The U.S. Supreme Court debated the reach of the federal securities laws, questioning whether investors can sue law firms and outside companies for their alleged roles in R. Allen Stanford’s $7 billion Ponzi scheme.

In an hour-long session sprinkled with questions about home loans and prenuptial agreements, the nine justices gave no clear indication how they will rule, directing skeptical questions at both sides.

The defendants to the suits are in the unusual position of arguing alongside the Securities and Exchange Commission and Obama administration. They are seeking a broad application of federal securities law — an interpretation that would thwart the Stanford suits from going forward under state law.

The case involves “classic securities fraud,” putting it under federal jurisdiction, said Elaine Goldenberg, a Justice Department lawyer.

The case tests a 1998 U.S. law enacted to prevent investors from using state courts to circumvent federal limits on class- action securities claims. Federal law prohibits punitive damages and requires higher levels of proof than many state laws. It also bars the type of “aiding and abetting” suits the investors are seeking to press in the Stanford cases.

Uniform Standards

Under the 1998 law, known as the U.S. Securities Litigation Uniform Standards Act or SLUSA, investors can’t sue under state law if the case is based on a misrepresentation made “in connection with the purchase or sale of a covered security.”

Because the phrase “in connection with” also governs the SEC’s jurisdiction in a separate statute, a ruling barring the Stanford suits might simultaneously bolster the commission’s powers.

The defendants in the Stanford case include units of Willis Group Holdings Plc, a London-based insurance broker. They are accused of writing letters that gave the investors reason to believe the certificates of deposit they bought were backed by safe, liquid investments. The investors sued the units along with the administrator of a trust Stanford used in his scheme.

Investors are also suing two law firms, Proskauer Rose LLP and Chadbourne & Parke LLP, for allegedly lying to the SEC and helping Stanford evade regulatory oversight. The defendants deny wrongdoing.

Not ‘Covered’

The CDs, issued by Stanford’s bank and sold by his securities firm, don’t qualify as “covered” under the federal SLUSA law. That means the CDs by themselves don’t give the defendants the right to have the state-law case dismissed.

“Nobody contends that we bought anything other than non- covered assets,” the investors’ lawyer, Tom Goldstein, argued today.

The law firms and Willis units argue that SLUSA applies because the Stanford Financial Group Co. reneged on promises to use proceeds from the investments to buy securities that are covered. “Covered” securities include publicly traded stocks and bonds.

Justice Antonin Scalia indicated he read the statutory language — “in connection with the purchase or sale of a covered security” — as letting the Stanford suits go forward.

“There has been no purchase or sale here,” he said. “It can’t be in connection with a purchase or sale that has never occurred.”

‘In Connection’

Justice Samuel Alito disagreed, suggesting he read the “in connection with” phrase broadly.

“It doesn’t say a misrepresentation ‘about’ the covered security,” Alito said. “It says a misrepresentation ‘in connection with.'”

Several justices said they were concerned that the position urged by the Obama administration and the defendants would expand the federal securities laws to a number of new areas. Chief Justice John Roberts asked whether a person would be violating the securities law by lying about stock ownership on a mortgage application.

Justice Elena Kagan asked a similar question about someone who agreed in a prenuptial agreement to sell Google stock in order to buy a home.

“Is that covered by the securities law now?” she asked Paul Clement, the lawyer for the defendants.

Clement said the court didn’t need to go that far to rule in favor of his clients, saying the promise to buy covered securities was central to the Stanford fraud.

“The security of the underlying investments was the most important factor” in prompting the investors to buy the CDs, he said.

‘Tangentially Related’

A New Orleans-based federal appeals court said the alleged misrepresentations were “only tangentially related” to any covered security. The ruling let investors’ suits filed under Louisiana and Texas state law go forward, reversing a trial judge who had thrown out the claims.

A federal jury convicted Stanford in March 2012 on 13 charges brought in connection with his Ponzi scheme, including four counts of wire fraud and five of mail fraud. He was sentenced in June to 110 years in prison.

Prosecutors said Stanford wasted investors’ money on failing businesses, yachts and cricket tournaments and secretly borrowed as much as $2 billion from his bank. In a Ponzi scheme, money from the newest investors is used to fund the returns that have been promised to previous investors.

The Supreme Court cases are Chadbourne & Park v. Troice, 12-79; Willis v. Troice, 12-86; and Proskauer Rose v. Troice, 12-88.