Federal Judge: Gingrich-Era Bars Not Easily Circumvented

Federal Judge: Gingrich-Era Bars Not Easily Circumvented

Lucy Koh, the US. District Court judge for the Northern District of California, has granted judgment for a defendant, Schwab Investments, in a much-watched case. Koh has short-circuited litigation in which plaintiffs sought recovery for the style drift that allegedly afflicted a number of Schwab entities as the globe headed into the financial crises of 2007-08.

News reports say that the plaintiff will appeal to the Ninth Circuit Court of Appeals. Unless the Ninth Circuit overturns Koh, and thereby limits the combined preemptive effect of two 1990s era federal statutes, this will be the end of the Northstar matter.

Style Drift Heading Toward Crisis

Northstar Financial Advisors maintained, through five iterations of its complaint, (and two earlier appeals to the Ninth Circuit) that the Schwab Total Bond Market Fund cheated investors when it began investing in high risk non-U.S. agency collateralized mortgage obligations around August 31, 2007, and that this was at odds with the fund’s stated investment objective of tracking the Lehman Brothers U.S. Aggregate Bond Index. Not only were the CMOs at issue not part of the index, they were substantially more risky than the instruments that did constitute same.

Through the period of the global financial crisis, specifically from September 1, 2007 to February 27, 2009, the Fund incurred a loss of 4.8%. If it had in fact tracked the Lehman Index it would have gained 7.85% during the same period.

The court had dismissed an earlier version of this complaint back in March 2011, on the ground that all of the causes of action ran afoul of the Securities Litigation Uniform Standards Act of 1998.

SLUSA was an effort to keep certain sorts of claim, especially certain class actions, out of the state courts – they had been heading into state courts largely to avoid the more rigorous pleasing standards impose three years before by the Private Securities Litigation Reform Act, one of the consequences of former Speaker Newt Gingrich’s Contract with America.

Northstar was brought in federal court, but in essence it asked that federal court to employ state law, on contract interpretation and a covenant of fair dealing for example, as part of the end run around PSLRA. So this, too, was deemed unacceptable under SLUSA.

Breaches of Fiduciary Duty

But the court, in response to earlier versions of this complaint, had allowed further attempts at revision and, as of last year, the counts alleging breaches of fiduciary duty had survived challenge under SLUSA.  This wasn’t because the district court ever took the view that SLUSA preclusion wasn’t available. Rather, for procedural reasons the plaintiffs were found to have abandoned that particular defense in regard to those counts.

So with the issue of dismissal off the table, the court turned to the question of judgment on the pleadings: that is, the issue of whether the complaint stated sufficient facts to be plausible on its face. Oddly, the slightly different procedural posture allowed the court to do now what it refrained from doing on the earlier motion to dismiss: it applied SLUSA to the fiduciary claims. And it found that, yes, SLUSA preemption does apply here, too.

In the hope and expectation of putting a firm end to the matter, the court also denied Northstar leave to amend. “Over five successive complaints, Northstar’s fiduciary duty claims have hinged upon and continue to hinge upon the same misrepresentation or omission of material fact….Here, in light of the circuymstances recited above, the Court finds that providing Northstar additional leave to amend would be futile.”


If it is appealed, then this case may shed some light on the question of how much of a difference Chadbourne makes.  Chadbourne, a 2014 decision by the U.S. Supreme Court, seemed to at least some observers to usher in a new and narrower interpretation of SLUSA, meaning an increase of leeway for state-law based causes of action that impinge on the world of securities.  The plaintiffs’ attorneys certainly pressed that view before Judge Koh. But she was not sympathetic to that claim, writing that the high court in Chadbourne “sought only to construe the covered security requirement … and not any other part of SLUSA.”

For the moment, the takeaway is that the anti-class action moves of the Gingrich Congress in the securities world are to be so easily circumvented.



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