Christopher Brown v. John Calamos

In the

United States Court of Appeals

For the Seventh Circuit

No. 11-1785

C HRISTOPHER B ROWN, individually and

on behalf of a class,

Plaintiff-Appellant,

v.

JOHN P. C ALAMOS, S R., trustee of Calamos Convertible

Opportunities and Income Fund, et al.,

Defendants-Appellees.

Appeal from the United States District Court

for the Northern District of Illinois, Eastern Division.

No. 10 C 6558—Elaine E. Bucklo, Judge.

A RGUED S EPTEMBER 22, 2011—D ECIDED N OVEMBER 10, 2011

Before P OSNER, FLAUM, and SYKES, Circuit Judges.

P OSNER, Circuit Judge. The Securities Litigation Uni-

form Standards Act of 1998 (SLUSA) prohibits secu-

rities 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

2 No. 11-1785

omission of a material fact in connection with the pur-

chase 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 (2006); see also id. at 636; Merrill Lynch, Pierce,

Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82 (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 plain-

tiff’s complaint alleged the misrepresentation or omis-

sion 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,

No. 11-1785 3

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 share-

holders 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 partici-

pants 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.

4 No. 11-1785

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 com-

mon shareholders as the fund’s owners. The com-

plaint 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 invest-

ments 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 con-

tinue indefinitely, because . . . the term of the AMPS was

perpetual.” Although as we said preferred stock despite

No. 11-1785 5

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 share-

holders. 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 bor-

rowed 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 conse-

quences 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 the AMPS thinking their invest-

ment would always be liquid. For example, the Swiss

banking giant UBS agreed to buy back many AMPS at par.

6 No. 11-1785

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 chil-

dren)—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 addi-

tional 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 per-

petual”—is interpreted most naturally as alleging a

misrepresentation: that the AMPS would never be re-

No. 11-1785 7

deemed. 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 in-

vesting in the fund was that the investor would ob-

tain 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 com-

plaint can be interpreted as “alleging a misrepresenta-

tion or [in fact, and] omission of a material fact in con-

nection 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., No. 09-6265, 2011 WL 3926376, at *4

(6th Cir. Sept. 8, 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 the 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,

8 No. 11-1785

between an inessential factual allegation (“an extraneous

detail”—“complaints are often filled with more informa-

tion than is necessary . . . [;] the inclusion of such extrane-

ous 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 “inessen-

tial,” 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 par-

ticular 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, adopted by the Ninth

Circuit in Stoody-Broser v. Bank of America, No. 09-17112,

2011 WL 2181364, at *1 (9th Cir. June 6, 2011), takes off

from the literalist approach of Atkinson and Segal

but allows the removed suit to be dismissed without

prejudice, 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 a fresh state-

court complaint after dismissal of the removed suit, and

No. 11-1785 9

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 pleadings 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 ground that the suit is barred by

SLUSA is jurisdictional and therefore without prejudice,

despite a word in the Supreme Court’s decision in

Kircher v. Putnam Funds Trust, supra, 547 U.S. at 644, that

might seem to point in that direction: “If the action is

precluded, neither the district court nor the state court

may entertain it, and the proper course is to dismiss. If

the action is not precluded, the federal court likewise has

no jurisdiction to touch the case on the merits, and the

proper course is to remand to the state court that can

deal with it.” The word is “likewise.” If SLUSA is not a

bar to the suit, the federal court lacks jurisdiction

(unless there is a basis for federal removal jurisdic-

tion other than SLUSA) except to determine that it has no

jurisdiction. Id. But when SLUSA is a bar, it operates as

an affirmative defense, which is a defense on the merits,

not a jurisdictional defense. See Fed. R. Civ. P. 8(c); Turek

v. General Mills, Inc., No. 10-3267, 2011 WL 4905732, at *1

(7th Cir. Oct. 17, 2011). We think that what the Court

must have meant in Kircher when it used the word “like-

wise” is that the district court has no authority to con-

sider whether the removed suit has merit—whether for

10 No. 11-1785

example there was a breach of the duty of loyalty in

this case. Once it decides that SLUSA either is or is not

a bar to the suit, the court has finished; either way it has

no further business with the case.

A critic of the Sixth Circuit’s literalist approach 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 preju-

dice, once the case shorn of its fraud allegations resumes

in the state court, the plaintiff—who must have thought

the allegations added something to his case, as why else

had he made them?—may be sorely tempted to rein-

troduce 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 Securi-

ties Litigation Reform Act had placed on federal suits

for securities fraud would be thwarted.

Against this it can be argued that dismissal with preju-

dice is too severe a sanction for what might be an irrele-

vancy added to the complaint out of an anxious desire to

No. 11-1785 11

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, however, is that it could lead

to inconclusive haggling over whether an implication

of fraud could be extracted from allegations in the com-

plaint 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 litiga-

tion—as in this case. The allegation of fraud would be

difficult and maybe impossible to disentangle from the

charge of breach of the duty of loyalty that the defendants

owed their investors. This is not because a suit for breach

of that duty would have been hopeless had the defendants

at the outset made full and accurate disclosure—had told

the purchasers of common stock that the AMPS, though

they had no maturity date, could be redeemed at any

time without the authorization of the common share-

holders; that redemption might be motivated by con-

cern with maintaining good business relations with

investment banks and brokerage houses; and that in the

event of redemption the capital that the fund would

substitute for the redeemed AMPS might provide less

leverage (because of higher interest rates) and riskier

leverage (because of short maturity), and thus depress

12 No. 11-1785

the risk-adjusted earnings of the common shareholders.

These disclosures would be ineffectual against a claim of

breach of the duty of loyalty because that duty is not

dissolved by disclosure (“we are disloyal—caveat emptor!”).

Schock v. Nash, 732 A.2d 217, 225 n. 21 (Del. 1999); Suther-

land v. Sutherland, No. 2399-VCL, 2009 WL 857468, at *3-4

(Del. Ch. Mar. 23, 2009); Edward P. Welch & Robert S.

Saunders, “Freedom and Its Limits in the Delaware

General Corporation Law,” 33 Del. Corp. L.J. 845, 859-60

(2008); cf. Sample v. Morgan, 914 A.2d 647, 663-64 (Del. Ch.

2007). Investors often will knowingly and intelligently

waive legal protections if compensated, but no sane

investor would knowingly put himself at the mercy of

a disloyal investment manager (or so at least the

Delaware courts believe).

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 straight-

forward 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 mem-

bers 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 profit-

ability in order to shore up the profitability of other

No. 11-1785 13

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 (1991); Brehm v.

Eisner, 746 A.2d 244, 254-55 (Del. 2000), and the board

might—in all likelihood would—form a special litiga-

tion committee that after considering the question

would decide that a suit was not in the corporation’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 (corre-

sponding to a board of directors) of the same fund

complex would not constitute a conflict of interest that

would permit the requirement of demand to be waived,

provided the board was independent, In re Mutual

Funds Investment Litigation, 384 F. Supp. 2d 873, 878-79

(D. Md. 2005)—an issue to which we turn.

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

14 No. 11-1785

“independent,” 15 U.S.C. §§ 80a-2(a)(3), (a)(19), and the Act

contains a list of prohibited affiliations with the mutual

fund’s advisor or underwriter. 15 U.S.C. § 80a-2. Like most

advisors Calamos Advisors runs multiple funds, and it

uses the same six-member board of trustees, five of whom

are “independent” within the meaning of the Act, to

oversee all the funds; this is what is called a “unitary”

board. See Business Roundtable v. SEC, 647 F.3d 1144, 1154

(D.C. Cir. 2011); Investment Company Institute, Report of

the Advisory Group on Best Practices for Fund Directors:

Enhancing a Culture of Independence and Effectiveness 27-29

(June 24, 1999). It is not improper for a mutual fund

complex to have a unitary board rather than boards with

different members for each fund. (A couple of the Calamos

boards have a seventh member, but we can ignore that

detail.) Most mutual fund complexes have unitary

boards, as noted in Business Roundtable v. SEC, supra.

Calamos Advisors had of course a pecuniary interest in

protecting 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 ex-

ceeds) the requisite percentage of independent directors,

12 Del. Code § 3801(d); Beam v. Stewart, 845 A.2d 1040,

1048-49 (Del. 2004); In re Mutual Fund Investment Litigation,

supra, 384 F. Supp. 2d at 878-79; Strougo v. Scudder, Stevens

& Clark, Inc., 964 F. Supp. 783, 802 (S.D.N.Y. 1997), is, as

a unitary board, responsible to the entire family of

funds, including future funds because the present value

of an enterprise is the discounted value of its future

earnings. This responsibility may require the board to

make tradeoffs to the disadvantage of investors in one of

No. 11-1785 15

the funds for the sake of the welfare of the family as a

whole. See Seidl v. American Century Cos., 713 F. Supp. 2d

249, 259, 261 (S.D.N.Y. 2010); Restatement (Third) of

Trusts § 78(1) and comment c(8) (2007); Vanguard

Group, SEC Release No. IC-11645, 1981 WL 36522, at *4-5

(Feb. 25, 1981). The complaint alleges that the trustees

will benefit financially from the creation of new funds

that will come under the supervision of the unitary

board. But the fact that management profits from an

increase in the size of its enterprise is not a breach of

its duty of loyalty to shareholders.

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, 129

S. Ct. 1937, 1949 (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 (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,

the breach appears to rest on an allegation of fraud, as

is often the case.

Nor can the suit be saved by amending the com-

plaint to delete the passage that injected fraud into the

16 No. 11-1785

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 recognized

in Rockwell Int’l Corp. v. United States, 549 U.S. 457, 474 n. 6

(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 de-

fendant from defending in the court that obtained juris-

diction 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 despite his disclaimer. The likeli-

hood 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 com-

plaint 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-manipula-

tion rule were not a bar as well.

The suit was properly dismissed on the merits.

A FFIRMED.

11-10-11