While institutional trustees may have once slept soundly considering themselves immune from class action lawsuits relating to the purchase or sale of securities on behalf of a trust, the Ninth Circuit’s recent ruling in Banks v. Northern Trust Corp. (9th Cir. 2019) 929 F.3d 1046, sounds a rousing wake up call for every trustee who professionally manages multiple trusts.
Federal law generally prohibits class actions relating to (1) misrepresentations of material fact in connection with the purchase or sale of a security, and (2) the alleged use of any manipulative device in connection with the purchase or sale of a security. Thus, for the most part, cases involving these types of allegations can only be brought individually. While institutional trustees have always had to be careful in what representations they make in the purchase or sale of securities, the potential for massive liability from class action litigation has largely been a non-issue.
However, the court in Banks v. Northern Trust Corp. clarified that this general rule does not apply to claims brought against a trustee by beneficiaries of an irrevocable trust. Therefore, institutional trustees with a large volume of trust administration files, and especially those associated with an institution that provides investment products, should now be on high alert for the potential for class action claims to be brought against them.
The History of Securities Class Actions
In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”), which heightened pleading standards for asserting securities class action claims in an attempt to reduce frivolous class action securities lawsuits. To avoid the PSLRA requirements, plaintiffs began asserting federal law securities claims as state law causes of action. So, in 1998, Congress passed the Securities Litigation Uniform Standards Act (“SLUSA”), which prohibited class actions in which a plaintiff alleges:
(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.
SLUSA applies regardless of whether the case is brought in federal or state court and regardless of whether the asserted cause of action is based on federal or state law. Under PSLRA and SLUSA, courts routinely dismiss class action claims against agents and institutions when the allegations fall in to one of the categories above.
What was Northern Trust Accused of?
Lindie Banks was the beneficiary of an irrevocable trust, of which Northern Trust Corporation (“Northern”) served as trustee. Banks filed a class action lawsuit in the U.S. District Court for the Central District of California against Northern, claiming Northern invested the trust funds in its affiliated funds portfolio, rather than investing a more lucrative third party fund, because Northern made more money if it used its own affiliated fund. Banks also alleged Northern charged improper and excessive fees for routine preparation of fiduciary tax returns. Banks’ complaint stated that Northern’s actions reflected company policy and affected a wide class of beneficiaries, and was therefore appropriately brought as a class action.
In response Northern filed a motion to dismiss the class action, citing SLUSA’s rule that cases involving misrepresentations, manipulation or deception in connection with the purchase or sale of a security can only be brought individually. The district court agreed with Northern’s argument and dismissed the case. Undeterred, Banks appealed to the Ninth Circuit, which sided with Banks and reversed the dismissal.
Beware of Beneficiary Claims
Citing Chadbourne & Parke LLP v. Troice, 571 U.S. 377 (2014), the Ninth Circuit explained that SLUSA applies only to misrepresentations made “in connection with” the sale of a security, which means that the misrepresentation must have made “a significant difference to someone’s decision to purchase” the stock. For this to occur, someone other than the alleged fraudster needs to be the one making the decision to buy or sell the stock. In other words, if the only person who decides to buy or sell stock is the person who made the misrepresentation, then the decision to purchase or sell could not have been influenced by the misrepresentation, and therefore the “in connection with” requirement has not been met.
Here, Banks was a beneficiary of an irrevocable trust and had no control over how Northern managed the trust’s funds. While Northern owed Banks a fiduciary duty, she could not direct Northern to take any specific action or alter Northern’s powers as trustee without petitioning the court. Banks thus played no role in Northern’s decisions as to which funds to invest in. Accordingly, “in connection with” requirement of SLUSA was not met and a class action lawsuit could be maintained against Northern.
The Ninth Circuit further explained that, if Northern had been Banks’ agent, the situation might have turned out differently because then Northern’s conduct could affect the decision to purchase the security thereby satisfying the “in connection with” requirement.
While every trustee must be honest with beneficiaries regarding investment decisions, professional trustees that administer multiple trusts need to be aware of the potential for class action liability when administering trusts where the beneficiary has no authority to direct the trust’s investments, especially if the trustee routinely invests in an affiliated fund.