Supreme Court Update: Walden v. Fiore (12-574), Chadbourne & Parke LLP v. Troice (12-79) and Kaley v. United States (12-464)

March 3, 2014 Supreme Court Update

Greetings, Court fans!

We're back with the three remaining decisions from last week: Walden v. Fiore (12-574), refining matters of personal jurisdiction; Chadbourne & Parke LLP v. Troice (12-79), permitting state law class actions to proceed against various persons and entities – including two law firms – accused of facilitating Allen Stanford's massive Ponzi scheme; and Kaley v. United States (12-464), finding that defendants have no right to a judicial hearing to contest a pre-trial freeze on their assets, even where they seek to use the assets to pay for their counsel of choice.

Earlier this Term, in Daimler AG v. Bauman (2014), the Court addressed federal courts' personal jurisdiction over a defendant based on conduct unrelated to the lawsuit (so-called "general jurisdiction"). Last week, in Walden v. Fiore (12-574), the Court tackled jurisdiction over a defendant based on contacts specific to the litigation ("specific jurisdiction"). Both cases reinforce that personal jurisdiction defenses are alive and well and should be carefully considered by defense counsel.

Walden was a police officer working as a deputized agent for the DEA at an Atlanta airport. Based on a tip from the TSA, Walden approached Fiore, a resident of Nevada, during her layover and found that she was traveling with nearly $97,000 in cash. (She claimed to be a professional gambler.) After a drug-sniffing dog performed a sniff test, Walden seized the cash. Fiore alleged that Walden later assisted in preparing a false and misleading affidavit of probable cause to support forfeiture of the cash. Fiore's luck later turned, however, and the cash was released. Apparently not satisfied, Fiore filed suit against Walden in Nevada district court arguing that her rights were violated by the original search and seizure of the cash and the continued detention of the money based on the allegedly false affidavit prepared by Walden. She argued that jurisdiction over Walden was proper in Nevada because he engaged in an intentional tort directed toward harming an individual who he knew was a Nevada resident. The district court found no jurisdiction, but the Ninth Circuit reversed, concluding that intentionally preparing a false affidavit in an effort to detain funds of a Nevada resident was sufficient to subject Walden to jurisdiction in Nevada.

The Court unanimously reversed, in an opinion by Justice Thomas. Personal jurisdiction is "principally concerned with protecting the liberty interests of the nonresident defendant, not the interests of the plaintiff." Thus, the personal jurisdiction analysis must focus on "the defendant's contacts with the forum State itself, not the defendant's contacts with persons who reside there." No matter how significant the plaintiff's contacts with the forum state may be, those contacts will not be determinative of the personal jurisdiction analysis, as it is the defendant's contacts that matter. While a defendant's contacts with the plaintiff and with the forum state often may be intertwined, this was an example where they were not. Here, while Fiore had contacts with Nevada because she was a Nevada resident, Walden had none at all. He seized the cash and drafted the affidavit in Georgia. Walden's knowledge that Fiore was a Nevada resident, and that his conduct would therefore cause harm in Nevada, simply was not enough to support jurisdiction. So, Fiore can now focus all her energy on cards, instead of courts.

We turn now to the case that generated the most buzz, at least in law firm circles. In Chadbourne & Parke LLP v. Troice (12-79), together with Willis of Colorado Inc. v. Troice (12-86) and Proskauer Rose LLP v. Troice (12-88), the Supreme Court held that the Securities Litigation Uniform Standards Act of 1998 ("SLUSA" or "the Act") did not preclude class actions based on state law against various persons and entities accused of facilitating Allen Stanford's massive Ponzi scheme, because the alleged misrepresentations were too tangentially related to the securities covered by the Act.

Though overshadowed by Bernie Madoff, Allen Stanford also ran a Ponzi scheme of epic proportions. He and his associates sold certificates of deposit in Stanford International Bank, telling investors the CDs were safe because the bank was buying securities to back up the CDs. Instead, Stanford used the money to repay old investors, finance speculative real estate ventures, sponsor polo teams, etc., all to the tune of $6 billion. When the scheme unraveled, Stanford went to prison, and various groups of investors went looking for ways to recover their money. Eventually, several class actions were filed against persons and entities who had worked with Stanford, including the law firms Chadbourne & Parke and Proskauer Rose. The plaintiffs alleged that the firms helped Stanford perpetrate the fraud in violation of Louisiana and Texas state law. The defendants argued that the actions were precluded by SLUSA, and the District Court agreed, but the Fifth Circuit reversed.

The Court sided with the investors, in a 7-2 decision headed by Justice Breyer. Breyer was joined by the Chief, and Justices Scalia, Thomas, Ginsburg, Sotomayor, and Kagan. Under the federal securities laws and the Court's precedents, persons who have been injured by fraud in connection with the purchase or sale of any security may bring a private suit for damages. However, private plaintiffs may not sue "secondary actors" who did not participate in making the fraudulent statements, and must comply with the heightened pleading standards of Federal Rule of Civil Procedure 9(b). Plaintiffs' lawyers have sought to avoid these federal hurdles by bringing securities-related claims under state law instead. Congress tried to limit this workaround by enacting SLUSA in 1998. SLUSA preludes class actions based on state law alleging fraud "in connection with the purchase or sale of a covered security." "Covered security" is narrowly defined as a security listed on a national securities exchange or issued by a mutual fund company.

In this case, everyone agreed that the CDs sold by Stanford International Bank were not "covered securities" under SLUSA. The question was whether SLUSA reached the misrepresentations about the covered securities the bank was allegedly buying. The Court held that it did not. "A fraudulent misrepresentation or omission is not made ‘in connection with' such a ‘purchase or sale of a covered security' unless it is material to a decision by one or more individuals (other than the fraudster) to buy or sell a ‘covered security.'" To begin, the Act focuses on transactions in covered securities, not transactions in uncovered securities. A "connection" only matters if a misrepresentation makes a significant difference to someone's decision to purchase or sell a covered security. While the Court has previously held that the "in connection with" standard should be interpreted broadly, every securities case in which the Court has found a fraud to meet that standard involved investors who bought or sold, or tried to buy or sell an ownership interest in a covered security. Interpreting "in connection with" more broadly than that would interfere with state laws providing remedies for victims of ordinary state frauds. The Court dismissed the government's and the dissent's concerns that its holding would limit the SEC's enforcement capabilities simply because §10(b) of the Securities Exchange Act also uses the phrase "in connection with the purchase or sale of any security." The term "security" in §10(b) covers a wider array of financial products than "covered securities" under SLUSA. Indeed, the SEC had already successfully brought an enforcement action against Stanford and Stanford Internal Bank. Finally, the Court also rejected the dissent's concerns that its holding would subject law firms and other secondary actors to complex and costly state law litigation. By enacting heightened pleading standards and SLUSA, Congress had sought to protect entities that participate in the market for nationally traded securities from abusive class-action suits. While the Court's holding would continue to allow state-law suits against entities who did not participate in selling securities on U.S. national exchanges, it was "difficult to see why the federal securities laws would be—or should be—concerned with shielding such entities from lawsuits."

Justice Thomas wrote a separate short concurrence to criticize the "in connection with" standard as indeterminate and providing insufficient guidance, but agreeing with the Court's opinion insofar as it applied a limiting principle to the standard.

Justice Kennedy, joined by Justice Alito, dissented. In their view, the majority's holding would thwart Congress's intent to make federal law, as opposed to state law, the principle vehicle for bringing securities class actions. As SLUSA's "in connection with" language comes from §10(b) of the Securities Exchange Act, it must be given the same meaning. The majority's narrow interpretation of "in connection with" would "inhibit the SEC and private litigants from using federal law to police frauds and abuses that undermine confidence in the national securities market." At the same time, the majority would allow the very state-law claims Congress intended to prohibit, placing a serious burden on attorneys, accountants, brokers, and investment advisers nationwide. The dissenters would have found the requisite connection with the purchase or sale of covered securities in this case, as the fraud centered on misrepresentations that the CDs were a secure and liquid investment because the bank was buying nationally traded securities.

Finally, in Kaley v. United States (12-464), a divided Court held that persons who have been indicted by a grand jury may have their assets frozen without a hearing to contest the grand jury's probable cause finding, even where they seek to use the assets to pay for their counsel of choice.

After Kerri and Brian Kaley were indicted on charges of stealing and reselling prescription medical devices, the government sought and obtained a restraining order preventing the Kaleys from transferring any assets traceable to the alleged offenses. The frozen assets included a $500,000 certificate of deposit that the Kaleys intended to use for legal expenses. The Kaleys moved to vacate the restraining order, and the District Court eventually agreed to give them an evidentiary hearing on whether the frozen assets were traceable to the alleged conduct. But the Kaleys told the court that they didn't want to dispute traceability, they wanted to challenge whether the alleged conduct constituted a crime in the first place. (The Kaleys maintained that the medical devices at issue were unwanted, excess hospital inventory that were legally obtained and resold.) The court refused to grant such a hearing, and the Eleventh Circuit affirmed.

The Court also affirmed, in an interesting 6-3 split. Justice Kagan wrote for the majority, joined by Justices Scalia, Kennedy, Thomas, Ginsburg, and Alito. In Justice Kagan's view, two cases decided twenty-five years earlier "cast the die" in this one. First, Caplin & Drysdale, Chartered v. United States (1989) held that the Fifth Amendment right to due process and the Sixth Amendment right to counsel would not protect a convicted defendant from having to forfeit assets just because he had set them aside to pay an attorney. Second, United States v. Monsanto (1989) held that an indicted defendant's assets may be frozen before trial if probable cause exists to believe that (1) the defendant committed an offense permitting forfeiture, and (2) the property at issue had the requisite connection to that crime. Since Monsanto, lower courts have generally granted hearings to determine traceability, but have split on whether to allow defendants to contest that they committed a crime. The Court now sided with the "nays." By returning an indictment, a grand jury has already determined that probable cause exists to believe that the defendant committed the offense. If a grand jury's determination is sufficient to place a defendant in custody, the Court reasoned, then it is sufficient to freeze a defendant's assets without further judicial review. Relitigating probable cause for the asset freeze could force prosecutors to disclose evidence or case strategy prematurely, or lead to inconsistent results, undermining the grand jury's constitutionally proscribed role and the integrity of the criminal justice system.

The Court rejected the Kaleys' argument that the balancing test of Mathews v. Eldridge (1976) compelled a hearing in their case. Assuming without deciding that Mathews applied – the government argued that it should not apply to criminal procedural rules – the balance tipped in favor of the government. The government's interest in freezing potentially forfeitable assets was in equipoise with the Kaleys' interest in retaining the counsel of their choice. But the Kaleys were unable to show that the additional process of an adversarial hearing was likely to reduce the risk of an erroneous deprivation, because probable cause is a relatively low standard. Indeed, though courts in some Circuits had granted the type of hearing the Kaleys sought, the Kaleys were unable to identify a single case where a court found probable cause to be lacking.

The Chief penned the dissent, joined by Justices Breyer and Sotomayor. Focusing on defendants' right to the counsel of their choice, the dissenters criticized the majority's decision as being "at odds with our constitutional tradition and basic notions of fair play." The dissent downplayed the risks of relitigation: grand juries would still decide who had to stand trial, while judges would decide the separate issue of pre-trial asset restraint, likely based on different evidence. In any event, in the dissent's view, few things could do more to undermine the integrity of the criminal justice system "than to allow the Government to initiate a prosecution and then, at its option, disarm its presumptively innocent opponent by depriving him of his counsel of choice—without even an opportunity to be heard." As for the Mathews v. Eldridge balancing test, the majority had given too short shrift to the defendants' interests, exaggerated the government's concerns, and flubbed analysis of the third factor altogether. "It takes little imagination to see that seizures based entirely on ex parte proceedings create a heightened risk of error." A defendant could challenge errors in an indictment at trial, but could only meaningfully challenge an erroneous deprivation of his right to counsel if a hearing were provided before trial.

We'll be back soon with today's cert grants (no new opinions today).

Kim, Jenny & Julie

From the Appellate and Complex Legal Issues Practice Group at Wiggin and Dana. For more information, contact Kim Rinehart or any other member of the Practice Group at 203-498-4400