Wilson et al v. Wells Fargo Advisors LLC et al

Filing 18

REPORT AND RECOMMENDATIONS- GRANTING 4 MOTION to Dismiss for Failure to State a Claim, GRANTING 6 MOTION to Dismiss Based upon SLUSA Preempting Plaintiffs' Action. Please note that when filing Objections pursuant to Federal Rule of Civ il Procedure 72(b)(2), briefing consists solely of the Objections (no longer than ten (10) pages) and the Response to the Objections (no longer than ten (10) pages). No further briefing shall be permitted with respect to objections without leave of the Court. Objections to R&R due by 11/13/2012. Signed by Judge Sherry R. Fallon on 10/22/2012. (lih)

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE
DIANE A. WILSON and HARRY J.
WILSON, on Behalf of Themselves and
All Others Similarly Situated,
Plaintiffs,
v.

WELLS FARGO ADVISORS, LLC,
WELLS FARGO SECURITIES, LLC,
WELLS FARGO ADVISORS
FINANCIAL NETWORK, LLC, and
WELLS FARGO DELAWARE TRUST
COMPANY,
Defendants.

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Civil Action No. 11-511-SLR-SRF

REPORT AND RECOMMENDATION
I.

INTRODUCTION
Presently before the court are the Motions to Dismiss brought by Wells Fargo Advisors, LLC,

Wells Fargo Securities, LLC, and Wells Fargo Advisors Financial Network, LLC (collectively, the
"Non-Trust Defendants") and Wells Fargo Delaware Trust Company (the "Trust Defendant;"
together with the Non-Trust Defendants, the "Defendants"), seeking dismissal of the complaint on
the basis that it fails to state a claim and is preempted by federal law, namely, the Securities
Litigation and Uniform Standards Act of 1998 ("SLUSA"), 15 U.S.C. 77p(b ), 78bb(f)(l ).
Plaintiffs Diane A. Wilson and Harry J. Wilson ("Plaintiffs") filed this class action lawsuit
in the Delaware Court of Chancery asserting claims under Delaware law against all Defendants for
breach of fiduciary duties and breach of a settlement agreement arising from the collapse of the
market for investments known as auction rate securities ("ARS") that Defendants allegedly

underwrote, marketed and sold. Defendants removed the action to this court and filed the pending
motions to dismiss. 1 For the reasons set forth below, I recommend that the court grant the motions
to dismiss, without prejudice.

II.

BACKGROUND
On May 5, 2011, Plaintiffs filed a class action complaint in the Court of Chancery for the

State of Delaware against Defendants, alleging causes of action for breach of fiduciary duty and
breach of a settlement agreement. (D.I. 1, Ex. A) On June 10,2011, Defendants removed the action
to this Court. (D.I. 1) The parties jointly stipulated that the time for Defendants to respond to the
Complaint would be July 1, 2011. (D.I. 3) Defendants filed their respective motions to dismiss on
July 1, 2011. (D.I. 4, 6) The motions to dismiss are presently before the Court.
Plaintiffs are residents of Florida and are settlors and beneficiaries of the Diane A. Wilson
Irrevocable Delaware Trust I (the "Wilson Trust"), a Delaware trust created through Wachovia Bank
and Delaware Trust Company ("Wachovia Trust"). (D.I. 1, Ex. A at ,-r,-r 7, 11-12, 75-76) Plaintiffs
brought this action on behalf of themselves and all others similarly situated, as representatives of a
proposed class of"[ a ]11 trusts and trust beneficiaries who had trusts at Wachovia Trust and Wells
Fargo that held ARS which were not bought back after Wachovia's settlement with the SEC." (!d.
at ,-r 95)
The Trust Defendant is a successor to Wachovia Bank and Delaware Trust Company
("Wachovia Trust") and is a Delaware corporation. (D.I. 1 at ,-r 13) The Non-Trust Defendants are
successors to Wachovia Securities, LLC and Wachovia Capital Markets, LLC (together,

1

The Non-Trust Defendants join in the Trust Defendants' motion to dismiss based on federal
preemption under SLUSA. The Trust and Non-Trust Defendants have asserted separate but similar
arguments in support of the motion to dismiss for failure to state a claim.
2

"Wachovia"), and are Delaware limited liability companies? (!d. at ~~ 14-16) The Non-Trust
Defendants are broker-dealers registered with the Securities and Exchange Commission (the "SEC")
pursuant to Section 15(b) of the Exchange Act and are registered investment advisers pursuant to
Section 203(c) of the Investment Advisers Act of 1940. (!d.) The Non-Trust Defendants offer a
variety of financial, advisory, brokerage, asset management and other services to millions of retail
customers nationwide. (!d.)
Wachovia Trust Company, Inc. operated as a trust company that offered trust administration,
investment management, philanthropic advisory, and estate settlement services. (!d.

at~

17) The

company was bought by Wells Fargo. (!d.) A.G. Edwards was a division ofWachovia which was
consolidated into Wachovia's broker-dealer operations on January 1, 2008. (!d.

at~

18)

Wachovia Trust was named the trustee of the Wilson Trust after its creation on June 22,
2005. (!d.

at~~

75, 77) As trustee, Wachovia Trust had sole discretion in purchasing assets with

the Wilson Trust property. (!d.

at~

78) In August 2005, Wachovia Trust purchased auction rate

securities ("ARS") to be held by the Wilson Trust. (!d.

at~

79)

ARS are "bonds issued by municipalities, student loan entities, and corporations, or preferred
stock issued by closed-end mutual funds, with interest rates or dividend yields that are periodically
reset through auctions." (!d.

at~

19) The issuer of each ARS selects broker-dealers to underwrite

the offering and manage the auction process. (!d. at ~ 20) Before an auction, each participating
broker-dealer accepts orders from its customers and submits the orders to the auction agent. (!d. at

2

Specifically, Wells Fargo Advisors, LLC is the successor to Wachovia Securities, LLC, and
defendant Wells Fargo Securities, LLC is the successor to Wachovia Capital Markets, LLC. (D.I.
1, Ex. 1 at ~~ 14, 15) Plaintiffs allege in the complaint that Wells Fargo Advisors Financial
Network, LLC is another successor to Wachovia Securities, LLC and Wachovia Capital Markets,
LLC. (!d. at ~ 16)
3

~

21) Customers bid the lowest interest rate or dividend they are willing to accept, and the auction

clears at the lowest rate bid that is sufficient to cover all of the securities for sale. (!d.) If there are
not enough bids to cover the securities for sale, the auction fails and the issuer pays a maximum
"penalty" rate. (!d. at~~ 21-22) Prior to February 2008, if there were not enough bids placed by
customers to purchase all of the securities sold in an auction, the broker-dealer purchased the
remaining ARS into its own inventory to prevent a failed auction, called a "support bid." (!d.

at~

23)
Wachovia underwrote and acted as sole or lead broker-dealer on a number of ARS offerings,
and acted as contractual broker-dealer on other ARS auctions. (!d.

at~

24) Wachovia followed the

industry practice of using its own capital to place support bids to prevent a failed auction. (!d.

at~

25) Customers who purchased ARS through accounts at A.G. Edwards were given a secondary
market between auctions by Wachovia, which allowed customers to reduce their ARS holdings to
cash by selling their ARS directly to A. G. Edwards' inventory without waiting to place an order on
the next auction date. (!d.

at~ 26)

Wachovia did not place any limitations on this par daily liquidity

service. (!d.)
Wachovia taught its financial advisors to market ARS to customers as cash alternatives or
money market instruments. (!d.

at~~ 40-44)

A. G. Edwards and Wachovia did not disclose the risks

associated with ARS to financial advisors or customers and downplayed disclosures regarding
auction failures, support bids and the discretionary nature of par daily liquidity. (!d.

at~~

32-37)

In December 2007 and January 2008, customer demand for ARS decreased due to investor
concerns about the creditworthiness of certain ARS insurers, higher than normal ARS inventory at
A. G. Edwards, interest rate trends in the ARS market and the existence of auction failures. (!d. at
4

~

45) Wachovia downplayed the risk of auction failures to its customers by stating that ARS had

high, above market penalty rates if an auction failed to compensate the holder for the lack ofliquidity
and to create incentives for the issuer to provide liquidity by redeeming the ARS. (ld.

at~

68)

Wachovia did not disclose that certain ARS had low, below market penalty rates. (ld.)
On February 13, 2008, Wachovia's senior management stopped A.G. Edwards' par daily
liquidity service, and the next day, stopped placing support bids in ARS auctions for which
Wachovia acted as lead manager or sole broker-dealer. (ld.

at~

74) The ARS market collapsed

shortly thereafter, and Wachovia's customers were unable to liquidate about $14 billion in ARS
holdings. (!d.)
The SEC filed a complaint against Wachovia Securities, LLC in the United States District
Court for the Northern District of Illinois, alleging violations of Section 15(c) of the Securities
Exchange Act of 1934 for its ARS practices. (ld.

at~

76) Wachovia Securities, LLC reached a $7

billion settlement with customers who invested in ARS before the market for those securities
collapsed. (Id.

at~

77) Wachovia Capital Markets, LLC voluntarily agreed to provide identical

relief to its ARS customers. (!d. at ~ 78) The settlement provided that Wachovia would buy back
ARS from accounts maintained by Wachovia on or before February 13, 2008, and would pay
customers who sold their ARS below par value between February 13, 2008 and November 10, 2008
the difference between par value and the sale price of the ARS, plus reasonable interest. 3 (!d. at~
79) Wachovia further agreed to compensate customers who took out loans from Wachovia after

The facts herein are taken from Plaintiffs' complaint. However, the Consent Judgment that
Wachovia Securities, LLC executed with the SEC indicates that it was to "make an offer to buy back
Eligible ARS at par ... "from its "Individual Eligible Customers" who were defined to include "all
customers who purchased ARS from Wachovia into accounts maintained at W achovia on or before
February 13, 2008." (D.I. 5, Ex. B)
3

5

February 13, 2008 because ofliquidity concerns and offered to lend its customers the full par value
of their ARS, pending the contemplated buyback, with interest rates set so that customers would
have no negative carry on their loans. (Id.)
The Wilson Trust continued to hold the ARS purchased by Wachovia Trust as of August
2010. (Id.

at~

80) Wachovia Trust listed the ARS at full par value and market value on the Wilson

Trust account statements. (Id. at ~ 81) Wachovia Trust never informed Plaintiffs that the Wilson
Trust held ARS, that Wachovia had entered into a settlement which included the buyback of all ARS
by June 30, 2009, or that the ARS held by the Wilson Trust had lost all or most of their market value.
(Id. at ~~ 82-85)

In September 2010, the Wilson Trust assets were transferred to an account maintained by
Wells Fargo (the "Wilson Account"). (Id.

at~

86) The account manager for the Wilson Account

informed Plaintiffs for the first time that the ARS had little to no value. (Jd.

at~

87) Wachovia,

Wachovia Trust, and Wells Fargo did not buy back the ARS from the Wilson Trust after the collapse
of the ARS market, and the ARS continued to be listed at full par and market value on Wilson Trust
statements. (Id.

at~~

89-90) Moreover, Wachovia, Wachovia Trust and Wells Fargo continued to

charge management fees based on the ARS' s full par and market value despite a lack of any liquidity
or market value. (!d.

at~

91) Plaintiffs only received notice of the ARS' s true market value after

the Wilson Trust assets were transferred to the Wilson Account at Wells Fargo. (!d.

III.

at~

92)

LEGAL STANDARD
To state a claim upon which relief can be granted pursuant to Rule 12(b)( 6), a complaint must

contain a "short and plain statement of the claim showing that the pleader is entitled to relief." Fed.
R. Civ. P. 8(a)(2). Although detailed factual allegations are not required, the complaint must set

6

forth sufficient factual matter, accepted as true, to "state a claim for relief that is plausible on its
face." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007); see also Ashcroft v. Iqbal, 556
U.S. 662, 663 (2009). A claim is facially plausible when the factual allegations allow the court to
draw the reasonable inference that the defendant is liable for the misconduct alleged. Twombly, 550
U.S. at 555-56; Iqbal, 556 U.S. at 663. The court "need not accept as true threadbare recitals of a
cause of action's elements, supported by mere conclusory statements." !d.
Following the Supreme Court's decision in Iqbal, district courts have conducted a two-part
analysis in determining the sufficiency of the claims. First, the court must separate the factual and
legal elements of the claim, accepting the complaint's well-pleaded facts as true and disregarding
the legal conclusions. Iqbal, 556 U.S. at 663. Second, the court must determine whether the facts
alleged in the complaint state a plausible claim by conducting a context-specific inquiry that
"draw[s] on [the court's] experience and common sense." !d. at 663-64; Fowler v. UPMC

Shadyside, 578 F.3d 203, 210 (3d Cir. 2009). As the Supreme Court instructed in Iqbal, "[w]here
the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct,
the complaint has alleged- but it has not 'show[n]'- 'that the pleader is entitled to relief."' Iqbal,
556 U.S. at 679 (quoting Fed. R. Civ. P. 8(a)(2)).

IV.

DISCUSSION
A.

SLUSA Preemption
1.

Legal standard

Removal of a civil action that was filed in state court is generally proper if the federal court
would have had original jurisdiction to address the matter. 28 U.S.C. § 1441; see also Rowinski v.

Salomon Smith Barney, Inc., 2003 WL 22740976, at *2 (M.D. Pa. Nov. 20, 2003). Defendants
7

indicate that this Court has jurisdiction under SLUSA as well as 28 U.S.C. §§ 1331 and 1441. 4 (D.I.
1) The Court must therefore determine whether SLUSA precludes 5 Plaintiffs' state law claims. See

Rowinski, 2003 WL 22740976, at *2.
SLUSA provides that:
No covered class action based upon the statutory or common law of any State or
subdivision thereof may be maintained in any State or Federal court by any private
party alleging (A) a misrepresentation or omission of a material fact in connection with the
purchase or sale of a covered security; or
(B) that the defendant used or employed any manipulative or deceptive device
or contrivance in connection with the purchase or sale of a covered security.
15 U.S.C. § 78bb(t)(l). Therefore, SLUSA "mandates removal and then dismissal of any: (1)
covered class action; (2) based on state law; (3) alleging a misrepresentation or omission of a
material fact or act of deception; (4) in connection with the purchase or sale of a covered security."

Alessi v. Beracha, 244 F. Supp. 2d 354, 357 (D. Del. 2003).
The parties' dispute centers only on whether the complaint alleges a misrepresentation or
omission of a material fact "in connection with" the purchase or sale of a covered security. Material

4

Alternatively, Defendants indicate that removal is based upon the Class Action Fairness Act
of2005 ("CAFA"), Pub. L. No. 109-2, 119 Stat. 4 (2005), as codified at 28 U.S.C. §§ 1332, 1441,
and 1453. (D.I. 1 at~~ 18-28) This alternative basis for removal is not addressed in the briefing on
the motion to dismiss. As such, the Court will not address removal jurisdiction under CAFA at this
juncture.
ln Kircher v. Putnam Funds Trust, 547 U.S. 633,636 n.1 (2006), the Supreme Court held
that SLUSA "does not itself displace state law with federal law but makes some state-law claims
nonactionable through the class action device in federal as well as state court." "In other words,
SLUSA does not provide a federal rule of decision in lieu of a state one, but instead provides a
federal defense precluding certain state law actions from going forward." Proctor v. Vishay
lntertechnology Inc., 584 F.3d 1208, 1219 (9th Cir. 2009). As a result, the defense is more properly
characterized as a federal preclusion defense, and does not fall under the complete preemption
exception to the well-pleaded complaint rule of28 U.S.C. § 1331. ld. at 1219-20; Kircher, 547 U.S.
at 636 n.l.
5

8

misrepresentations and omissions are one element of the SLUSA preclusion analysis. See Rowinski

v. Salomon Smith Barney Inc., 398 F.3d 294,299-300 (3d Cir. 2005). The other element requires
that such material misrepresentations occur "in connection with" the purchase or sale of a covered
security. !d. at 300-01. SLUSA does not define the language "in connection with the purchase or
sale of a security." Spencer v. Wachovia Bank, NA., 2006 WL 3408043, at *6 (S.D. Fla. May 10,
2006).
In construing the statute, the Supreme Court has cautioned against a narrow interpretation,
declaring that the "in connection with" language must be given the same broad construction as the
language of Section 1O(b) and Rule 1Ob-5 of the Exchange Act. Merrill Lynch, Pierce, Fenner &

Smith Inc. v. Dabit, 547 U.S. 71, 85 (2006). Interpreting SLUSA broadly, the Supreme Court has
concluded that the identity of the plaintiff is not dispositive in determining whether state law causes
of action are precluded by SLUSA. Dabit, 547 U.S. at 85. Therefore, any distinction between
holders of securities and purchasers or sellers of securities is irrelevant. !d. at 88-89. Rather, "the
requisite connection is established where a 'fraudulent scheme' and a securities transaction
'coincide."' Rowinski, 298 F.3d at 300 (quoting SEC v. Zandford, 535 U.S. 813, 825 (2002)
(conducting an analysis under § 1O(b) and Rule 1Ob-5)). When the gravamen of the complaint
involves a misrepresentation or omission, and when that conduct coincides with a transaction
involving a covered security, SLUSA mandates dismissal. Siepel v. Bank ofAm., NA., 239 F.R.D.
558, 567-68 (E.D. Mo. 2006).
The nature of the relief requested by the plaintiff is also relevant in "connecting" the
allegations of the complaint to the purchase or sale of securities. See Rowinski, 398 F.3d at 301.

9

Where, as here, 6 a plaintiffs theory of damages includes the recovery of excess trust management
fees or investment losses, there is no doubt that such charges are incurred in connection with the
purchase or sale of securities. See id.
Although courts must "be wary of efforts to circumvent SLUSA through artful pleading"
when conducting the SLUSA preclusion analysis, the converse is also true. Siepel v. Bank ofAm.,
NA., 239 F.R.D. 558, 567-68 (E.D. Mo. 2006). The parties must not "lose sight of the general

presum[ption] that Congress does not cavalierly pre-empt state-law causes of action." Dabit, 547
U.S. at 87 (internal citations and quotations omitted).

Courts have cautioned that a broad

interpretation of SLUSA "does not transform every breach of fiduciary duty into a federal securities
violation," and a "defendant may not recast plaintiffs Complaint as a securities fraud class action
so as to have it preempted by SLUSA." Grundv. Del. Charter Guarantee & Trust Co., 788 F. Supp.
2d 226, 241 (S.D.N.Y. 2011) (quoting SEC v. Zandford, 535 U.S. 813, 825 n.4 (2002)); Paru v.
Mutual ofAm. Life Ins. Co., 2006 WL 1292828, at *3 (S.D.N.Y. May 11, 2006). A rule ofthumb

is that the claims must have "more than some tangential relation to the securities transaction" before
they will be precluded under SLUSA. Falkowski v. Imation Corp., 309 F.3d 1123, 1130-31 (9th
Cir. 2003), abrogated on other grounds by Proctor v. Vishay Intertechnology Inc., 584 F.3d 1208
(9th Cir. 2009).

6

By way of example, Count I of the complaint for breach of fiduciary duty states that
"Wachovia Trust I Wells Fargo continued to collect management fees based on the non-existent
market value of ARS." (D.I. 1, Ex. 1 at~ 105) The complaint then requests relief in the form of
compensatory, consequential, incidental, and punitive damages as compensation for Defendants'
breaches of fiduciary duty. (ld. at 31-32)
10

2.

Parties' contentions

In support of their preemption argument, Defendants contend that the allegations in the
complaint illustrate that misrepresentations were made in connection with the purchase or sale of the
ARS, specifically citing: ( 1) allegations that the Non-Trust Defendants misled Plaintiffs regarding
the increasing risks associated with ARS, the liquidity and safety of ARS and the risk of auction
failures; (2) allegations that the Trust Defendant failed to notify or inform Plaintiffs that the Wilson
Trust held ARS with no market value; (3) allegations that the Trust Defendants failed to inform
Plaintiffs that the Non-Trust Defendants had entered into agreements offering to buy back certain
ARS; and (4) allegations that the Trust Defendants represented that the Wilson Trust ARS retained
full value and liquidity. (D.I. 7 at 10) Although the complaint is framed as a class action for breach
of fiduciary duty and breach of a settlement agreement, Defendants contend that its overarching
theme is based on misrepresentations and omissions of material facts and deceptive conduct in
connection with the purchase and sale of securities. (!d. at 14) Defendants note that enforcement
of SLUSA does not leave Plaintiffs without a remedy because SLUSA preempts only state law
claims brought as a class action or brought by more than fifty people. (!d. at 15)
In response, Plaintiffs contend that the allegations set forth in the complaint should not be
preempted by SLUSA because they have no connection to the purchase or sale of a covered security. 7
(D.I. 10 at 4) Specifically, Plaintiffs contend that Defendants' actions occurred after the ARS were
sold, and any allegations concerning the purchase of securities merely serve as background to the

Plaintiffs concede in their answering brief that~ 97 (c) should be struck from the complaint:
"Plaintiffs concede a drafting error and agree that~ 97(c) should be struck from the Complaint. That
sub-paragraph is inconsistent with the allegations in Counts I-III which relate to failing to buy-back
the ARS and continuing to charge fees for non-existent values on the securities." (D .I. 10 at 5 n.1)
7

11

complaint. (!d. at 4-5) Moreover, Plaintiffs contend that Defendants' collection of management fees
on non-existent values and their failure to buy back the ARS pursuant to the SEC agreement,
properly form the basis for state law causes of action for breach of fiduciary duty and breach of
contract. (!d. at 4)

3.

Analysis

I recommend that Defendants' motion to dismiss be granted as it pertains to the issue of
SLUSA preclusion. Although the claims are framed as causes of action for breach of fiduciary duty
and breach of a settlement agreement, the gravamen of the complaint involves misrepresentations
and omissions of material fact in connection with securities transactions. Specifically, the complaint
alleges in relevant part that Defendants:
"misrepresented to ... customers that ARS were safe, highly liquid investments
comparable to cash or money market instruments. As a result, numerous customers
purchased ARS using funds that they needed to remain available on a short-term
basis." (D.I. 1, Ex. A at~ 1)
"did not ... adequately disclose that: (1) auctions could fail, rendering customers'
ARS holdings illiquid, (2) an auction's success may depend on a broker-dealer ...
placing support bids in an auction, and (3) the par daily liquidity service ... could be
withdrawn at any time." (!d. at~ 2)
"became aware of mounting evidence that the firm and its customers could no longer
rely on the historical stability of the ARS market" but "nevertheless, continued to
market ARS to its customers as highly liquid investments." (!d. at~ 3)
"refused to buy back ARS from trusts that purchased and held ARS as trust
property." (!d. at~ 8)
"continued to carry ARS at full par value on trust statements and continued to charge
trust management fees on the full par value." (!d. at~ 9)
"failed to notify trust beneficiaries of the settlement and ARS buy back, failed to
participate in the buy back in their role of trustee in charge of trust assets, and
knowingly continued to charge fees based on inaccurate, non-existent securities
12

values." (!d.

at~

10)

"continued to market ARS as highly liquid securities through mid-February 2008
even though its employees knew or were reckless in not knowing that the risk of
auction failures had materially increased." (!d. at~ 45)
"did not give its customers current, complete and accurate information about
increasing risks of investing in ARS." (!d. at~ 47)
"downplayed the risk [of auction failure] by stating that ARS had high, above market,
penalty rates if an auction failed to compensate the holder for the lack ofliquidity and
to create incentives for the issuer to provide liquidity by redeeming the ARS ...
[and] did not disclose that, at least under market conditions in late 2007 and early
2008, certain ARS had low, below market, penalty rates." (!d. at~ 68)
"never informed Mr. and Mrs. Wilson that the Wilson Trust held ARS." (!d.

at~

82)

"never informed Mr. and Mrs. Wilson that Wachovia entered into a settlement that
included the buy back of all ARS by June 30, 2009, such as the ones held by the
Wilson Trust." (!d. at~ 83)
"never informed Mr. and Mrs. Wilson that the ARS held by the Wilson Trust had lost
all or most of their value." (!d. at~ 84)
"continued to represent to Mr. and Mrs. Wilson that the ARS held by the Wilson
Trust retained their full value and liquidity." (!d. at~ 85)
"actively concealed the true value of the ARS held by the Wilson Trust." (!d.

at~

93)

In 1995, Congress enacted the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-4
et seq. ("PSLRA") to curb perceived abuses of federal class action securities litigation. See
Rowinski, 398 F.3d at298;Atkinson v. Morgan Asset Mgmt., Inc., 658 F.3d 549,552 (6th Cir. 2011).

However, to circumvent PSLRA, plaintiffs filed such actions in state courts, artfully pleading their
claims as state law causes of action, such as claims for breach of fiduciary duty and breach of
contract. To halt such efforts to litigate around PSLRA, Congress enacted SLUSA in 1998.
Congress envisioned a broad interpretation of SLUSA to ensure the uniform application of federal

13

fraud standards. Rowinski, 398 F .3d at 299. The claims in issue illustrate that the overarching theme
of the complaint is Defendants' misrepresentations and omissions regarding the liquidity and value
of ARS and the risks associated with investing in ARS.
Similar to the facts set forth in Dab it, Plaintiffs' complaint alleges that Defendants' financial
advisors relied on incomplete information provided to them by Defendants in encouraging customers
to purchase ARS as a low-risk investment vehicle equivalent to cash. See Dabit, 547 U.S. at 75.
In both cases, the misrepresentations allegedly caused Plaintiffs to continue to hold their securities
beyond the point when they would have otherwise redeemed them if the truth had been known. Id.;

see also In re Edward Jones Holders Litig., 453 F. Supp. 2d 1210, 1215 (C.D. Cal. 2005)
(concluding that SLUSA preempted the plaintiffs action where the defendant "willfully tailored and
distorted its investment advice to steer Plaintiffs and the class members to the Preferred Funds, then
encouraged them to hold those funds for the long term."). The allegations in Plaintiffs' complaint
suggest that Plaintiffs 8 would have sold their shares earlier, participated in the buy back, or refrained
from investing in ARS in the first place if they had been given complete and accurate information.
In light of the Supreme Court's decision in Dabit, these allegations are sufficient to bring the
complaint within the ambit of SLUSA preclusion.
Despite Plaintiffs' contentions that the allegations of misrepresentations and omissions in the
complaint are intended merely to provide background, Plaintiffs incorporate these allegations into
each count of the complaint as a factual predicate to the claims. The Third Circuit has held that this

8

Although Plaintiffs in the instant matter did not themselves purchase ARS, the Supreme
Court has extended SLUSA preclusion to holders of securities, holding that "the identity of the
plaintiffs does not determine whether the complaint alleges fraud 'in connection with the purchase
or sale' of securities." Dabit, 547 U.S. at 89.
14

is sufficient to satisfY the misrepresentation prong under SLUSA. See Rowinski, 398 F.3d at 300
("[P]reemption does not tum 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."); see also Prof'! Mgmt. Assocs., Inc. Employees' Profit Sharing Plan v. KPMG LLP, 335
F.3d 800, 803 (8th Cir. 2003) (determining that allegations regarding misrepresentations and
omissions were incorporated by reference in the negligence count).
Plaintiffs cite a line of cases from the Southern District of New York cautioning against
attempts by defendants to recast a plaintiffs complaint as a securities lawsuit so as to have it
preempted by SLUSA. See, e.g., Grundv. Del. Charter Guarantee & Trust Co., 788 F. Supp. 2d 226
(S.D.N.Y. 2011). Notably, Plaintiffs do not analogize the facts of the cited cases to the facts set forth
in the instant complaint, and the cases are distinguishable.
The court in Grund concluded that SLUSA did not preclude the plaintiffs complaint because
misrepresentations were not made "in connection with" a securities transaction where the plaintiffs
assets were deposited into a Ponzi scheme that outwardly purported to invest in covered securities.
Id. at 243. The nature of the Ponzi scheme substantially influenced the court's analysis, and similar

facts are not present in the instant matter.
In Paru v. Mutual ofAm. Life Ins. Co., the parties agreed that the complaint contained no
explicit allegation of a misstatement or omission and, upon review, the court agreed with the parties'
assessment. 2006 WL 1292828, at *3-4 (S.D.N.Y. May 11, 2006). In contrast, for the reasons
previously stated, Plaintiffs' allegations in the present matter regarding Defendants' failure to buy
back the ARS and abide by the settlement agreement are inextricably connected to the
misrepresentations and omissions made regarding the risks associated with investing in ARS.

15

The court's decision inXpedior Creditor Trustv. Credit Suisse First Boston (USA) Inc. was
decided prior to the Supreme Court's decision in Dabit, and determined that only the language of
the causes of action themselves must sound in fraud or contain allegations of misrepresentations or
omissions. 341 F. Supp. 2d 258, 269 (S.D.N.Y. 2004) (making no finding with respect to the "in
connection with" requirement after determining that the complaint alleges neither a
"misrepresentation or omission of a material fact"). This determination is inconsistent with Third
Circuit precedent cautioning against "artful pleading" and negating any distinction between legal and
factual allegations in a complaint for purposes of determining whether SLUSA precludes the action.

See Rowinski, 398 F.3d at 300. 9
Plaintiffs also refer to Pension Committee of Univ. of Montreal Pension Plan v. Bank of

America Securities, LLC, in which the district court based its decision on a determination that the
funds at issue were not covered securities. 750 F. Supp. 2d 450, 453-54 (S.D.N.Y. 2010). The
parties in the instant matter agree that ARS are "covered securities."
B.

Amendment of the Complaint

In the event that the court concludes the complaint is precluded by SLUSA, Plaintiffs contend
that they should be permitted to proceed with the balance of the claims or to amend the complaint
to remove any allegations of misrepresentations or omissions that are not required elements of the
causes of action alleged in the complaint. (D .I. 10 at 5) In the alternative, Plaintiffs request leave

9

The Third Circuit has further clarified that, "[t]o be a factual predicate, the fact of a
misrepresentation must be one that gives rise to liability, not merely an extraneous detail ... While
it may be unwise ... to set out extraneous allegations of misrepresentations in a complaint, the
inclusion of such extraneous allegations does not operate to require that the complaint must be
dismissed under SLUSA." LaSala v. Bordier et Cie, 519 F.3d 121, 141 (3d Cir. 2008). The Third
Circuit's decision in LaSala is distinguishable from the present matter, in which the facts are
inextricably intertwined with the causes of action and are not merely extraneous details.
16

to amend for purposes of removing the class action allegations and proceeding individually in the
event that the Court finds that none of the allegations may be brought as a class action, even with
amendment. (!d. at 6) In response, Defendants contend that a plaintiff may not evade SLUSA's
preemption by filing an amendment that omits express references to deceptive and manipulative
conduct or disavows reliance on such allegations. (D.I. 12 at 7)
The Rowinski court suggests in dicta that separate examination of each count ofthe complaint
to determine whether it is precluded by SLUSA is inconsistent with the statutory language. See
Rowinski, 398 F.3d at 305. "The statute does not preempt particular 'claims' or 'counts,' but rather

preempts 'actions,' 15 U.S.C. § 78bb(f)(l), suggesting that if any claims alleged in a covered class
action are preempted, the entire action must be dismissed." !d. Ultimately, the Third Circuit
determined that it was unnecessary to reach a definitive conclusion on the issue because the plaintiff
had incorporated every paragraph of the complaint into each cause of action, compelling the
conclusion that each count was preempted by SLUSA. Jd.; see also Atkinson, 658 F.3d at 556
("[B]ecause all of Plaintiffs' claims include allegations of fraud, SLUSA damns each one."). The
same is true in the instant matter (D .I. 1, Ex. A at

~~

102, 108, 114 ), and as such, Plaintiffs'

complaint is precluded by SLUSA in its entirety.
Allowing Plaintiffs to amend the complaint to remove references to misrepresentations and
omissions would defeat the purpose of the statute by inviting artful pleading. 10 Removing specific
terms from the complaint in an attempt to circumvent SLUSA preclusion would not alter the

10

The court further notes that, although Plaintiffs have requested leave to amend the
complaint as an alternative argument in opposition to Defendants' motions to dismiss, Plaintiff has
not filed a formal motion for leave to amend pursuant to Rule 15, and no proposed amended
complaint is before the court.
17

"essence" ofthe claims in this case. Rowinski, 398 F.3d at 301. A plaintiff cannot avoid preclusion
under SLUSA through " ... artful pleading that removes the covered words ... but leaves in the
covered concepts." Atkinson, 658 F.3d at 555 (quoting Segal v. Fifth Third Bank, NA., 581 F.3d
305, 310-11 (6th Cir. 2009)).
Plaintiffs cite no authority in support of their alternative request for leave to amend for
purposes of removing the class action allegations and proceeding individually. Although SLUSA
preclusion mandates dismissal, it does not foreclose Plaintiffs from bringing individual state law
claims because "SLUSA does not pre-empt any cause of action. It simply denies the use of the classaction device to vindicate certain claims." See Dabit, 547 U.S. at 72, 87 (SLUSA preemption "does
not deny any individual plaintiff, or indeed any group offewer than 50 plaintiffs, the right to enforce
any state law cause of action that may exist.").
Therefore, it is recommended that the complaint should be dismissed, without prejudice. 11

C.

Additional Grounds for Dismissal Based on Failure to State a Claim

In addition to SLUSA, Defendants raise other, independent grounds for dismissal of
Plaintiffs' claims, namely, for failure to state a claim for breach of fiduciary duty or breach of
contract. In response, Plaintiffs concede that they did not assert causes of action for breach of
fiduciary duty against the Non-Trust Defendants in Counts I and II of the complaint, and they did
not assert a cause of action for breach of contract against the Trust Defendant in Count III of the
complaint. (D.I. 9 at 8-9; D.I. 10 at 7) I recommend that, to the extent the complaint does not state

11

A dismissal without prejudice is consistent with the Third Circuit's decision in Rowinski,
which stressed that SLUSA "does not preempt particular 'claims' or 'counts' but rather preempts
'actions,' suggesting that if any claims alleged in a covered class action are preempted, the entire
action must be dismissed." Rowinski, 398 F.3d at 305 (internal citation omitted).
18

a cause of action for breach of fiduciary duty against the Non-Trust Defendants or a cause of action
for breach of contract against the Trust Defendants, those claims should be dismissed. See Figueroa
v. U.S. Postal Serv., 422 F. Supp. 2d 866, 879 (N.D. Ohio 2006) (plaintiffs failure to respond to
defendant's arguments on a Rule 12(b)( 6) motion to dismiss was a concession that the cause of
action failed to state a claim upon which relief could be granted).

It is unnecessary for me to consider the additional bases for dismissal under Rule 12(b)(6)
in light of my determination that SLUSA precludes the class action. I will defer ruling on these
additional grounds for dismissal until after any objections to this Report and Recommendation are
resolved.

V.

CONCLUSION
For the foregoing reasons, I recommend that the court grant Defendants' motion to dismiss

the complaint, without prejudice, as precluded by SLUSA.
This Report and Recommendation is filed pursuant to 28 U.S. C. § 63 6(b )( 1)(B), Fed. R. Civ.
P. 72(b)(l), and D. Del. LR 72.1. The parties may serve and file specific written objections within
fourteen (14) days after being served with a copy ofthis Report and Recommendation. Fed. R. Civ.
P. 72(b). The objections and responses to the objections are limited to ten (10) pages each.
The parties are directed to the court's Standing Order In Non ProSe Matters For Objections
Filed Under Fed. R. Civ. P. 72, dated November 16,2009, acopyofwhich is available on the court's
website, www.ded. uscourts.gov.

Dated: October 22, 2012

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