Supreme Court Ponders Suits in Stanford Fraud Over Securities That Never Existed

WASHINGTON â€" On the first day of its new term, the Supreme Court heard arguments in a case arising from one of the most brazen frauds in recent history, the $7 billion Ponzi scheme orchestrated by R. Allen Stanford.

Victims of R. Allen Stanford’s fraud are suing lawyers, brokers and others.

Mr. Stanford was convicted last year of running the scheme over more than two decades, offering fraudulent high-interest certificates of deposit at the Stanford International Bank, which was based on the Caribbean island of Antigua. He was sentenced to 110 years in prison.

Investors, unable to get their money back from Mr. Stanford and his companies, filed class-action suits against law firms, insurance brokers and financial services companies, saying those businesses also bore responsibility for the fraud. The plaintiffs filed their suits under state laws that are more welcoming to class actions than federal law.

The question for the justices was whether such state suits were proper in light of the Securities Litigation Uniform Standards Act, a 1998 federal law that was meant to stop end runs around the protections offered to defendants under federal law. The 1998 law bars many state-law class actions based on asserted fraud “in connection with the purchase or sale of a covered security.”

Teasing out the meaning of that phrase occupied the justices for a lively hour.

Two things were undisputed. First, the C.D.’s sold by Mr. Stanford’s companies were not “covered securities” as defined in the 1998 law. Second, Mr. Stanford and his associates had falsely told the buyers of the C.D.’s that the proceeds would be invested in liquid securities, at least some of which would have been “covered securities” had they existed. But they did not.

Some justices seemed troubled by a securities fraud case that involved only phantom securities.

“If I’m trying to get a home loan and they ask you what assets you have and I list a couple of stocks and, in fact, it’s fraudulent, I don’t own them, that’s a covered transaction?” Chief Justice John G. Roberts Jr. asked.

Justice Elena Kagan asked a similar question about promises made in prenuptial agreements.

Paul D. Clement, representing the defendants, who wanted to take advantage of the 1998 law to dismiss the lawsuits, said three words in it were enough to reach many misrepresentations. “The ‘in connection with’ requirement,” he said, “can take something that might otherwise be plain fraud and if there’s a misrepresentation in connection with a security or a covered security, that makes it securities fraud.”

“My goodness,” responded Justice Stephen G. Breyer. If that is so, he went on, there must be countless instances of securities fraud.

Justice Antonin Scalia probed a different part of the law. “I had assumed that the purpose of the securities laws was to protect the purchasers and sellers of the covered securities,” he said, adding that “there is no purchaser or seller of a covered security involved here.”

Justice Kagan suggested a distinction: lies about securities, even nonexistent ones, may be securities fraud if they moved markets. “How has this affected a potential purchaser or seller in the market for the relevant securities?” she asked. “And here there’s nothing to say.”

Elaine J. Goldenberg, arguing on behalf of the federal government in support of the defendants, urged the justices to adopt a broad interpretation of the 1998 law. “A false promise to purchase covered securities using the fraud victims’ money in a way that they are told is going to benefit them,” she said, “is a classic securities fraud.”

She added that the Stanford scheme had harmed investor confidence.

Justice Anthony M. Kennedy responded that many things can do that.

“If you went to church and heard a sermon that there are lots of people that are evil,” he said, “maybe then you wouldn’t invest.”

Thomas C. Goldstein, a lawyer for the investors, urged the court not to interpret the phrase “in connection with” too broadly.

“Because, metaphysically, everything is connected with everything else, we’re going to have to draw a line,” he said. “There’s going to have to be some limit.”

Justice Samuel A. Alito Jr. was less sure. “All that’s in the text of the statute is ‘in connection with,’ which is open-ended,” he said.

The court consolidated three cases for Monday’s argument: Chadbourne & Parke v. Samuel Troice, No. 12-79; Willis of Colorado v. Troice, No. 12-86; and Proskauer Rose v. Troice, No. 12-88.

In other action on Monday, the court refused to hear Argentina’s appeal of a lower court’s decision in favor of hedge funds that held bonds on which the country had defaulted.

As is their custom, the justices offered no reasons for turning down the appeal, Argentina v. NML Capital, 12-1494. The court’s brief order noted that Justice Sonia Sotomayor took no part in the matter, but it did not say why.

The appeal was from an interim decision last year from the United States Court of Appeals for the Second Circuit, in New York, and the justices may yet have an opportunity to consider whether to hear a separate appeal from the lower court’s final decision, issued in August.

The case was brought by bondholders who were owed more than $1.3 billion and who refused to accept reduced payments after Argentina’s default in 2001. Most of the nation’s other creditors accepted such payments in later debt swaps.

The Second Circuit ruled that Argentina had violated a contractual promise to treat all bondholders equally.

A version of this article appears in print on October 8, 2013, on page B3 of the New York edition with the headline: Supreme Court Ponders Suits in Stanford Fraud Over Securities That Never Existed .