The district court for the Northern District of Texas, presiding over a securities class action settlement involving Securities America, Inc. (“SAI”), entered a temporary restraining order on Feb. 13, 2012, enjoining the Montana Commissioner of Securities and Insurance from seeking restitutionary relief for the benefit of Montana residents who are part of the settlement class. The order does not restrain the state from pursuing remedies other than restitution. The court will consider whether to enter a permanent injunction after the Montana Commissioner of Securities and Insurance has had additional time to brief the issue. The court’s decision carries significant implications for companies facing parallel class litigation and regulatory enforcement actions.
Customers of Securities America, Inc. ("SAI") filed related class actions against the brokerage firm in 2009 concerning securities purchased through SAI in two companies later revealed as Ponzi schemes. See McCoy v. Cullum & Burks Securities, Inc., 3:11-cv-191-F; Billitteri v. Securities America, Inc., 3:09-cv-1568-F; and Toomey v. Hofhines, 3:10-cv-1833-F (after settlement, the claims against SAI were consolidated as a separate case, Mitchell v. Securities America Inc. et al., 3:11-cv-1948-F). On August 4, 2010, the Montana Commissioner of Securities and Insurance issued a Cease and Desist Order and Notice of Proposed Agency Action against SAI. The enforcement proceeding concerned the same subject matter as the class litigation.
In February 2011, the parties to the securities class actions sought preliminary approval of a class-wide settlement agreement involving payments to class members, a class-wide release of claims and provisions enjoining pending or future legal action concerning claims to be released by class members. Through the class settlement approval process, state securities regulators, including Montana and Massachusetts, as well as the North American Securities Administrations Association, Inc. ("NASAA") and the Financial Litigation Division of the Texas Attorney General, all objected to the settlement's effect of precluding state regulatory enforcement actions.
Over the regulators’ and NASAA’s objections, the court issued an order on May 5, 2011, granting preliminary approval of the settlement and preliminarily certifying the class for settlement purposes. In a letter to the court dated June 23, 2011, Montana informed the court that it was the only state agency with a regulatory action remaining against SAI, and that it continued to object “to any provision in any prospective settlement that would limit or impede state securities regulators, in any way, from bringing enforcement actions for violations of state law.” See Billitteri, June 23, 2011, Letter from Commissioner of Securities & Insurance, Office of the Montana State Auditor (Doc. No. 458).
On August 9, 2011, the district court, Judge Royal Ferguson, granted final approval to the settlement, which provided $80 million for the benefit of class members. In addition, the settlement:
Bar[s] and permanently enjoin[s] Settlement Class Members, and any other persons purporting to act in the name of, or on behalf of, or for the benefit of any Settlement Class Members, from prosecuting, commencing or continuing any and all Released Claims which they had or have against the Releasees in any forum.
Settlement Agreement (Doc. No. 426, Ex. 1), Part C.4. In granting final approval of the settlement, the district court observed that the settlement did not bar state securities regulators from bringing claims for violations of their “laws or securities regulations” in pursuit of relief other than restitution, such as “fines, penalties, or injunctive relief.” Order Granting Final Approval (Doc. No. 474), at 31.
Since that time, Montana has pursued its administrative proceeding against SAI on behalf of six Montana investors, five of whom were members of the class action settlement and one of whom had separately settled with, and released all claims against, SAI in arbitration. After SAI requested that Montana dismiss its claims for restitutionary relief with prejudice, to which Montana refused, SAI filed a motion for a temporary restraining order and preliminary injunction on Feb. 1, 2012, to enforce the settlement order against Montana and enjoin its enforcement proceedings seeking restitution.
Grounds for Enjoining State Regulators From Obtaining Restitutionary Relief
SAI moved for injunctive relief on two grounds. First, SAI argued that when a state seeks fines, penalties and injunctions, it acts in its sovereign capacity, but when it seeks restitution, it acts in a representative capacity. Because the investors Montana seeks to represent have released all potential claims against SAI, Montana should be barred from obtaining a second recovery on their behalf.
SAI relied on In re Baldwin-United Corp., 770 F.2d 328, 331 (2d Cir. 1985), in which the Court of Appeals for the Second Circuit affirmed a district court order enjoining New York’s Attorney General from commencing an action “on behalf of or derivative of the rights of any plaintiff or purported class member.” Id. at 333-34. The district court feared that competing state suits would “impair” its jurisdiction, not only impeding judgments following settlement, but also settlement negotiations themselves. Id. at 333.
Thirty-one states appealed, arguing that the district court lacked statutory and constitutional authority to enjoin them. Id. at 331, 340, 355. The Second Circuit rejected the statutory arguments, noting that under the All Writs Act, 28 U.S.C. § 1651, district courts may “enjoin actions in state court where necessary to prevent relitigation of an existing federal judgment, notwithstanding the fact that the parties to the original action could invoke res judicata in state courts against any subsequent suit brought on the same matters.” Baldwin, 770 F.2d at 335 (citations omitted). The Second Circuit also rejected the states’ constitutional argument that state sovereign immunity guaranteed by the 11th Amendment barred the injunction. Id. at 341. The court held that when states assert claims personal to their citizens, the states do not act as sovereigns, and the 11th Amendment does not apply. Id.
SAI also argued that final judgment in a class action is res judicata as to all claims of the settling class members based on the same facts and circumstances, and that this principle applies when a state pursues an action on behalf of a settled class. See People ex rel. Spitzer v. Applied Card Systems, Inc., 11 N.Y.3d 105, 125-26 (2008) (Court of Appeals of New York held that res judicata precluded New York’s Attorney General from pursuing claims of restitution against a bank on behalf of consumers who had already settled class action claims against that bank).
The Northern District of Texas Decision
After receiving opposition papers from Montana, the Northern District of Texas agreed with SAI’s arguments as to the court’s power under the All Writs Act “to enjoin state action where necessary to prevent the re-litigation of an existing federal judgment,” and on February 13, 2012, the court entered an order temporarily restraining Montana from seeking restitution as part of its administrative proceeding against SAI. See Mitchell, Temporary Restraining Order (Doc. No. 22), at 3.
Relying principally on In re Baldwin-United Corp., the court concluded that Montana’s pursuit of the settling defendants for restitution “threaten[ed] the jurisdiction” of the federal district court and “the finality of its judgment.” Id. at 4. The court further concluded that enjoining Montana’s attempt to secure restitution on behalf of the plaintiffs did not implicate Montana’s sovereign immunity because in seeking compensation for its residents, Montana was not the real party in interest. Id. at 3.
In order to permit Montana additional time to respond, the court reserved judgment on SAI’s application for a permanent injunction. The Temporary Restraining Order remains in effect until February 27, 2012. Id. at 5.
Financial institutions defending federal class action litigation are often simultaneously faced with state regulatory investigations and enforcement proceedings, either in coordination through NASAA or piecemeal by various states. The enforcement actions, brought under state Blue Sky laws, typically seek an array of relief, including penalties and fines, disgorgement, injunctive relief and restitution for investors residing in the states. In addition, financial firms facing federal class action litigation frequently defend against actions initiated by state attorneys general seeking a variety of remedies, including restitution. The Northern District of Texas’ decision in SAI’s case reaffirms the authority of federal courts, seminally demonstrated in In re Baldwin, to protect the courts’ jurisdiction over class settlements, blocking double-recovery by settling class members, while simultaneously respecting the states’ authority to enforce state law insofar as the relief pursued by regulators and attorneys general does not include restitution.
While the Northern District of Texas’ decision provides protection against duplicative recovery, firms still must grapple with the prospect of state enforcement actions seeking fines, penalties, disgorgement and injunctive relief, often pursued by multiple states simultaneously. To make matters more difficult, various states’ investigations and enforcement proceedings rarely proceed on congruent schedules or seek identical relief, providing for great uncertainty with respect to the timing and costs for a firm to finally resolve matters involving multiple adversaries.
The Northern District of Texas’ decision in SAI confirms that there may be significant benefits in settling class litigation before or simultaneous with reaching settlements with the states. Doing so may afford greater control over one of the usual components of many consent agreements reached with state securities regulators and attorneys general — restitution. On the other hand, the decision may incentivize states to expedite enforcement proceedings when a potential settlement of parallel class litigation threatens the states’ ability to obtain restitution. In all cases, firms should consider carefully the interplay between state regulatory enforcement actions and class litigation when constructing a strategy for resolving all pending matters.
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This article was originally published by Bingham McCutchen LLP.