SLUSA and Reversed Incentives

Normally, corporate defendants sued for fraud seek, wherever possible, to have the fraud claims dismissed as redundant of contract claims, under such authorities as Bridgestone/Firestone, Inc. v. Recovery Credit Servs., Inc., 98 F.3d 13 (2d Cir. 1996) (in order to maintain a claim of fraud, a plaintiff must either ‛(i) demonstrate a legal duty separate from the duty to perform under the contract; or (ii) demonstrate a fraudulent misrepresentation collateral or extraneous to the contract; or (iii) seek special damages that are caused by the misrepresentation and unrecoverable as contract damages.“). SLUSA changes all that. First, it puts defendants in federal court, which is procedurally defense-friendly (see out post of October 17, 2007). Second, it eliminates all state causes of action. The catch: the plaintiff must be suing for fraud — specifically, securities fraud.

Thus in Kurz v. Fidelity Mgmt. & Res. Co., 2007 U.S. Dist. LEXIS 80127 (S.D. Ill. Oct. 30, 2007), the plaintiffs were former investors in investment portfolios managed by the defendants, who, the plaintiffs alleged, violated their NASD and NYSE duties to obtain ‛best execution“ (i.e., pricing) in effecting portfolio transactions. The plaintiffs alleged that this breached the confirmation agreements that the defendants entered into with the plaintiffs — agreements that imposed a contractual duty of best execution by incorporating, impliedly, the NASD and NYSE requirements. District Judge J. Phil Gilbert tentatively accepted the defendants’ argument that these contract claims were in reality claims of fraud in connection with the purchase or sale of securities, triggering SLUSA jurisdiction and preemption of all state law causes of action:

Although [plaintiffs] are at pains in their complaint to avoid terms like fraud and misrepresentation, the basis for their state-law claims of breach of contract is undisclosed conflicts of interest and omissions of material fact by [defendants] Fidelity and FMR. Thus, it appears that the claims in this case involve alleged misrepresentations or omissions of material fact within the meaning of SLUSA. Finally, given that the claims in this case involve alleged violations of the duty imposed on Fidelity and FMR to obtain best execution for customers in executing portfolio transactions, it appears that those claims are "in connection with" the purchase or sale of securities for SLUSA purposes.

[Citations omitted.] Held, plaintiffs ordered to show cause why the case should not be dismissed pursuant to SLUSA.

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