Magyery v. Transamerica Financial Advisors, Inc.

Citations: 315 F. Supp. 2d 954; 2004 U.S. Dist. LEXIS 7602; 2004 WL 926941Docket: 3:03 CV 0777 AS

Court: District Court, N.D. Indiana; April 16, 2004; Federal District Court

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The case involves Plaintiff Michael Magyery, who filed a putative class action against Defendants Transamerica Financial Advisors, Inc., Lawrence Hill, and Hill Associates, alleging state law claims of conversion, breach of contract, breach of fiduciary duty, and negligent supervision. The litigation arose from Magyery's investment in a retirement account managed by Transamerica and Hill, where he contends that Hill engaged in unauthorized trading that resulted in significant losses. 

The Defendants removed the case to federal court, asserting that the claims are completely preempted by the Securities Litigation Uniform Standards Act of 1998 (SLUSA). Magyery seeks to remand the action back to state court, arguing that SLUSA's preemption does not apply. The court must determine the jurisdictional issue of whether the state law claims are preempted by SLUSA, which would warrant dismissal of the claims. If not preempted, the case would be remanded to state court. The background includes specifics about the agreement Magyery signed, which he claims bound the Defendants to only act on his explicit instructions regarding securities transactions. The court has received briefs and held oral arguments on the motions, leading to this memorandum and order.

A state court civil action can be removed to federal court under 28 U.S.C. 1441(b) if it arises under federal law. The "well-pleaded complaint rule" allows a plaintiff to avoid federal jurisdiction by exclusively pleading state law claims, even if federal defenses are available. However, a notable exception occurs when a federal statute completely preempts a state-law cause of action, transforming it into a federal claim and allowing for removal.

In the 1990s, Congress enacted the Private Securities Litigation Reform Act (PSLRA) to address abuses in private securities litigation, imposing stricter pleading requirements and procedural limitations to deter frivolous lawsuits. This led many plaintiffs to file state law claims to bypass the PSLRA's constraints. In response, the Securities Litigation Uniform Standards Act (SLUSA) was passed, establishing federal courts as the exclusive venue for class actions alleging material misrepresentations or omissions in connection with covered securities. Under SLUSA, a state law claim is completely preempted if it constitutes a "covered class action" based on state law, alleges misrepresentation, and relates to the purchase or sale of covered securities.

The parties agree that the case is a class action involving covered securities, but they dispute whether there has been a misrepresentation or omission of material fact. While there is some debate about the connection to the purchase or sale of securities, the plaintiffs’ claims are linked to the defendants' actions regarding the selling and repurchasing of funds in their equity accounts. The resolution of the removal issue is crucial for determining jurisdiction and affects all pending motions in the case.

SLUSA, enacted in 1998, has limited case law regarding its preemptive reach, with the Seventh Circuit yet to issue a ruling. The Eighth Circuit's decision in *Green v. Ameritrade* established that SLUSA preempted state-law claims, but after the plaintiffs amended their complaint to a single breach of contract claim without fraud allegations, the Eighth Circuit found it was not preempted, affirming remand to state court. In the Second Circuit case *Spielman v. Merrill Lynch*, the court held that while SLUSA allows removal of securities fraud class actions based on state law, the district court must ensure the complaint meets SLUSA's substantive requirements for subject matter jurisdiction. The plaintiffs in *Spielman* alleged misrepresentation of transaction fees, but the court ruled such claims were not "in connection with" securities transactions, leading to remand. 

The Eleventh Circuit's ruling in *Riley v. Merrill Lynch* indicated that while SLUSA does not bar claims related solely to the retention of shares, claims involving both purchases and retention are barred. The current case distinguishes itself from *Green* because the plaintiffs' breach of contract claim is tied to the unauthorized sale of their securities. Unlike *Riley* and *Spielman*, the current complaint does not allege misrepresentations or omissions, suggesting an avoidance of SLUSA's preemptive reach. However, the defendants argue that implicit misrepresentations are inherent in the plaintiffs' breach of contract claim, specifically regarding promises concerning consent for buying or selling.

Allegations of misrepresentation arise from Mr. Hill's unauthorized sale and subsequent repurchase of Plaintiffs' securities, which the Defendants argue qualifies as an omission. Central to the case is whether these claims constitute material misrepresentations or omissions under SLUSA preemption and if they are sufficiently linked to the transaction of securities. Both parties reference various district court opinions to bolster their arguments. Plaintiffs cite cases like Burns v. Prudential Securities, Inc., which determined that unauthorized trading alone does not constitute securities fraud and that SLUSA's preemption requires allegations of misrepresentation or omission with "scienter"—the intent to deceive. Other courts have adopted this view, while some, including the Defendants' cited case Winne v. Equitable Life Assur. Soc. of the U.S., reject the need for scienter, emphasizing that SLUSA amends provisions beyond just 10(b) of the 1934 Act, which do not necessitate intent to deceive. The Winne court argues that claims under the 1933 Act do not require showing intent, contrasting with the findings in Burns. The overall legal landscape is inconsistent, with a clear division on the requirement of scienter for SLUSA preemption, reflecting differing judicial interpretations based on case facts.

In Riley, the plaintiff argued that scienter was crucial in determining whether a state law claim was merely a substitute for federal securities laws, thus potentially barred by the Securities Litigation Uniform Standards Act (SLUSA). The Eighth Circuit acknowledged that while SLUSA preempts claims that do not require scienter, the Riley complaint specifically alleged misrepresentations and omissions of material facts. The plaintiffs contended that these misrepresentations induced them to buy and retain shares of the Growth Fund.

The Eighth Circuit distinguished Riley from previous cases like Burns and Green, where the claims, although related to securities, did not constitute fraud. The court suggested that a claim for securities fraud must be present in the complaint for SLUSA preemption to apply. Similarly, in Winne, plaintiffs claimed that misrepresentations regarding Fixed and Variable Annuities led to penalties, reinforcing the necessity of fraud allegations for SLUSA applicability.

In MDCM Holdings, Inc. v. Credit Suisse First Boston Corp., the court ruled that breach of contract claims were not preempted by SLUSA, as MDCM did not allege any fraudulent intent on Credit Suisse's part but merely that the bank failed to fulfill its contractual promises. The court emphasized that proving breach of contract did not require evidence of the defendant's mental state, as long as it was shown that the contractual obligations were unmet.

The court examined the Joint Explanatory Statement of the Committee of Conference associated with SLUSA’s passage, which indicated that Congress intended to establish federal courts as the exclusive venue for most securities class action lawsuits. The statement highlighted the establishment of uniform national rules for securities litigation and aimed to prevent litigation from shifting to state courts post-PSLRA. It suggested that Congress intended to preempt state law claims alleging misrepresentations and omissions that could be construed as securities fraud, even if framed differently.

The Plaintiffs' Complaint alleges a breach of contract, asserting that Defendant Hill violated an agreement not to buy or sell their securities without authorization, resulting in damages. The Defendants argue that this breach should be construed as securities fraud, warranting preemption under the Securities Litigation Uniform Standards Act (SLUSA). The Court finds this argument unconvincing, noting that unauthorized trading and breach of contract are established issues in securities law and typically do not lead to federal jurisdiction under these laws. Unauthorized trading is not inherently a violation of the Securities Exchange Act of 1934 or SEC Rule 10b-5. A complaint based solely on a broker executing trades without consent is characterized as a breach of contract or fiduciary duty rather than fraud. The Court references a prior case, Consolidation Services, which highlights that misunderstanding the nature of misrepresentation could improperly convert breaches of contract into fraud claims. 

Under Indiana law, actual fraud cannot be based on unfulfilled promises or future conduct, and the parties agree that Mr. Hill did not intend to breach the contract; his unauthorized actions were motivated by a desire to benefit his clients. The Court concludes that Mr. Hill’s promise not to sell the Plaintiffs' stock does not support a securities fraud claim. The unauthorized trading, occurring only twice with no evidence of concealment, fails to meet the threshold for securities fraud. The Court also addresses the Defendants' claim that the Supreme Court's decision in Zandford alters the legal landscape by potentially allowing unauthorized trading to be actionable under 10(b), indicating that this interpretation must be contextualized. Overall, the Court determines that the claims do not satisfy the conditions for SLUSA preemption, allowing the Plaintiffs' state law claims to proceed.

In Zandford, a broker engaged in unauthorized sales from plaintiffs' accounts and misappropriated the funds. While the Supreme Court indicated that such misappropriation serves as persuasive evidence of a violation under 10(b), it clarified that misappropriation is not a necessary element for establishing this offense. The current case, however, does not present a claim of a scheme to defraud associated with the sale of securities, rendering Zandford inapplicable. Historically, plaintiffs preferred federal courts for securities fraud claims, facing resistance from defendants. The enactment of the PSLRA and SLUSA in the 1990s shifted this dynamic, as defendants now seek federal jurisdiction to dismiss state law claims, while plaintiffs aim to remain in state court. For defendants to gain federal jurisdiction, they must demonstrate that the plaintiffs' complaint includes allegations of misrepresentation or omission of a material fact related to securities transactions. In this instance, defendants did not establish the necessary elements for SLUSA preemption. Consequently, the Defendants' Motion to Dismiss is denied, and the Plaintiffs' Motion to Remand is granted, resulting in the case being remanded to Elkhart Superior Court No. 2. Additional notes highlight differing conclusions from the Eighth Circuit regarding appellate review and caution against defendants' attempts to reframe a complaint to invoke SLUSA preemption.