Seventh Circuit Court of Appeals Rules That State Law “Holder” Class Actions Are Preempted

April 6, 2005

On April 5, 2005, the United States Court of Appeals for the Seventh Circuit issued an important decision broadly interpreting the preemptive scope of the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") to reach state-law class actions brought by "holders" of securities - i.e., persons who may not satisfy the purchaser-seller standing limitation imposed on privateRule 10b-5 plaintiffs under the Supreme Court’s decision in Blue Chip Stamps v. Manor Drug Stores.  "Holder" class actions have become an attractive vehicle for plaintiffs seeking to avoid SLUSA preemption and, in turn, the pleading and proof requirements imposed on federal-law securities actions by the Private Securities Litigation Reform Act of 1995 ("PSLRA").  In previous cases, the plaintiffs’ bar had generally been successful in arguing that SLUSA does not reach claims that private parties could not bring in federal court under the rule of Blue Chip Stamps.  This recent decision forecloses that argument in the Seventh Circuit, and could lead other courts to reexamine the issue.

The Seventh Circuit decision arises out of a large number of lawsuits asserting various claims relating to "market timing" in the mutual fund industry.  Gibson Dunn, on behalf of our client Janus Capital Management LLC, has led a coalition of mutual fund complexes represented by the Nation’s preeminent securities litigators.  In a prior decision in the case, the Seventh Circuit held that SLUSA-based remand orders are appealable notwithstanding the general bar on the appealability of remand orders in 28 U.S.C. section 1447(d).  On the merits, the Seventh Circuit held in the most recent decision that mutual fund investors generally will satisfy the purchaser-seller limitation because funds have "substantial daily turnover, so [a] class of ‘all holders’ during even a single day contains many purchasers and sellers."  The court also held that even where state-law plaintiffs expressly disavow purchaser-seller claims in their complaint, SLUSA preempts all claims that could be brought by the Securities and Exchange Commission under Section 10(b) of the Exchange Act, regardless of whether a private plaintiff could bring the same suit under Rule 10b-5.  In other words, the court held that SLUSA’s preemptive reach is coextensive with liability under Section 10(b), notwithstanding the Blue Chip Stamps limitation on standing applicable to private lawsuits.  SLUSA’s preemptive effect, the court explained, "is not confined to knocking out state-law claims by investors who have winning federal claims, as plaintiffs suppose."

Given the large number of class actions that are filed in state court-including particularly in southern Illinois, where these cases were filed-the Seventh Circuit’s decision represents an important victory for corporate defendants.  As the court explained: "plaintiffs’ effort to define non-purchaser-non-seller classes is designed to evade PSLRA in order to litigate a securities class action in state court in the hope that a local judge or jury may produce an idiosyncratic award.  It is the very sort of maneuver that SLUSA is designed to prevent."  The decision ensures that, at least in the Seventh Circuit, SLUSA will prevent such maneuvering, as well as limit the strike suit settlements the specter of idiosyncratic awards produce.  As the court put it, SLUSA "covers both good and bad securities claims-especially bad ones."

The case is
Kircher et al. v. Putnam Funds Trust et al., Nos. 04-1495 etc.  For more information regarding this decision or the mutual fund litigation generally, please contact the Gibson Dunn lawyer with whom you work or Mark A. Perry in our Washington office at 202-887-3667.  For more information about SLUSA or the firm’s securities litigation expertise, please contact Jonathan C. Dickey in our Palo Alto office at 650-849-5324, Wayne W. Smith in our Orange County office at 949-451-4108, or Robert F. Serio in our New York office at 212-351-3917.

© 2005 Gibson, Dunn & Crutcher LLP