Judge Batts’ opinion in In Re Kingate Securities Litigation shows how difficult it can be to bring a class action alleging state law claims– even against an off-shore Madoff “feeder fund” that lost $3 billion of its investors’ money.  The funds in question were pass through vehicles which gave investors the “opportunity” to invest with Madoff.  Because they were off-shore, the funds investors were not protected by the federal securities laws.

Needless to say, the investors were unhappy with the ultimate outcome of their investment, and sued the funds for fraud and mismanagement.  The question before Judge Batts was whether the state law class actions claims against the fund were barred by the Securities Litigation Uniform Standards Act of 1998.  According to Judge Batts, SLUSA’s purpose is “to prevent plaintiffs from seeking to evade the protections against abusive securities litigation… by filing class action fraud claims based on state law rather than on Federal securities law.”  The SLUSA bar applies where the defendant is alleged to have misrepresented or omitted a material fact or employed a manipulative device or contrivance “in connection with the purchase or sale” of a security, and plaintiffs are a class of more than 50 prospective members.

In order to avoid the SLUSA bar, the investors made the interesting argument that their claims arose from misrepresentations and mismanagment on the part of the funds, and not from Madoff’s securities fraud. Therefore they argued that their claims were not “in connection with” the securities that Madoff purchased, or pretended to purchase. But Judge Batts did not go for it, and applied the majority view in the SDNY. 

 “[T]he Funds’ sole objective was to be invested with Madoff and BMIS in New York. Further, the misstatements and omissions Plaintiffs allege largely concern Madoff’s purported trading strategy and/or Defendants’ alleged duties and promises to oversee Madoff, audit Madoff, or otherwise ensure that Madoff was purchasing covered securities on behalf of the Funds—and thus on behalf of Plaintiffs—as Plaintiffs intended him to do. The Court therefore concludes that Plaintiffs’ claims are brought in connection with the covered securities Madoff pretended to purchase, bringing them within SLUSA’s purview.”

Judge Batts dismissed the case with prejudice finding that even with “artful pleading,” this was exactly the type of class action Congress intended to preempt with SLUSA. “Here, Plaintiffs can avoid SLUSA preemption of their fraud claims only by reconstituting their class of thousands as a class of fewer than fifty, which would in itself bring this action outside this Court’s jurisdiction. Repleading the fraud claims would therefore be futile. Repleading Plaintiffs’ non-fraud claims would also be futile, since all of Plaintiffs’ claims would be preempted by the Martin Act [New York state’s securities law that doesn’t allow for private claims] even if repleaded. Accordingly, leave to replead is DENIED as futile.”