Christоpher BROWN, individually and on behalf of a class, Plaintiff-Appellant, v. John P. CALAMOS, Sr., trustee of Calamos Convertible Opportunities and Income Fund, et al., Defendants-Appellees.
No. 11-1785.
United States Court of Appeals, Seventh Circuit.
Decided Nov. 10, 2011.
Argued Sept. 22, 2011.
664 F.3d 123
Michael F. Derksen, Attorney, Morgan, Lewis & Bockius, John W. Rotunno (argued), Attorney, K & L Gates LLP, Chicago, IL, for Defendants-Appellees.
Before POSNER, FLAUM, and SYKES, Circuit Judges.
POSNER, Circuit Judge.
The Securities Litigation Uniform Standards Act of 1998 (SLUSA) prohibits securities class actions if the class has more than 50 members, the suit is not exclusively derivative, relief is sought on the basis of state law, and the class action suit is brought by “any private party alleging a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.”
If such a suit is brought in a state court the defendant can remove it to federal district court and move to dismiss it.
The class consists of the owners of the common stock of Calamos Convertible Opportunities and Income Fund, a closed-end investment fund, which is to say a fund in which the owners of the fund‘s common stock are not permitted to redeem their shares, unlike investors in an open-ended fund, who can at any time cash out their fractional share of the fund‘s assets. The common shareholders of a closed-end investment fund are thus the owners of a corporation whose principal assets are investments.
Besides issuing common stock, the fund in this case issued shares of preferred stock that specified an interest rate (the interest on preferred stock is called a “dividend,” but functionally it is interest rather than an equity return) recomputed at short intervals (35 days was the longest) through an auction process. The participants in such an auctiоn bid for preferred stock. The bidder who submits the highest bid, and therefore accepts the lowest interest rate (because the yield of a fixed-income security is inversely related to its price), becomes the owner of the preferred stock. Such stock is called “auction market preferred stock” (“AMPS“).
The auctions give the owners of the preferred stock liquidity; for they can sell the stock at the auctions, which as we said are (or rather were) frequent. And although preferred stock is actually a form of bond, like common stock it does not have a maturity date, as almost all bonds do, though there are such things as perpetual bonds—most famously the consols issued by the British government beginning in 1751 and still a component, though nowadays a minor one, of the United Kingdom‘s public debt.
The money that the fund‘s common shareholders had paid the fund for their stock was рooled with the money paid by the preferred shareholders for their shares (the AMPS), and the pool of money was invested. The earnings from the investments, minus the fund‘s expenses, including the interest expense paid to the preferred shareholders, enured to the benefit of the common shareholders as the fund‘s owners. The complaint alleges that at first this was a good deal for the common shareholders because interest rates on AMPS were very low, so that the fund was borrowing on the cheap and using the borrowed money to buy investments that generated a much higher return than the AMPS interest rates. This was leverage in operation: If you lend $100 of your own money at 5 percent, your rate of return is 5 percent, but if you borrow another $100 at 2 percent, and lend the $200 you now have at 5 percent, you increase your earnings from $5 to $8 ($200 × .05 = $10; $100 × .02 = $2; $10 - $2 = $8), and thus the rate of return on your invеstment of $100 rises from 5 percent ($5/$100) to 8 percent ($8/$100). (For a lucid description of the market for closed-end investment funds’ AMPS and the market‘s demise, see Investment Company Institute, 2011 In-
The complaint alleges among other things that “the Fund‘s public statements indicated that the holders of its common stock could realize, as one of the significant benefits of this investment, leverage that would continuе indefinitely, because ... the term of the AMPS was perpetual.” Although as we said preferred stock despite the name is a form of debt, it is perpetual debt in the sense of not having a maturity date, that is, a date on which the lender is entitled to be repaid. But it isn‘t really “perpetual,” as we‘re about to see.
When the financial system fell into crisis in 2008, the auction-market preferred-stock market failed; not enough investors wanted tо buy AMPS. This should not have made a difference to the defendant fund‘s common shareholders. The preferred shareholders, the owners of the AMPS, being unable to sell their AMPS were stuck with the interest rate set at the last auction before the auction market collapsed, and that interest rate was low. But the owners were of course upset and the fund, though it had no duty to do so, redeemed their shares—and indeed at a price above market value. The fund replaced the AMPS money, but with money that was not only borrowed at higher interest rates but borrowed short term, which increased the risk to the fund, since it no longer had a secure capital base beyond what the common shareholders had paid for their shares.
The complaint alleges that the reason the fund redeemed the AMPS, despite the untoward consequences for the common shareholdеrs, was that Calamos Advisors—the fund‘s parent and a codefendant—wanted to curry favor with the investment banks and brokerage houses that were facing lawsuits both from regulatory agencies and from disappointed customers who had purchased AMPS thinking their investment would always be liquid. For example, the Swiss banking giant UBS agreed to buy back many AMPS at par. See In re UBS Auction Rate Securities Litigation, No. 08 CV 2967(LMM), 2009 WL 860812 (S.D.N.Y. Mar. 30, 2009).
Calamos Advisors managed multiple funds and relied on the banks and brokers to market shares in its future funds (because its funds were closed end, there was no occasion to market shares in the current funds), and so needed to maintain the good will of those entities. And so the parent sold its child (actually one of its 20 children)—the Calamos Convertible Opportunities and Income Fund—down the river, in breach of its fiduciary obligations to the fund‘s common shareholders, in order to placate banks and brokers. The suit names as additional dеfendants the members of the parent‘s board of trustees, whose job it was to make sure that the parent dealt fairly with the investors in each and every fund.
The plaintiff is emphatic that this is a suit for breach of fiduciary obligation and not for securities fraud—and in fact the complaint contains the following disclaimer: “Plaintiff does not assert by this action any claim arising from a misstatement or omission in connection with the purchase or sale of a security, nor does plaintiff allege that Defendants engaged in fraud in connection with the purchase or sale of a security.” Nevertheless the passage we quoted earlier from the complaint—“the Fund‘s public statements indicated that the holders of its common stock could realize, as one of the significant benefits of this investment, leverage that would continue indefinitely, because ... the term of the AMPS was рerpetual“—is interpreted most naturally as alleging a misrepresentation: that the AMPS would never be redeemed. The quoted passage doesn‘t
A misleading omission is also alleged, at least implicitly: the omission to state that the fund might at any time redeem AMPS on terms unfavorable to the common shareholders because motivated by the broader concerns of the entire family of 20 Calamos mutual funds—in other words an allegation of failure to disclose a conflict of interest that if disclosed would have given pause to potential investors.
Should we stop here and affirm because the complaint can be interpreted as “alleging a misrepresentаtion or [in fact, and] omission of a material fact in connection with the purchase or sale of a covered security“? That is the approach—call it the literalist approach to SLUSA—taken by the Sixth Circuit in Atkinson v. Morgan Asset Management, Inc., 658 F.3d 549, 554-55 (6th Cir.2011), and Segal v. Fifth Third Bank, N.A., 581 F.3d 305, 311 (6th Cir.2009). The plaintiff urges the contrary approach taken by the Third Circuit in LaSala v. Bordier et Cie, 519 F.3d 121, 141 (3d Cir.2008)—that if proof of a misrepresentation or of a material omission is inessential to the plaintiff‘s success, the allegation is no bar to thе suit. LaSala, following the Third Circuit‘s earlier decision in Rowinski v. Salomon Smith Barney Inc., 398 F.3d 294, 300 (3d Cir.2005), distinguishes, however, between an inessential factual allegation (“an extraneous detail“—“complaints are often filled with more information than is necessary ... [;] the inclusion of such extraneous allegations does not operate to require that the complaint must be dismissed under SLUSA“) and a factual allegation that while not a necessary element of the plaintiff‘s cause of action could be critical to his success in the particular case. The former type of factual allegation does not doom the suit, but the latter does. Were it not for this qualification, which limits “inessential,” a plaintiff could evade SLUSA by making a claim that did not require a misrepresentation in every case, such as a claim of breach of contract, but did in the particular case. (We thus disagree with the statement in Segal, 581 F.3d at 311, that LaSala contradicts Rowinski.) This may be such a case, as we‘ll see.
An intermediate approach, found in Stoody-Broser v. Bank of America, 442 Fed.Appx. 247, 248 (9th Cir. 2011), takes off from the literalist approach of Atkinson and Segal but allows the removed suit to be dismissed without prеjudice, thus permitting the plaintiff to file an amended complaint that contains no allegation of a misrepresentation or misleading omission and so cannot be removed under SLUSA. We are doubtful about this approach. No longer in American law do complaints strictly control the scope of litigation; a plaintiff might be allowed by a state court to reinsert fraud allegations in the course of a litigation initiated by а fresh state-court complaint after dismissal of the removed suit, and to press them at trial. If the new complaint alleged fraud, the case could again be removed, and this time presumably would be dismissed with prejudice. But fraud might have been injected into the new state-court suit long after the complaint in that suit had been filed; and to allow removal of a complex commercial case after, maybe long after, the рleadings stage had been concluded would increase the length and cost of litigation unreasonably.
There is no merit to the suggestion that dismissal of a removed suit on the
A critic of the Sixth Circuit‘s literalist approаch might point to an ambiguity in the statutory word “alleging.” Everything in a complaint (except the request for relief) is an allegation in the sense that it is an assertion that has not been verified by the litigation process. Yet many of these assertions are not allegations in the sense of charges of misconduct for which the plaintiff is seeking relief. If an allegation of fraud is included as background and unlikely to become an issue in the litigation, why should it doom the suit? What if the complaint in this case had alleged irrelevantly that the Calamos management had defrauded the underwriter of the common stock that the fund had issued of the underwriter‘s agreed-upon fee?
But as we just explained in criticizing the cases that allow dismissal of a case barred by SLUSA without prejudice, once the case shorn of its fraud allegations resumes in the state court, the plaintiff—who must have thought the allеgations added something to his case, as why else had he made them?—may be sorely tempted to reintroduce them, and maybe the state court will allow him to do so. And then SLUSA‘s goal of preventing state-court end runs around limitations that the Private Securities Litigation Reform Act had placed on federal suits for securities fraud would be thwarted.
Against this it can be argued that dismissal with prejudice is too severe a sanction for what might be an irrelevancy added to the complaint out of an anxious desire to leave no stone unturned—a desire that had induced momentary forgetfulness of SLUSA. But a lawyer who files a securities suit should know about SLUSA and ought to be able to control the impulse to embellish his securities suit with a charge of fraud. A further concern with the literal approach is that it could lead to inconclusive haggling over whether an implication of fraud cоuld be extracted from allegations in the complaint that did not charge fraud directly.
The plaintiff in the present case must lose even under a looser approach than the Sixth Circuit‘s (not the Ninth Circuit‘s approach, however, but one close to the Third Circuit‘s), whereby suit is barred by SLUSA only if the allegations of the complaint make it likely that an issue of fraud will arise in the course of the
So it might seem that had the fund said nothing about the leverage advantages conferred by the absence of a maturity date for the AMPS, this would be a straightforward suit for a breach of the duty of loyalty, the breach consisting of redemptions harmful to the fund but helpful to future affiliated funds and thus to the Calamos enterprise as a whole and possibly to the members of the board of trustees as well—they would have more funds to supervise and so might be paid more. Such a suit would not be barred by SLUSA, though it would have to be brought as a derivative suit, Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1034, 1039 (Del.2004); Kircher v. Putnam Funds Trust, supra, 403 F.3d at 483, because the theory would be that the executives had hurt the fund itself by reducing its profitability in order to shore up the profitability of other funds in which they had interests. Thus the present case would have to be dismissed in any event, but it could be refiled as a derivative suit, rather than being forever barred, which would be the effect of our affirming the district court‘s judgment.
We don‘t know why the suit was not filed as a derivative suit, but one possibility is that the plaintiffs’ counsel feared losing control over it. Counsel would be required to demand that the corporation‘s board authorize suit, Del. Ch. Ct. R. 23.1(a); Kamen v. Kemper Financial Services, Inc., 500 U.S. 90, 101, 111, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991); Brehm v. Eisner, 746 A.2d 244, 254-55 (Del.2000), and the board might—in all likelihood would—form a special litigation committee that after considering the question would decide that a suit was not in the corpоration‘s best interest. Kahn v. Kohlberg Kravis Roberts & Co., L.P., 23 A.3d 831, 834-35, 841 (Del.2011); Zapata Corp. v. Maldonado, 430 A.2d 779, 785 (Del.1981). The fact that the same persons served on multiple boards of trustees (corresponding to a board of directors) of the same fund complex would not constitute a conflict of interest that would permit the requirement
The Investment Company Act of 1940 establishes a dual governance structure under which an advisor (defendant Calamos Advisors) makes the investment decisions and a board of trustees monitors the advisor‘s management of the fund. At least 40 percent of the trustees must be “independent,”
Calamos Advisors had of course a pecuniary interest in protеcting the entire Calamos family of funds. But the existence of such an interest is not a breach of loyalty. The Calamos board of trustees, which has (in fact exceeds) the requisite percentage of independent directors,
So without the allegation that the Calamos Convertible Opportunities and Income Fund misrepresented the characteristics of its capital structure, a charge of breach of loyalty might not be plausible. See Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009); Atkins v. City of Chicago, 631 F.3d 823, 831-32 (7th Cir.2011). The fraud allegations may be central to the case. Cf. United States v. O‘Hagan, 521 U.S. 642, 651-52, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997); Ryan v. Gifford, 935 A.2d 258, 271 (Del.Ch.2007); LaSala v. Bordier et Cie, supra, 519 F.3d at 126, 129-30. The suit is therefore barred by SLUSA under any reasonable standard. The fact that the complaint disclaims any claim of fraud cannot save it. The disclaimer just signifies a commitment not to seek relief under the fraud provisions of state securities law. Though the suit is for breach of fiduciary obligations,
Nor can the suit be saved by amending the complaint to delete the passage that injected fraud into the case. Some courts think this proper, U.S. Mortgage, Inc. v. Saxton, 494 F.3d 833, 842-43 (9th Cir.2007); Behlen v. Merrill Lynch, 311 F.3d 1087, 1095-96 (11th Cir.2002), but it is contrary to the “forum manipulation” rule reсognized in Rockwell Int‘l Corp. v. United States, 549 U.S. 457, 474 n. 6, 127 S.Ct. 1397, 167 L.Ed.2d 190 (2007); see also Townsquare Media, Inc. v. Brill, 652 F.3d 767, 773 (7th Cir.2011); In re Burlington Northern Santa Fe Ry., 606 F.3d 379, 380-81 (7th Cir.2010) (per curiam). For then it is a case not just of the plaintiff‘s abandoning his federal claims but of his seeking to prevent the defendant from defending in the court that obtained jurisdiction of the case on his initiative. That is called pulling the rug out from under your adversary‘s feet. Anyway deletion of the fraud allegation would not be credible, if we are correct that the allegation may well be central to the plaintiff‘s case desрite his disclaimer. The likelihood that he would do everything he could to sneak the allegation back into the case, if the complaint were amended and remand to the state court followed, would be so great as to make it imprudent to allow the complaint to be amended to delete the allegation. The district judge would therefore not have been required to allow such an amendment even if the forum-manipulation rule were not a bar as well.
The suit was properly dismissed on the merits.
AFFIRMED.
RICHARD A. POSNER
UNITED STATES CIRCUIT JUDGE