Minnesota District Court Dismisses State Law Claims Arising From Sale Of Reverse Convertible Notes As Barred By SLUSA, Even Though Notes Were Not Traded On A National Exchange
On October 13, 2016, Judge Susan Nelson of the United States District Court for the District of Minnesota dismissed a putative class action against RBC Capital Markets (a broker-dealer subsidiary of non-party Royal Bank of Canada (“RBC”)) which alleged that RBC Capital had violated the Minnesota Securities Act and state common law in connection with its sale of reverse convertible notes (“RCNs”) to plaintiffs. Luis v. RBC Capital Mkts., LLC, No. 16-CV-00175-SRN-JSM, 2016 WL 6022909 (D. Minn. Oct. 13, 2016). The Court held that the action was precluded under the Securities Litigation Uniform Standards Act (“SLUSA”), finding that the RCNs were “covered securities” under SLUSA even though they were not traded on an exchange. The case is significant as apparently the first federal decision to consider whether a security is “covered” under SLUSA on the basis that it is “a security of the same issuer that is equal in seniority” to another security of the issuer that is listed on a national exchange. 15 U.S.C. § 77r(b)(1)(C).
The RCNs consisted of a high yield note linked to the performance of an unrelated reference asset (typically a stock), and gave RBC (the issuer of the underlying note) the right to repay an investor’s principal investment at a set amount of the underlying reference asset if that reference asset fell below a set price. Plaintiffs asserted seven state law claims, including claims under the Minnesota Securities Act, and for common law fraud, negligence, breach of contract and breach of fiduciary duty, all of which were premised on allegations that RBC Capital failed to warn of the risks associated with the RCNs, misrepresented the nature of the RCNs, and omitted material information related to the RCNs.
The Court held that SLUSA precluded plaintiffs’ claims. Judge Nelson first observed that, under Eighth Circuit Precedent, SLUSA precludes claims where four conditions are met: the action (1) is a “covered class action”; (2) purports to be based on state law; (3) alleges a material misstatement or omission; and (4) the alleged misstatement or omission was made “in connection with the purchase or sale of a covered security.” The parties did not dispute that the first two conditions were satisfied. Judge Nelson found that the third condition was also satisfied because, at their core, all of the asserted claims were based on alleged misstatements or omissions about the riskiness of the RCNs.
Finally, Judge Nelson concluded that the RCNs were “covered securities” under a little-discussed SLUSA provision (15 U.S.C. § 77r(b)(1)(C)). Plaintiffs argued that the RCNS were not “covered” because they were not traded on an exchange, even though the reference assets were. Judge Nelson, however, noted that “covered securities” was also defined to include “a security of the same issuer that is equal in seniority” to an exchange traded security. Here, the underlying notes were RBC notes, the prospectus for which made clear that they were of the same seniority to RBC common stock (which is listed on a national exchange). Thus, the Court concluded, the RCNs met the textual definition of a “covered security” under SLUSA. Judge Nelson also found that plaintiffs’ counterargument would render statutory language superfluous, and that although no federal court had applied this SLUSA provision, dismissal was consistent with state court precedent considering the provision.
The decision reinforces that SLUSA is intended to be read expansively to preclude attempts to avoid the heightened pleading standards and other limitations applicable to federal securities law claims.