Second Circuit Holds That SLUSA Is Not Triggered By A Holder’s Passive Retention Of A Security Following An Alleged Misrepresentation Of Which The Holder Is Unaware
On April 10, 2018, the United States Court of Appeals for the Second Circuit revived and remanded to state court a putative class action brought against AXA Equitable Life Insurance Company. O’Donnell v. AXA Equitable Life Ins. Co., No. 17-1085, 2018 WL 1720808 (2d Cir. 2018). Plaintiff, a holder of a variable deferred annuity policy from defendant, brought a putative class action against defendant in Connecticut state court alleging breach of contract based on defendant’s alleged failure to obtain prior written approval before implementing a “volatility management strategy” that affected the performance of the annuity. Defendant removed the case to the United States District Court of Connecticut, where it successfully moved to transfer the action to the United States District Court for the Southern District of New York (“SDNY”). The district court denied plaintiff’s motion to remand the action to state court and granted defendant’s cross-motion to dismiss the case as being precluded under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). The Second Circuit reversed, holding that a security holder’s passive retention of a security following an alleged misrepresentation of which the holder is unaware does not meet the requirement that an alleged misstatement be made “in connection with” the purchase or sale of a security under SLUSA, and instructed the district court to remand the action to Connecticut state court.
By way of background, the New York State Department of Financial Services (“DFS”) alleged that defendant had not been forthcoming when seeking regulatory approval for implementing the volatility management strategy for certain variable annuity policies. The variable annuity possessed characteristics of both insurance products and investment securities, with the beneficiary assuming the risk of the underlying securities. After defendant eventually reached a settlement with the DFS in 2014, plaintiff filed this putative class action in state court alleging that defendant implemented the strategy in breach of its contractual duties and without obtaining prior regulatory approval, thereby reducing the returns on his insurance portfolios. Defendant removed the action to federal court, arguing that, solely for the purpose of SLUSA removal and dismissal, the alleged breach of contract depended on a misrepresentation allegedly made to the DFS in connection with the purchase or sale of a security and was therefore precluded from state court by SLUSA. After the action was removed and transferred to the SDNY, the district court held that the removal was appropriate under SLUSA, and dismissed the case.
The Second Circuit reversed the district court, holding that plaintiff’s action was not subject to removal and dismissal pursuant to SLUSA. As an initial matter, under SLUSA, covered class actions that allege state law securities fraud in connection with the purchase or sale of covered securities are removable to federal court where they must be dismissed. The Court held that while the complaint met three of the requirements for SLUSA preclusion—(i) that the action was a covered class action, (ii) based on state common law, and (iii) involved a covered security—the complaint did not meet the fourth criterion for SLUSA preclusion, which requires that the alleged misstatement be made “in connection with” the purchase or sale of the security.
In addressing the “in connection with” issue, the Second Circuit noted at the outset that courts may apply the “artful plaintiff rule” and “look beyond the face of the . . . complaint” to determine if it alleges securities fraud “in connection with” the purchase or sale of covered securities. The Court then noted that the complaint lacked any allegations that “an actual securities transaction ever occurred,” before holding that that plaintiff did not plausibly allege that any decision to purchase or hold the policy at issue was related in any way to the alleged misstatements made by defendant to the DFS. In fact, the Court held, there was no indication that plaintiff was even aware of the alleged misrepresentation made to DFS when he made his purchase. Citing the Supreme Court’s decision in Chadbourne & Parke LLP v. Troice, 134 S.Ct. 1058, 188 L.Ed.2d 88 (2014), the Second Circuit held that while an inducement to action or forbearance can satisfy the “in connection” requirement, a misrepresentation is not made “in connection with” a purchase of a covered security unless it is material to the decision to purchase or hold that security. Accordingly, the Court concluded that it was satisfied that a misrepresentation to a regulator and the inaction of a securities holder following a misrepresentation of which the holder or the market more generally is unaware “did not affect the holder’s decisions.” To find otherwise, the Court found, “would be a bridge too far even for the artful pleading rule.” Accordingly, the Court reversed the district court’s decision and instructed the district court to remand the case to Connecticut state court.
The decision reinforces that unless a defendant is able to link an alleged misrepresentation or omission to plaintiff’s decision to purchase, sell, or hold a covered security, federal courts may be hesitant to permit removal and dismissal of putative class actions filed in state court on the basis of SLUSA.