If you’re lucky enough to be arriving at the airport in Antigua, you'll see the Stanford Cricket Ground next door. Once jumping with first-class West Indies cricket matches, it has been abandoned in the wake of revelations that the investment operations of its namesake, R. Allen Stanford, were a $7.1 billion Ponzi scheme. The locals call it Sticky Wicket Stadium — and now the U.S. Supreme Court has weighed in on the assets of the man who queered that particular pitch. In a trio of cases, the court has opened the door for state-law class-action suits by the victims of Stanford’s fraud.
What makes the case interesting is not just the underlying scam, but also the way the government tried to deal with it. From a Ponzi connoisseur’s standpoint, Stanford’s scheme was deliciously simple: He sold investors certificates of deposit in his own, Antigua-based Stanford International Bank. He promised a return of 10 percent, and he told buyers that their investments were backed by readily liquid securities.
The Securities and Exchange Commission brought Stanford’s operation crashing down when it sued in 2009. In 2012, the Texan was convicted of wire fraud, conspiracy and obstruction of justice. The former Sir Allen — Antigua knighted him in 2006 and took the title back in 2009 — now resides in the high- security federal penitentiary in Coleman, Fla. He'll be there for 110 years.
Naturally, Stanford’s former depositors wanted their money back. The investors filed a number of class actions alleging fraud and demanding whatever assets Stanford could produce. The SEC had gotten a federal court to agree that all suits against Stanford or his third-party service providers should be made ancillary to the SEC’s suit; the same federal court also froze the defendant’s assets. Therefore, the investor-plaintiffs chose to file their class-action suits in state, not federal, courts, where they might be able to get paid.
The state suits had the bizarre effect of putting the SEC on the side of Stanford and his co-defendants, who all agreed that the state suits should not go forward. The argument they dreamed up was based on the U.S. Securities Litigation Uniform Standards Act of 1998, mellifluously known as SLUSA. SLUSA was designed to funnel securities-related class actions into the federal courts, where attorneys’ fees could be controlled and national standards maintained. The law says that you can’t bring a case in state court if you’re alleging “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.” A “covered security” means one covered by the Securities Act of 1933 — essentially, listed on a national exchange.
Antiguan CDs aren’t covered by U.S. securities laws because they aren’t traded on a national exchange. Taken literally, SLUSA only applies to the purchase or sale of a “covered security.” So the SEC and Stanford needed a more creative argument for why SLUSA trumped the state lawsuits. They came up with the argument that there actually was a covered security involved in Stanford’s scheme: the imaginary liquid assets that he had said were backing his bank. Those make-believe assets would have been covered securities under current law, notwithstanding their nonexistence. If Stanford’s lie about those securities was “material” to the investors’ purchasing decisions, the SEC argued, then the state lawsuits were barred by SLUSA.
The Supreme Court rejected the argument 7-2. It held that SLUSA did not apply because Stanford never sold investors any covered securities; he just pretended that such securities existed in the background of his uncovered CDs. To fit under the law, the court said, Stanford would have had to make misrepresentations that were material to the actual purchase or sale of a covered security.
The court also rejected the government’s argument for a broad interpretation of the phrase “in connection.” Justice Stephen Breyer, writing for the court, explained that “the basic consequence of our holding” was to “permit victims of this (and similar) frauds to recover damages under state law.”
But why, you may well ask, did the government want to block the lawsuits? The answer lies in the SEC’s enforcement ambitions. When the government first charged Stanford criminally, it included specific federal securities charges. But it dropped these in favor of more generic wire fraud and conspiracy precisely because of the fear that Stanford hadn’t actually sold any covered securities. The government wanted a broader interpretation of SLUSA because it wanted a broader interpretation of “covered security” in order to expand its prosecutorial jurisdiction.
Justice Anthony Kennedy, joined by Justice Samuel Alito, agreed with the government, and in a sharp dissent he warned that “the result will be lessened confidence in the market.” Kennedy essentially argued that the SEC’s jurisdiction should be as broad as possible, because more enforcement means more confidence in more markets. To this, Breyer replied that the government would still have plenty of rope to hang Stanford and similar fraudsters. “The only difference” between the two approaches, Breyer said, was that the court’s approach left the state courts open under circumstances in which “no person actually believed he was taking an ownership position” in a U.S. market.
It’s hard to say whether more enforcement is always good for markets. And it’s doubtful whether it would be so terrible if defrauded investors always had to seek their remedies in federal court, subject to — gasp — limited attorneys’ fees. What’s clear is that, at least in this case, the Supreme Court identified more closely with defrauded investors than with aggressive government enforcers.
Noah Feldman, a law professor at Harvard University and the author of “Cool War: The Future of Global Competition,” is a Bloomberg View columnist.
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