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Taking a broad reading of the Securities Litigation Uniform Standards Act, a federal appeals court has upheld the removal and dismissal of a state court class action suit against Salomon Smith Barney brought by brokerage customers who claimed they were given biased investment research. In Rowinski v. Salomon Smith Barney Inc., a unanimous three-judge panel of the 3rd U.S. Circuit Court of Appeals found that although the suit sounded only in state law claims — breach of contract, unjust enrichment and state consumer protection law — the allegations related to the purchase or sale of securities and were therefore pre-empted by SLUSA. Chief U.S. Circuit Judge Anthony J. Scirica found that SLUSA was passed in 1998 to close a “loophole” that stemmed from the 1995 Private Securities Litigation Reform Act. The PSLRA implemented a host of procedural and substantive reforms, Scirica noted, including “more stringent pleading requirements to curtail the filing of meritless lawsuits.” But by 1998, Scirica said, “Congress concluded that plaintiffs were circumventing the requirements of the PSLRA by filing private securities class actions in state rather than federal court.” SLUSA was “designed to close this perceived loophole,” Scirica said, “by authorizing the removal and federal pre-emption of certain state court securities class actions.” Scirica noted that the Senate Banking Committee report called for “a broad interpretation of SLUSA to ensure the uniform application of federal fraud standards.” SLUSA pre-empts state-court class actions alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” In the suit against Salomon Smith Barney, a class of retail brokerage customers alleged that the company’s investment research was unlawfully biased in favor of the firm’s investment banking clients.Specifically, the suit alleged that Salomon Smith Barney “artificially inflates the ratings and analysis of its investment banking clients” in order to “curry favor with investment banking clients and reap hundreds of millions of dollars in investment banking fees.” The suit alleged that the National Association of Securities Dealers fined Salomon Smith Barney for “issuing materially misleading research reports” and that “examples of [the] defendant’s providing retail brokerage customers with biased and misleading analyst reports abound.” In a breach of contract claim, the suit alleged that Salomon Smith Barney “failed to provide unbiased analysis” and therefore breached its contracts with class members. In an unjust enrichment claim, the suit sought reimbursement of “fees and charges” paid to Salomon Smith Barney in exchange for “objective and unbiased investment research and analysis.” And in a claim under Pennsylvania’s Unfair Trade Practices and Consumer Protection Law, the suit sought recovery of “millions of dollars in unnecessary and unwarranted brokerage fees and charges” attributable to Salomon Smith Barney’s failure “to disclose material facts to its retail brokerage customers” regarding “the relationship between its analysts and its investment bankers.” Lawyers for Salomon Smith Barney removed the suit to the U.S. District Court for the Middle District of Pennsylvania. Plaintiffs’ lawyers filed a motion to have the suit remanded to state court, but U.S. District Judge James M. Munley denied it and instead granted Salomon Smith Barney’s cross-motion to dismiss based on SLUSA pre-emption. Relying on the U.S. Supreme Court’s 2002 decision in SEC v. Zandford, Munley held that the complaint, although framed in terms of state law, nevertheless alleged a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security. On appeal, plaintiffs’ lawyers argued that Munley erred in holding that the case was pre-empted by SLUSA because neither the “misrepresentation” nor the “in connection” elements were satisfied. Attorney Ira N. Richards of Trujillo Rodriguez & Richards, along with Roberta D. Liebenberg and Arthur M. Kaplan of Fine Kaplan & Black and Michael J. Boni of Kohn Swift & Graf, argued that the “breach of contract claim does not involve a misrepresentation or omission.” Scirica disagreed, saying, “Plaintiff contends that because ‘misrepresentation’ is not an essential legal element of his claim under Pennsylvania contract law, the factual allegations of misrepresentation included in the complaint are irrelevant to the SLUSA inquiry.” In an opinion joined by U.S. Circuit Judge D. Michael Fisher and Morton I. Greenberg, Scirica found that the issue was “straightforward” since the suit “is replete with allegations that Salomon Smith Barney disseminated biased and materially misleading investment research.” Such allegations, Scirica found, “readily satisfy the misrepresentation requirement under SLUSA.” Scirica found that the plaintiffs’ suggested distinction — between the legal and factual allegations in a complaint — is “immaterial” under the statute because SLUSA pre-empts any covered class action “alleging” a material misrepresentation or omission in connection with the purchase or sale of securities. “Under this provision, pre-emption does not turn on whether allegations are characterized as facts or as essential legal elements of a claim, but rather on whether the SLUSA prerequisites are ‘alleged’ in one form or another,” Scirica wrote. “A contrary approach, under which only essential legal elements of a state law claim trigger pre-emption, is inconsistent with the plain meaning of the statute. Furthermore, it would allow artful pleading to undermine SLUSA’s goal of uniformity — a result manifestly contrary to congressional intent,” Scirica wrote. Turning to the “in connection” element, Scirica found that the plaintiffs were claiming that the complaint states a straightforward breach of contract claim, while Salomon Smith Barney insisted that the suit, while nominally resting on state law, nevertheless alleges a material misrepresentation in connection with the purchase or sale of securities. Scirica found that the question turned on whether the plaintiffs’ allegations — charging Salomon Smith Barney with systematically and materially misrepresenting its investment banking clients’ investment ratings and analyses — were “connected” to the purchase or sale of securities. He found they were because the suit “alleges a fraudulent scheme coinciding with the purchase or sale of securities.” In the suit, Scirica said, the plaintiffs allege that Salomon Smith Barney systematically misrepresented the value of securities to the investing public in order to curry favor with investment banking clients and reap millions in fees. “For this purported scheme to work, investors must purchase the misrepresented securities. Absent purchases by ‘duped’ investors and a corresponding inflation in the share price, Salomon Smith Barney’s biased analysis would fail to benefit its banking clients and, in turn, would fail to yield hundreds of millions of dollars in investment banking fees,” Scirica wrote. “The scheme, in other words, necessarily ‘coincides’ with the purchase or sale of securities,” Scirica wrote. The suit also “arises from the broker/investor relationship,” Scirica said, “the very purpose of which is trading in securities.” Attorneys Richard A. Rosen of Paul Weiss Rifkind Wharton & Garrison in New York and Joseph G. Ferguson of Rosenn Jenkins & Greenwald in Scranton. Pa., represented Salomon Smith Barney in the appeal.

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