By Britt Latham and Jason Hale
The Sixth Circuit’s decision in Atkinson v. Morgan Asset Management, Inc., No. 09-6265, 2011 WL 3926376 (6th Cir. Sept. 8, 2011), marks the first appellate court ruling to analyze whether mutual fund shareholders fit within the first so-called “Delaware carve-out” exception to the Securities Litigation Uniform Standards Act of 1998.
The Delaware carve-out preserves certain class actions arising under state law from SLUSA’s otherwise broad preclusive reach. The exception allows shareholders to pursue state law claims as part of a class action in state or federal court concerning nationally traded securities, including securities issued by registered investment companies. To fit within the exception, SLUSA provides that “[a] covered class action … may be maintained … if it involves … the purchase or sale of securities by the issuer or an affiliate of the issuer exclusively from or to holders of equity securities of the issuer.” 15 U.S.C. §§ 77p(d)(1)(B); 78bb(f)(3)(A)(ii).
In Atkinson, the plaintiff shareholders hoped to wedge themselves into the first Delaware carve-out. Relying on the redemption rights associated with a mutual fund, the shareholders argued that the “holding” of their mutual fund shares was tantamount to a purchase or sale of such shares because of the funds’ obligation to redeem. Shareholders argued that the funds’ redemption obligations amounted to an on-going contract for these mutual funds to purchase investors’ shares and fit within the carve-out’s language of the funds’ exclusively purchasing (or redeeming) shares from investors.
Relying on the plain language of the statute, the Sixth Circuit rejected the shareholders’ arguments, and held that the purported “contract to purchase” argument of a mutual fund’s redemption requirement really amounted to a “holder claim,” as investors would be, at most, “holders of ‘contracts to purchase.’” 2011 WL 3926376 at *3.
The Court also considered the consequences if the shareholders’ argument were accepted: “Plaintiffs ask us to shield from PSLRA’s federal protections nearly every class action involving shareholders in open-end mutual funds.” Id. at *4. Accordingly, the Court declined the shareholders’ invitation to extend the Delaware carve-out to holders of mutual funds.
Had the shareholders prevailed, mutual fund investors would have a considerably easier time avoiding federal jurisdiction with its heightened pleading requirements and pursuing class actions in state court. It is not difficult to imagine the impact such a development might have on the $3 trillion mutual fund industry. Instead, the Sixth Circuit’s decision will make it much more difficult for plaintiffs to avoid federal jurisdiction in favor of potentially friendlier state court jurisdictions in class actions alleging securities fraud. As the first appellate court decision to interpret the language of the carve-out as it relates to mutual funds, this decision likely will be at the forefront of the other federal courts’ consideration of this and similar issues arising under SLUSA and its Delaware carve-outs.
Finally, while not reaching the issue, the Court hinted that SLUSA precludes the entire action, rather than specific claims asserted in an action. Id. at *5. This issue has been the subject of a circuit-split for some time. See, e.g., In re Lord Abbett Mutual Funds Fee Litig., 553 F.3d 248 (3d Cir. 2009); Proctor v. Vishay Intertechnology Inc., 584 F.3d 1208, 1226-28 (9th Cir. 2009); In re Enron Corp. Sec. Litig., 535 F.3d 325, 341-42 (5th Cir. 2008); Dabit v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 395 F.3d 25, 47 (2d Cir. 2005), rev’d on other grounds, 547 U.S. 71 (2006); Behlen v. Merrill Lynch, 311 F.3d 1087, 1095 (11th Cir. 2002).
(Britt K. Latham is a Member of Bass, Berry & Sims PLC, focusing his practice on complex business, securities and class action litigation and the representation of clients in connection with internal and governmental investigations. M. Jason Hale is an attorney at Bass, Berry & Sims PLC, focusing his practice on general commercial litigation with an emphasis in business disputes, corporate and securities matters, and financial products and broker-dealer litigation).