As observers have discussed the kinds of problems that the U.S. Supreme Court’s Cyan decision can create, specific concerns have included the possibility of parallel state and federal court litigation, and even the possibility of parallel litigation in multiple states. In the course of the discussion of these issues, these litigation risks might have seemed merely theoretical. However, a series of lawsuits filed against a recent IPO company show that these kinds of multiple and parallel litigation risks are far from merely theoretical. The raft of jurisdictionally complicated litigation the company now faces shows the extent of the problems that Cyan creates. The company’s situation also underscores the dramatic need for Congress to address revise the securities laws in order to prevent these kinds of situations.
Background Regarding Cyan
As discussed here, in March 2018, the U.S. Supreme Court unanimously held in the Cyan, Inc. v. Beaver County Employees Retirement Fund that state court retain concurrent jurisdiction over liability actions filed under the Securities Act of 1933, and that ’33 Act liability actions filed in state court cannot be removed to federal court.
The Supreme Court’s holding means that a prospective ’33 Act claimant has a choice whether to file his or her lawsuit in either federal or state court. It also means that different claimants might chose to file in state court or in federal court. The most significant potential impact from this holding is on IPO companies, although as I have emphasized in prior blog post, the Cyan decision could also affect companies conducting follow-on or secondary offerings as well.
SmileDirectClub’s IPO
SmileDirectClub is a direct-to-consumer company that manufactures and markets clear dental alignment treatments. In September 2019, the company completed an initial public offering in which it sold raised approximately $1.27 billion net of various expenses. The company’s shares began trading on NASDAQ on September 12, 2019.
Underlying Trade Practices Litigation
On September 24, 2019, a number of plaintiff doctors filed a lawsuit in the Middle District of Tennessee on behalf of a putative class of dentists, orthodontists, and consumers. Among other things, the complaint in the lawsuit alleges false advertising, fraud, negligence, and deceptive trade practices. The complaint alleges a variety of supposed improper practices, including with respect to regulatory compliance, with respect to the company’s marketing of the dental alignment treatments. The complaint also alleges a number of consumer complaints regarding the treatments. The complaint also alleges that the company’s offering documents in connection with its IPO “failed to disclose the existence of numerous bona fide complaints” about the company’s practices.
The IPO-Related Securities Lawsuits
According to the company’s November 14, 2019 quarterly filing with the SEC on Form 10-Q (here), the company has now been hit with a series of IPO-related lawsuits in a number of different jurisdictions:
In September and October 2019, a number of purported stockholder class action complaints were filed against us, members of our board of directors, certain of our current officers, and the underwriters of our IPO. The following eight complaints have been filed to date: Mancour v. SmileDirectClub, Inc., 19-1169-IV (TN Chancery Court filed 9/27/19), Vang v. SmileDirectClub, Inc., 19c2316 (TN Circuit Court filed 9/30/19), Fernandez v. SmileDirectClub, Inc., 19c2371 (TN Circuit Court filed 10/4/19), Wei Wei v. SmileDirectClub, Inc., 19-1254-III (TN Chancery Court filed 10/18/19), Andre v. SmileDirectClub, Inc., 19-cv-12883 (E.D. Mich. filed 10/2/19), Ginsberg v. SmileDirectClub, Inc., 19-cv-09794 (S.D.N.Y. filed 10/23/19), Ginsberg v. SmileDirectClub, Inc., 19-cv-962 (M.D. Tenn. filed 10/29/19), Nurlybayev v. SmileDirectClub, Inc., 19-177527-CB (Oakland County, MI Circuit Court filed 10/30/19).
The complaints all allege, among other things, that the registration statement filed with the SEC on August 16, 2019, and accompanying amendments, and the Prospectus filed with the SEC on September 13, 2019, in connection with our initial public offering were inaccurate and misleading, contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading, and omitted to state material facts required to be stated therein. The complaints seek unspecified money damages, other equitable relief, and attorneys’ fees and costs. All of the actions are in the preliminary stages. The Company denies any alleged wrongdoing and intends to vigorously defend against these actions.
For example, the Vang complaint (referenced in the above excerpt from the company’s 10-Q, copy here), filed in the Circuit Court for Davidson County, Tennessee, purports to be filed on behalf of persons who purchased securities in or traceable to the company’s IPO. The complaint names as defendants the company; certain of its directors and officers; and its offering underwriters.
The Vang complaint refers to the underlying trade practices class action lawsuit previously filed against the company, and alleges that in the Company’s offering documents, the defendants allegedly failed to disclose to investors, among other things, that the efficacy of the company’s treatment was overstated; that administrative personnel, rather than licensed doctors, provided treatment to company’s customers and monitored their progress, and thus, company’s practices did not qualify as teledentistry under applicable standards; and that, as a result, the company was subject to regulatory scrutiny for the unlicensed practice of dentistry.
The Vang complaint alleges that between the date of the company’s IPO and the date of the complaint, the company’s share price had declined nearly 44%. The complaint seeks to recover damages on behalf of the IPO investors under Sections 11 and 15 of the Securities Act of 1933.
As noted in the company’s 10-Q, in addition to at least four Tennessee state court securities class action lawsuits, the company has also been hit with several federal court securities class action lawsuits.
Thus, on October 2, 1029, a securities class action lawsuit was filed against the company in the Eastern District of Michigan (here). On October 23, 2019, a different plaintiff shareholder filed another federal court IPO-related securities class action lawsuit against the company in the Southern District of New York (here). In addition, on October 29, 2019, another plaintiff shareholder filed a separate federal court IPO-related securities class action lawsuit against the company in the Middle District of Tennessee (here).
Finally, as the company’s 10-Q also notes, in addition to the Tennessee state court securities class action litigation and the federal court securities class action litigation, the company has also been hit with a securities class action lawsuit filed in Oakland County, Michigan Circuit Court.
Discussion
The company obviously has been hit with a big heap of IPO-related litigation, which is a complication and concern in and of itself.
The fact that the company has multiple different lawsuits pending in several different federal courts is messy, but manageable, as the federal rules of civil procedure have mechanisms to consolidate the federal court cases.
The fact that the company has several lawsuits in Tennessee is also messy, but presumably there are procedures to consolidate the various lawsuits pending in Tennessee courts.
However, the fact that the company has IPO-related cases pending in federal court and in the courts of two different states is chaotic.
While there are mechanisms to consolidate cases within the federal court systems, and even to consolidate cases within Tennessee, there are no mechanisms to consolidate cases between the federal court system and the Tennessee state court system. There are no mechanisms to consolidate cases between the federal court system and the Michigan state court system. There are no mechanisms to consolidate cases between the Tennessee state court system and the Michigan state court system.
As things stand, SmileDirect must now fight a multi-front war. The fact that the defendants must now defend in multiple jurisdictions adds not only complexity and expense, it adds uncertainty and even the possibility of conflicting or inconsistent procedures and decisions. Among other things, one question that will have to be addressed is whether the state courts will apply the discovery stay applicable in federal court. In addition, another question is whether the state courts will apply different pleading standards that those that would be applicable in federal court. On a more practical level, if the time were to come when the defendants might seek to settle this litigation, they will struggle reaching settlements that will resolve claims as to all claimants in all putative classes.
This is obviously a huge mess. It wasn’t supposed to be this way. The whole idea when Congress passed the Securities Litigation Uniform Standards Act (SLUSA) in 1998 was that class action litigation under the federal securities laws was to go forward in federal court and federal court only. Apparently, and as the Cyan case itself shows, in enacting SLUSA Congress made a hash of it when it comes to the jurisdictional provisions of the ’33 Act. Cyan basically held that notwithstanding SLUSA, the concurrent state court jurisdiction for ’33 Act liability actions remains.
The last thing in the world Congress intended to do when it enacted SLUSA was to permit the kind of chaotic mess that SmileDirect now faces. On a more general level, without regard to what Congress may or may not have intended in SLUSA, it makes absolutely no sense for a company to have to face what is in effect the same lawsuit in multiple different jurisdictions.
I suppose one might say that the good news is that this is a problem that Congress could easily address. It was would be relatively simple fix to amend Section 22 of the ’33 Act to eliminate concurrent state court jurisdiction for ’33 Act liability claims and to provide for the removal to federal court of any ’33 Act liability actions that are filed in state court. Whether the potential for Congressional action can actually be considered “good news” depends on how your feel about the likelihood of the current divided and distracted Congress actually taking steps to provide a common sense solution to a totally out of control situation.
Setting aside the specifics of the Cyan-related issues here, there are a couple of other aspects of this situation that are worth considering. The first is that the company involved here is not the kind of developmental stage biotech IPO company or cutting edge high tech IPO company that typically is thought of as having to worry about the potential impact of Cyan. Even though SmileDirect is not one of these kinds of high-flying companies, it still finds itself caught up in having to deal the jurisdictional morass that Cyan has created.
The other thing about this overall situation that is worth considering is that SmileDirect has not been sued in state court in California or New York – the states whose courts are usually under discussion when the possibility of state court securities class action litigation is under discussion – but rather has been sued in state courts in Tennessee and Michigan. Which is a reminder that under Cyan, the courts of any of the country’s 50 states can come in to play, magnifying not only the threats involved with multi-jurisdiction litigation but multiplying the risks of conflicting or inconsistent rulings on issues such as the discovery stay, the applicable pleading standard, and so on.
The bottom line is that Cyan created a big mess. It is a tall order given our dysfunctional Congress, but this really is a situation that Congress needs to address.