not consider whether § 2 permits a claim brought by a minority group that is not sufficiently large and compact enough to constitute a majority in a single-member district.

In Growe v. Emison, Johnson v. DeGrandy, and LULAC v. Perry, the Supreme Court continued to sidestep the question by assuming, without deciding, that it is possible to state a § 2 claim for a racial group that makes up less than 50% of the population.

In Bartlett v. Strickland, the Court considered the “minimum-size” question under the first requirement of Gingles. It made clear that the holding only addressed the issue as it pertains to crossover districts, not coalition districts. In crossover districts, minority voters make up less than a majority of the voting population, but the minority population, at least potentially, is large enough to elect the candidate of its choice with the help of voters who are members of the majority and who cross over to support the minority’s preferred candidate. Coalition-district claims, on the other hand, involve two minority groups that form a coalition to elect the candidate of the coalition’s choice. The Court held that crossover districts are not protected under § 2.

THE ISSUE

Pursuant to § 2 of the Voting Rights Act, is the majority-minority requirement under the first Gingles precondition satisfied when minorities from more than one racial or ethnic group, joined together, constitute a majority of the citizen voting age population?

THE SPLIT

The 5th Circuit has been most explicit in permitting coalition districts. In Campos v. City of Baytown, the court held that minority voters can be aggregated so that “together, they are of such numbers residing geographically so as to constitute a majority in a single member district, they cross the Gingles threshold as potentially disadvantaged voters.” Still, the plaintiffs must prove the minorities actually vote together in a cohesive manner. The court determined that the standard for proving cohesion is whether the minority group together votes in a cohesive manner for the minority candidate.

Following Campos, the 2nd Circuit, 9th Circuit, and 11th Circuit have tacitly permitted coalition districts, though not as explicitly as the 5th Circuit. In both Badillo v. City of Stockton and Concerned Citizens of Hardee County v. Hardee County Board of Commissioners, the courts assumed it was acceptable to aggregate voters of different minority groups, but the plaintiffs in both cases failed to prove the requisite political cohesion necessary to satisfy the second Gingles requirement. In Bridgeport Coalition for Fair Representation v. City of Bridgeport, the 2nd Circuit assumed the coalition districts were covered under § 2 and that requisite political cohesion was proven to satisfy the elements of Gingles.

Deviating from the other circuits, the 6th Circuit refused to extend § 2 coverage to a minority group that includes more than one race or ethnicity. In Nixon v. Kent County, the court held that if Congress wanted to protect a minority group that was composed of more than one race or ethnicity, it would have used more words in the plural form in § 2, such as “protected classes” rather than “protected class.”

LOOKING FORWARD

Recently, the Supreme Court seems more willing to take on cases dealing with issues of independent redistricting commissions and partisan gerrymandering. It also has been willing to take on cases regarding § 5 of the Voting Rights Act, as well as the application of the Gingles factors in § 2 claims. While the Court has not yet signaled a willingness to take on the issue of coalition districts, the number of cases arising from the use of African-American and Hispanic voters to create the majority-minority districts will likely continue to increase as the Hispanic population continues to grow. If the Supreme Court does not take up the issue, there may be an increase in coalition districts drawn following the 2020 Census.

It’s Alive! (Or Is It?): Does Remmer’s Presumption of Prejudice for Jury Communication Still Apply?

BACKGROUND

In 1954, the Supreme Court held in Remmer v. United States that any unauthorized, private communication with a juror during a trial about any matter pending before the jury is presumptively prejudicial—and that the burden to prove that the contact was harmless to the defendant rests with the government. Remmer featured relatively straightforward facts: An unnamed person communicated with a juror about a profit that juror could make by bringing a verdict for the defendant. The juror reported the incident to the judge, who informed the prosecuting attorneys. The F.B.I. investigated the comment, but determined the statement was made in jest. The attorneys for the defendant were never notified by the judge or prosecutors, but instead found out about the comment and F.B.I. investigation from a newspaper article after the verdict. The Supreme Court held that “any private communication, contact, or tampering, directly or indirectly, with a juror during a trial about matter pending before the jury is . . . deemed presumptively prejudicial” if not authorized by the rules or instructions of the court, and required the government to prove that the communication was not harmful to the defendant. The case was remanded to the district court to hold a hearing to determine whether the incident was harmful to the petitioner.

While Remmer was long the standard regarding extrajudicial contact with jurors, the Court began to refine and narrow that standard. In Smith v. Phillips, a juror applied for a job in the prosecutor’s office during the trial. The Court held that due process required the trial court to hold a hearing where “the defendant has the opportunity to prove actual bias.” Phillips signaled a shift of burden to the defendant, rather than the government in Remmer. In O’Connor’s concurrence, she stated her concern that a hearing may be inadequate for uncovering a juror’s biases.

Later, in United States v. Olano, alternate jurors were present during jury deliberations. The Court’s opinion, written by O’Connor and grounded in similar logic to her concurrence in Phillips, held there “may be cases where intrusion should be presumed prejudicial, but a presumption of prejudice as opposed to a specific analysis does not change the ultimate inquiry: Did the instruction affect the jury’s deliberations and thereby its verdict?” The Court held the error of allowing alternate jurors to be present during jury deliberations did not “affect substantial rights” of the defendant.

ISSUE

Does the Remmer rebuttable presumption, which requires the government to rebut the presumption that extrajudicial contact with a juror about the matter pending before the jury is prejudicial, remain intact?

THE SPLIT

Since the Court’s decisions in Phillips and Olano, the circuit courts have answered differently the question of whether Remmer should be followed in whole, in part, or not at all. The splits revolve around two points of contention.

  1. Should Phillips be read broadly to apply the shift in burden to the defendant in all cases?
  2. Should the language of Olano be interpreted to imply a continuation of the rebuttable presumption standard or require a new standard of specific analysis of the intrusion’s effect on the verdict?

The Second, Fourth, Seventh, Ninth, Tenth, and Eleventh Circuits still follow Remmer’s standard of rebuttable presumption. These circuits have consistently held—as summarized in United States v. Greer, a Second Circuit case—that it “is well-settled that any extra-record information of which a juror becomes aware is presumed prejudicial” and that “[a] government showing that the information is harmless will overcome this presumption.”

The circuits have also attempted to narrow the applicability of the Court’s holding in Phillips by holding that Remmer still has broad applicability. The Fourth Circuit, in Stockton v. Virginia, held Phillips did not overturn the holding in Remmer and the presumption of prejudice is applicable in cases in which “the danger is not one of juror impairment or predisposition, but rather the effect of the extraneous communication upon the deliberative process of the jury.” The Seventh Circuit, in Hall v. Zenk, stated that the focus of Phillips is not about the shift in burden from the government to the defendant during a Remmer hearing, but rather about the defendant’s mere right to a hearing.

On the other hand, the First, Third, Fifth, Sixth, Eighth, and D.C. Circuits have deviated from the Remmer standard to varying degrees.

The Sixth and Eighth Circuits have focused on the shifting of the burden in Phillips from government to defendant. Both circuits have applied Phillips broadly, eliminating the presumption of prejudice and placing the burden on the defendant to demonstrate the communication affected their substantial rights.

The First, Third, Fifth, and D.C. Circuits have interpreted the language in Olano and O’Connor’s concurrence in Phillips to require specific analysis on the intrusion’s effect on the verdict. These circuits have held that the district court must evaluate the severity and likelihood of the communication resulting in prejudice before holding a Remmer hearing. The government is required to prove prejudice does not exist only when the court determines prejudice is likely. The Third Circuit cited O’Connor’s concurrence and held that “a finding of implied bias is reserved for those extreme situations and exceptional circumstances that leave ‘serious question whether the trial court subjected the defendant to manifestly unjust procedures resulting in a miscarriage of justice.’”

LOOKING FORWARD

Going forward, the Court may choose to address the two questions about which side carries the burden and whether there must be an analysis of the severity and likelihood of prejudice before a Remmer hearing. There are two types of cases that appear to be the most likely to result in the Court addressing the questions. The first type of case would be one where, using Phillips as precedent, the defendant has the burden to prove prejudice and is not able to meet the burden, but the government is unable to prove its burden either. (While this seems perhaps paradoxical and a solely academic question, this kind of result is possible because the burden for each side is so high; a situation could develop, therefore, where the issue of prejudice is a close call, and neither side can meet its heavy burden.) This scenario could mean that a motion for new trial could be decided by which party has the burden.

The second kind of case would be one in which a Remmer hearing is denied because the courts do not deem the severity and likelihood of prejudice to be high enough. This type of case may be less likely than the former, as it does mirror Phillips in many ways.

Ultimately, the possibility of these undesirable outcomes, coupled with the stark differences between the Circuits (and the relatively even divide between them), heightens the need for the Supreme Court to step in and clear the fog.