In a unanimous March 20, 2018 opinion written by Justice Elena Kagan, the U.S. Supreme Court held that state courts retain concurrent jurisdiction over class action lawsuits alleging only violations of the Securities Act of 1933’s liability provisions and that these state court class action lawsuits are not removable to federal court. The court’s holding resolves a lower court split in the authorities on question of whether or not the Securities Litigation Uniform Standards Act of 1998 (SLUSA) eliminated concurrent state court jurisdiction for these ’33 Act class action lawsuits or made the state court ’33 Act lawsuits removable to federal court.
As discussed below, Court’s ruling is likely to result in an increase in ’33 Act claims in state court, a development that could have unwelcome consequences for corporate defendants and their insurers. The Supreme Court’s March 20, 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund can be found here.
In 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA), which enacted a number of procedural reforms pertaining to securities class action litigation. In an effort to circumvent the PSLRA’s procedural requirements, a number of plaintiffs’ lawyers tried to file their clients’ lawsuits in state court, often under state law. In 1998, and in order to ensure that the lawsuits remained in federal court and subject to the PSLRA’s requirements, Congress passed SLUSA to preempt the state court jurisdiction and to require the “covered” class actions to go forward in federal court.
Even after the enactment of SLUSA, unanswered questions remained with respect to liability actions under the ’33 Act. Section 22(a) of the Securities Act of 1933 provides for concurrent state court jurisdiction for civil actions alleging violations of the ’33 Act’s liability provisions. Section 22(a) specifies further that when an action is brought in state court alleging a ’33 Act violation, the case shall not be removed to federal court.
One question in particular was whether the provisions of SLUSA, requiring “covered class actions” to be litigated in federal court, pre-empt the concurrent state court jurisdiction provisions in the ’33 Act. The various courts that have addressed the question have reached conflicting conclusions.
Background Regarding the Cyan Lawsuit
Cyan completed its IPO in May 2013. Shortly after the IPO, Cyan was hit with a securities class action lawsuit that was filed in state court in California. The state court lawsuit alleged violations of the ’33 Act. Rather than seeking to remove the lawsuit to federal court, Cyan filed a motion for judgment on the pleadings, in which the company argued in light of SLUSA that the state court lacked subject matter jurisdiction. The California trial court denied the company’s motion. The state court intermediate appellate court denied the company’s writ of mandate and/or prohibition. The company then sought to pursue a petition of review to the California Supreme Court, which was denied. Cyan then filed petition for writ of certiorari to the U.S. Supreme Court, which the Court granted.
In its Supreme Court briefs, Cyan argued that that SLUSA deprived state courts of concurrent jurisdiction over class actions brought under the ’33 Act. For their part, the plaintiffs argued that state courts retain their concurrent jurisdiction over ’33 Act liability suits. The plaintiff argued that SLUSA sought only to eliminate state court litigation under state law, not to eliminate the long-standing state court concurrent jurisdiction over ’33 Act suits. The U.S. government, which filed an amicus brief at the court’s request, argued a different position, contending that SLUSA had not eliminated concurrent state court jurisdiction for state court lawsuits, but had instead made such cases removable to federal court.
The March 20, 2018 Opinion
In its unanimous March 20, 2018 opinion, the U.S. Supreme Court affirmed the judgment of the court below, holding that “SLUSA did nothing to strip state courts of their longstanding jurisdiction to adjudicate class actions alleging only 1933 Act violations,” adding that “neither did SLUSA authorize removing such suits from state court to federal court.”
In reaching the conclusion about state court jurisdiction, the Court said “SLUSA’s text, read more straightforwardly, leave this jurisdiction intact.”
Cyan had argued that the purposes and legislative history showed the SLUSA had been intended to eliminate the efforts of claimants to circumvent the procedural requirements of the PSLRA by the expedient of filing their lawsuit in state court. Cyan argued that SLUSA’s purpose, as shown by the legislative history, was to eliminate the pursuit of securities claims in state court.
The Court declined to revise its reading of the statute itself based on consideration of the legislative history, saying “We do not know why Congress declined to require … that 1933 Act class actions be brought in federal court; perhaps it was because of the long and unusually pronounced tradition of according authority of state courts over 1933 Act litigation. But in any event, we will not revise that legislative choice, by reading [the relevant statutory language] in a most improbable way.” The Court added that “even if Congress could or should have done more, still it wrote the statute it wrote – meaning, a statute going so far and no further.”
The practical effect of the U.S. Supreme Court’s decision is, according to the Skadden law firm’s March 20, 2018 memo about the decision (here), that “state courts are now viable forums for plaintiffs asserting class action claims under the 1933 Act.” The decision, the memo adds, is “likely to result in an increase in 1933 Act claims brought in state courts.”
From the perspective of corporate defendants, there are a number of seriously negative implications from this outcome.
For starters, it means that defendants could face the prospect of having to litigate ’33 Act class action securities claims in multiple jurisdictions – including facing suits in both state and federal court, or even facing suits in multiple state courts. In its most recent annual report on securities class action lawsuit filings (here), Cornerstone Research specifically noted that of the state court ’33 Act class action lawsuits filed in California state court in 2017 (where these kinds of suits have proliferated in recent years), all of them involved parallel federal court lawsuits – so the defendants’ risk of facing multi-forum securities class action litigation clearly is for real.
The prospect of having to defend state court ’33 Act class action lawsuit presents a related negative consequence, which is, as the Court itself noted in the Cyan opinion (on pp.2-3), that many of the PSLRA’s procedural protections are available only to defendants in federal court securities class action lawsuits. Congress enacted these protections in the PSLRA precisely because it viewed the risk and reality of securities lawsuits as a significant problem for many corporations; yet the practical outcome of the Court’s holding in Cyan is that many of those protections will not be available for litigants now forced to defend themselves in state court class action litigation under the ’33 Act.
The recent experience of these kinds of lawsuits in California state court shows another problem defendants could face as they are forced to litigate these kinds of cases in state court. That is, the state courts are unfamiliar with these kinds of lawsuits. Among other things, it could mean that defendants could have a more difficult time extricating themselves from unmeritorious claims. The Cornerstone Research report to which I linked above details that ’33 Act claims filed in California state court in recent years were dismissed at a lower rate that are ’33 Act claims in federal court.
With respect to cases that are currently pending, the Court’s decision in Cyan may present an interesting conundrum. Many of the ’33 Act securities class action lawsuits filed in state courts in recent year were removed to federal court, where they are now pending. Can the plaintiffs in these removed proceedings, armed with the U.S. Supreme Court’s Cyan decision, now seek to have these cases remanded back to state court? I suspect that there are going to be a number of cases in which the plaintiffs now try to have the cases remanded. This could prove chaotic in cases that have been proceeding for some time in federal court. (To be sure, any plaintiff trying to raise this argument would likely face the defendants’ contention that legal questions about whether or not the case was properly removed are properly heard on appeal, after the entry of judgment at the district court level, along with any other legal issues appealed.)
I have to confess that I was a little bit surprised by the Court’s decision in this case — not based on my careful analysis of the relevant statutory language on which the Court relied, but rather on a more common sense notion that the whole reason Congress enacted SLUSA was to prevent plaintiffs from circumventing the PSLRA by filing securities class action lawsuits in state court. It would be (I thought) quite an anomaly if it were to be held that Congress required state law securities lawsuit to be filed in federal court, but at the same time continued to permit federal law securities lawsuits (at least those under the ’33 Act) to continue to be filed in state court. Yet as it turns out that is exactly what the Court held here – and not only that, the Court expressly addressed the questions raised by SLUSA’s purposes, basically saying that the Court was not going to challenge the statutory language based on conjecture about what Congress might have intended.
Regardless of whether or not SLUSA’s purposes and legislative history were in the end relevant to the Court’s analysis in this case, SLUSA’s purposes and legislative history remain relevant to consideration of where we are now.
As the Cyan court expressly recognized, the whole point of SLUSA was to prevent plaintiffs from making an end run around the PSLRA’s procedural protections, yet the outcome of Cyan is that at least plaintiffs filing ’33 Act claims can indeed circumvent the PSRLA by filing their lawsuit in state court. For me, this outcome is the result of the horrible job that Congress did in conforming the ’33 Act jurisdiction provisions to SLUSA.
In my humble opinion, Congress intended in SLUSA to require all securities class action lawsuits to be filed in federal court, in order to eliminate the circumvention of the PSLRA’s procedural requirements and protections. Congress did not intend that litigants could, notwithstanding SLUSA and its purposes, continue to file ’33 Act claims in state court and thereby circumvent the requirements of the PSLRA. The outcome of the Cyan case is the anomalous result of poor statutory drafting. Congress can and should fix this mess.
Companies may try to adopt their own remedial measures. For example, a March 20, 2018 Wall Street Journal article about the Cyan decision (here), quotes Stanford Law Professor Joseph Grundfest as saying that this decision may encourage companies to adopt corporate bylaws designating federal court as the exclusive forum for shareholder suits. (This idea, while interesting, raises the complicated question of whether a bylaw can eliminate a Congressional grant of jurisdiction.) The Court’s ruling in Cyan could also provide added fuel to the idea circulating in certain circles that companies should be able to adopt corporate bylaws requiring shareholder disputes to be arbitrated.
In any event, the Cyan decision has potentially serious implications for D&O insurers and they way they price IPO companies. IPO companies in California were already having to pay relatively higher D&O insurance premiums, compared to IPO companies based on other jurisdictions, because of the increased risk of securities litigation due to the possibility of state court suits in California. Now, as a result of the Supreme Court’s decision in Cyan, it is not just California IPO companies that face this increased securities litigation risk owing to the possibility of state court lawsuits; IPO companies in every state now face this heightened risk. This clearly could affect D&O pricing for all IPO companies, regardless of where they are located. These same concerns could apply to companies renewing their premiums in the early years after their IPOs, as well. This same line of analysis could also apply to companies conducting secondary offerings.
I recognize that some readers may disagree with me on my analysis. I strongly invite anyone with a contrary point of view to add their thoughts to this point using the blog’s comment feature.