Opinion ID: 4414424
Heading Depth: 4
Heading Rank: 2

Heading: The “in connection with” requirement

Text: The Supreme Court twice has spoken about SLUSA and its “in connection with” requirement. In Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006), the Court stressed that the “in connection with” requirement should be interpreted broadly, as “[a] narrow reading of the statute would undercut the effectiveness of the [PSLRA] and thus run contrary to SLUSA’s stated purpose,” which is to prevent state-law class actions from end-running the PSLRA. Id. at 86. The Court explained that “it is enough 1 SLUSA does not preclude a plaintiff from filing an individual (i.e., non-class action) state-law securities claim in state court. 2 Northern’s attempt to differentiate between subsections A and B of SLUSA is unpersuasive because the “in connection with” requirement is an element of both. See 15 U.S.C. § 78bb(f)(1)(A), (B). 8 BANKS V. NORTHERN TRUST that the fraud alleged ‘coincide’ with a securities transaction – whether by the plaintiff or by someone else” – to meet the “in connection with” requirement. Id. at 85. In Chadbourne & Parke LLP v. Troice, 571 U.S. 377 (2014), the Court revisited the “in connection with” requirement. The plaintiffs in Troice alleged that the defendants induced victims to purchase uncovered securities (certificates of deposit that are not traded on any national exchange) by falsely stating that covered securities (securities traded on a national exchange) backed the uncovered securities. Id. at 380. The Court held that SLUSA did not preclude the claims because the statute required “misrepresentations that are material to the purchase or sale of a covered security.” Id. at 387. In discussing materiality, the Court addressed the “in connection with” requirement, which demands “a connection . . . where the misrepresentation makes a significant difference to someone’s decision to purchase or to sell a covered security.” Id. at 387 (citing Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 36–40 (2011) (stating that a misrepresentation or omission is “material” if a reasonable investor would have considered the information significant when contemplating a statutorily relevant investment decision)). The Court also held that, under SLUSA, “[a] fraudulent misrepresentation or omission is not made ‘in connection with’ . . . a ‘purchase or sale of a covered security’” unless that fraudulent conduct “is material to a decision by one or more individuals (other than the fraudster) to buy or sell a ‘covered security.’” Id. at 387 (emphasis added). The Court stressed that “the ‘someone’ making that decision to purchase or sell must be a party other than the fraudster.” Id. at 388. “If the only party who decides to buy or sell a BANKS V. NORTHERN TRUST 9 covered security as a result of a lie is the liar, that is not a ‘connection’ that matters.” Id. The Court was careful to state that Troice did not overrule Dabit, noting: [I]n Dabit, we held that [SLUSA] precluded a suit where the plaintiffs alleged a “fraudulent manipulation of stock prices” that was material to and “‘coincide[d]’ with” third-party securities transactions, while also inducing the plaintiffs to “hold their stocks long beyond the point when, had the truth been known, they would have sold.” We do not here modify Dabit. Id. at 387 (citations omitted). Nevertheless, the Court distinguished Dabit and other dissimilar cases because they “involved a victim who took, tried to take, or maintained an ownership position in the statutorily relevant securities through ‘purchases’ or ‘sales’ induced by the fraud.” Id. at 389. The Court emphasized that “[e]very one of these cases . . . concerned a false statement (or the like) that was material to another individual’s decision to purchase or sell a statutorily defined security.” Id. at 393 (emphasis added) (internal quotation marks and alteration omitted). This case presents a question of first impression in this circuit: whether allegations concerning a trustee’s imprudent investments constitute activity “in connection with” the purchase or sale of securities when those allegations are brought by the beneficiaries of an irrevocable trust. Banks argues that any false statements or deceptive activity by Northern could not have been material to a beneficiary’s individual decision to purchase or sell a covered security for two reasons: (1) a beneficiary who is not also a trustee of an 10 BANKS V. NORTHERN TRUST irrevocable trust cannot make an individual decision to purchase or sell securities for the trust, and (2) Banks has no control over Northern’s decision to do so. Applying Troice here, we agree with Banks. Unlike an agent-principal relationship, beneficiaries who are not also trustees of an irrevocable trust cannot direct Northern’s actions as the trustee. Accordingly, even if Northern engaged in fraudulent conduct, that conduct does not change the fact that its beneficiaries are unable to purchase or sell covered securities. Northern contends that this difference between an agent and a trustee is a meaningless one. But if Northern were acting as an agent – similar to a stockbroker – Northern’s statements and allegedly deceptive conduct could meet SLUSA’s “in connection with” requirement because Banks (and other beneficiaries) could have relied on Northern’s statements to induce the purchase of the affiliated funds. Conversely, if Northern was in fact acting as a trustee, and if Banks did not have control over investment of trust assets, Northern’s deceptive or manipulative conduct resulted only in Northern – and no other party – purchasing affiliated funds. As Troice specifically notes, SLUSA does not preclude cases where “the only party who decides to buy or sell a covered security as a result of a lie is the liar” because “that is not a ‘connection’ that matters.” 571 U.S. at 388; see also O’Donnell v. AXA Equitable Life Ins. Co., 887 F.3d 124, 130 (2d Cir. 2018) (holding in a non-trust case that even if plaintiffs allege fraud, that fraud must be material to the plaintiffs’ decision to buy, sell, or hold a covered security to meet the “in connection with” requirement for SLUSA preclusion). BANKS V. NORTHERN TRUST 11 Caselaw and secondary sources support our conclusion that preclusion turns on the distinction between a trustee and an agent. As we previously have explained, while “both agents and trustees are fiduciaries . . . there are significant differences between the two.” N.L.R.B. v. United Bhd. of Carpenters & Joiners, Local No. 1913, 531 F.2d 424, 426 (9th Cir. 1976). Simply put, “[a]n agent acts for and on behalf of his principal and subject to his control,” while a “trustee acts for the benefit of the beneficiaries of the trust; he is an agent only if he agrees to hold title for the benefit and subject to the control of another.” Id. (citing Restatement 2d, Agency § 14B; Restatement 2d, Trusts § 8). In contrast to the beneficiary-trustee relationship, an agent acts subject to the control of his or her principal. This degree of control explains the difference between this case and S.E.C. v. Zandford, 535 U.S. 813, 822 (2002), upon which Northern heavily relies. In Zandford, the Supreme Court held that a broker could still be liable under § 10(b) of the Securities Exchange Act without making an affirmative misrepresentation because his principals granted him full discretion to trade stocks on their behalf. See id. at 822. Each time the broker “exercised his power of disposition for his own benefit, that conduct, without more, was” actionable under § 10(b). Id. at 821 (internal quotation marks omitted) (quoting United States v. Dunn, 268 U.S. 121, 131 (1925)). Northern argues Zandford shows that the level of control between an agent and a trustee does not matter because a principal can give full control to an agent – just like a trustee has full control of a trust. Northern overlooks the fact that the principal controls and directs the agent, who the principal likely has chosen. Unlike in the irrevocable trust context, a principal can revoke control from an agent in the course of their relationship. In 12 BANKS V. NORTHERN TRUST the irrevocable trust context, by contrast, unless otherwise specified in the trust instrument, a beneficiary cannot alter the powers of a trustee or remove the trustee without petitioning a court of law. See Cal. Prob. Code § 17200(10) (providing removal power to probate courts); Arnold H. Gold et al., California Civil Practice Probate and Trust Proceedings § 24:47, Westlaw (database updated May 2019) (explaining trustees can be removed only in accordance with the trust instrument or by a court). Here, the FAC does not allege that beneficiaries made any investment decision based on Northern’s conduct or statements. Quite the opposite: the FAC alleges that Banks had no control over how Northern invested the trust’s assets because Banks was only the beneficiary of an irrevocable trust. See FAC ¶¶ 16 (“[U]nder the governing trust instrument, all investment discretion lies exclusively with the trustee . . .”), 41 (“[A]s a legal matter, under the terms of their trust, [Northern] has sole discretion with regard to any and all investments.”), 359–60 (Northern “had the power and responsibility to administer and invest the trust assets in the best interests of the trust beneficiaries . . . [who] had no control over the investments”). The FAC also alleges that Northern conducted all the relevant purchases of covered securities without direction from Banks or other beneficiaries. Accordingly, Troice’s discussion of SLUSA’s “in connection with” requirement is directly on point. The FAC does not allege that Northern’s activities as trustee were “in connection with” any purchase or sale of covered securities by anyone other than Northern. Northern’s strongest support against our application of Troice – and its discussion of the “in connection with” requirement – are two pre-Troice cases: Segal v. Fifth Third Bank, N.A., 581 F.3d 305 (6th Cir. 2009), and Siepel v. Bank BANKS V. NORTHERN TRUST 13 of Am., N.A., 526 F.3d 1122 (8th Cir. 2008). In Segal, trust beneficiaries alleged that the trustee breached its fiduciary and contractual duties by investing in proprietary and higher fee accounts that benefited the trustee. 581 F.3d at 308. The Sixth Circuit affirmed the dismissal of the complaint, holding that SLUSA precluded the claims. See id. at 309– 10. In Siepel, the trust beneficiaries alleged state-law fiduciary duty claims against the trustee because it failed to disclose conflicts of interest in its selection of nationally traded securities. See 526 F.3d at 1124. The Eighth Circuit similarly held that SLUSA precluded the state-law claims because the fraud “coincided” with the trustee’s purchase of shares in the mutual funds. See id. at 1127. But the post-Troice decision in Henderson v. Bank of N.Y. Mellon Corp., 146 F. Supp. 3d 438 (D. Mass. 2015), explains why Northern’s reliance on Segal and Siepel is misplaced: [E]ven if the self-dealing allegations amount to a fraud claim, the fraud was not in connection with the purchase or sale of the covered securities except by the fraudster,
beneficiary, was powerless to buy or sell covered securities . . . . .... The analysis in both [Segal and Siepel] is foreclosed by Troice, because both cases rely on Dabit’s broad holding that for SLUSA to preempt, the fraud may merely “coincide” with the purchase or sale of covered 14 BANKS V. NORTHERN TRUST securities. Siepel, 526 F.3d at 1127; Segal, 581 F.3d at 312. 146 F. Supp. 3d at 443. 3 In Henderson, the plaintiff-beneficiaries brought similar fee and imprudent investment claims against the defendanttrustee. See id. at 440–41. The court held that in light of Troice, SLUSA did not preclude the claims. See id. at 443– 44. Northern argues Henderson directly contradicts Dabit and construes the “in connection with” requirement too narrowly. But Henderson’s understanding of Troice conforms with the Supreme Court’s explanation of the “in connection with” requirement: it must be read broadly, but not so broadly that the connection between a defendant’s conduct and the covered security becomes immaterial. 4 As we already concluded after Dabit, the claims should “have more than some tangential relation to the securities 3 Similarly, Northern’s reliance on Fleming v. Charles Schwab Corp., 878 F.3d 1146, 1155–56 (9th Cir. 2017), and Holtz v. JPMorgan Chase Bank, N.A., 846 F.3d 928, 929, 933–34 (7th Cir. 2017), is misplaced because both cases involved an agent-principal relationship. See also Taksir v. Vanguard Grp., 903 F.3d 95, 98 (3d Cir. 2018) (noting that Fleming and Goldberg v. Bank of America, N.A., 846 F.3d 913 (7th Cir. 2017) (per curiam), were factually distinguishable because those plaintiffs conceded that the alleged misconduct “was plainly material to brokerage customers”). 4 Northern asserts that we have cited Segal with approval multiple times. But those citations were only for the proposition that the substance and gravamen of the complaint govern in a preclusion inquiry. See Freeman, 704 F.3d at 1115; Fleming, 878 F.3d at 1153; Hampton v. Pac. Inv. Mgmt. Co. LLC, 705 F. App’x 558, 560 (9th Cir. 2017). We have not cited Segal for its application of SLUSA to state-law trust claims. BANKS V. NORTHERN TRUST 15 transaction.” Fleming, 878 F.3d at 1155 (quoting Freeman, 704 F.3d at 1116). 5 And as the Third Circuit explained in Taksir, “the Supreme Court in Troice made clear that . . . Troice clarifies – rather than modifies – Dabit.” 903 F.3d at 97. Northern would like us to read Dabit without considering its clarification in Troice. But we will not render Troice meaningless the way that Game of Thrones rendered the entire Night King storyline meaningless in its final season. Troice directly supports our conclusion that a trustee’s misconduct – over which a beneficiary of an irrevocable trust has no control – cannot constitute misconduct “in connection with” the sale of covered securities where “the only party who decides to buy or sell a covered security as a result of a lie is the [trustee].” Troice, 571 U.S. at 388. To use the language in Troice, the trustee is both the buyer and the “fraudster”; because the trustee can deceive only itself with any alleged misconduct, its misconduct does not require SLUSA preclusion. See also Bernard v. BNY Mellon Nat’l Ass’n, No. 2:18-cv-00783-CRE Dkt. 58 (W.D. Pa. June 14, 2019). Troice confirms that SLUSA’s “in connection with” requirement does not preclude claims brought by an 5 Northern also contends that we disavowed this application of Troice in Fleming, where in a footnote we rejected the argument that Troice “amended the Dabit ‘coincide’ standard.” 878 F.3d at 1155 n.5. This argument fails for two reasons. First, we agree that Troice did not amend Dabit, but simply clarified its application. Fleming’s holding – that the “in connection with requirement” should “have more than some tangential relation to the securities transaction” – supports our conclusion. Id. at 1155. Second, Fleming considered SLUSA preclusion in a situation involving brokers as agents, not the trust context. 16 BANKS V. NORTHERN TRUST irrevocable trust beneficiary – who has no control over the trustee – alleging imprudent investments by that trustee. 6 Here, the district court’s dismissal relied entirely on its conclusion that Northern was an agent of the trusts’ beneficiaries, a conclusion unsupported by the moving papers and the FAC. Not only did the district court fail to consider Banks’ allegations that the beneficiaries lacked any control over the trustees – an allegation supported by caselaw and secondary sources – but courts generally determine the existence of an agency relationship at the summary judgment stage, not in determining a motion to dismiss. See Rookard v. Mexicoach, 680 F.2d 1257, 1261 (9th Cir. 1982). Moreover, the district court’s brief discussion of Troice did not acknowledge Troice’s holding that the “in connection with” requirement is not met if the fraudster alone bought or sold the covered securities. The district court erred in concluding SLUSA precluded Banks’ imprudent investment claims. Because we conclude Banks’ imprudent investment claims do not meet the “in connection with” requirement for SLUSA preclusion, we need not decide whether the claims meet SLUSA’s fraudulent conduct requirement, i.e., whether Banks adequately alleged Northern (1) engaged in misrepresentation or omission of a material fact or (2) used or employed any manipulative or deceptive device or contrivance. We reverse and remand all of Banks’ imprudent investment claims. 6 Our opinion is limited to claims involving a trustee-beneficiary irrevocable trust relationship in which the trust instrument does not grant the beneficiary financial management trustee powers. We do not opine on how Troice may affect other state-law claims. BANKS V. NORTHERN TRUST 17