Brown v. Calamos

• Decision Date: 10 November 2011
• Docket Number: No. 11–1785.,11–1785.
• Citation: 664 F.3d 123
• Parties: Christopher 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.
• Court: U.S. Court of Appeals — Seventh Circuit

664 F.3d 123

Christopher 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.

Argued Sept. 22, 2011.Decided Nov. 10, 2011.

Carol V. Gilden, Attorney, Cohen Milstein Sellers & Toll PLLC, Chicago, IL, Gary A. Gotto (argued), Attorney, Keller Rohrback, P.L.C., Phoenix, AZ, for Plaintiff–Appellant.

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.” 15 U.S.C. § 78bb(f)(1), amending Securities Exchange Act of 1934; see also § 77p(b)(1), amending, in materially identical language, the Securities Act of 1933. A “covered security” is a security traded nationally and listed on a regulated national exchange. 15 U.S.C. § 78bb(f)(5)(E).

If such a suit is brought in a state court the defendant can remove it to federal district court and move to dismiss it. § 78bb(f)(2). And since “SLUSA is designed to prevent plaintiffs from migrating to state court in order to evade rules for federal securities litigation in the Private Securities Litigation Reform Act of 1995,” Kircher v. Putnam Funds Trust, 403 F.3d 478, 482 (7th Cir.2005), vacated and remanded on other grounds, 547 U.S. 633, 126 S.Ct. 2145, 165 L.Ed.2d 92 (2006); see also id. at 636, 126 S.Ct. 2145; Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82, 126 S.Ct. 1503, 164 L.Ed.2d 179 (2006); Gavin v. AT & T Corp., 464 F.3d 634, 640 (7th Cir.2006); Michael A. Perino, “Fraud and Federalism: Preempting Private State Securities Fraud Causes of Action,” 50 Stan. L. Rev. 273 (1998), the district judge must grant the motion. § 78bb(f)(2). The question presented by this appeal is whether the judge was correct to find that the plaintiff's complaint alleged the misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security and that therefore SLUSA forbade the suit. The district judge, agreeing, dismissed the suit, with prejudice, without first deciding whether to certify the class. 777 F.Supp.2d 1128, 1132 (N.D.Ill.2011).

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 auction 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 pooled 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 x .05 = $10; $100 x .02 = $2; $10 - $2 = $8), and thus the rate of return on your investment 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 Investment Company Fact Book,

ch. 4, pp. 57–60 (51st ed. 2011).)

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 continue 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 to 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 shareholders, 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 defendants 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 perpetual”—is interpreted most naturally as alleging a misrepresentation: that the AMPS would never be redeemed. The quoted passage doesn't say this in so many words, but a reasonable jury might find that the passage insinuated that a significant benefit of investing in the fund was that the investor would obtain leverage indefinitely because the AMPS had no maturity date.

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 ...