Over the last two years, there have been two important judicial decisions concerning Section 11 litigation. In March 2018, the United States Supreme Court unanimously held in the Cyan case that state courts retain concurrent jurisdiction over lawsuits asserting liability claims under the Securities Act of 1933, a development that has increased the number of state court securities class action lawsuits. In March 2020, in Salzberg v. Sciabacucchi, the Delaware Supreme Court upheld the facial validity of corporate charter provisions requiring Section 11 claims to be litigated in federal court. A June 22, 2020 post of the CLS Blue Sky Blog entitled “State Section 11 Litigation in the Post-Cyan Environment (Despite Sciabacucchi)” (here) assesses the Section 11 litigation environment in light of these developments. The paper, written by Stanford Law School Professor Michael Klausner and Jason Hegland, Carin LeVine, and Jessica Shin of Stanford Securities Litigation Analytics, summarizes the authors’ more detailed academic paper (here), as discussed below.
The Cyan Problem Detailed
As the authors elaborate, there are a least two significant problems with arising from the Cyan court’s affirmation that state courts retain concurrent jurisdiction for state court claims.
The first is that state courts do not provide the same procedural protections as are available in federal court under the PSRLA. Without these procedural protections, “plaintiffs’ attorneys may file weak cases in state court in the hope of pressuring defendants to settle.”
The second problem is that there is nothing to stop plaintiffs’ lawyers from filing a duplicate lawsuit in state court even if there already is a Section 11 claim filed in federal court (and vice versa).
The authors’ analysis of their data set of Section 11 claims filed between the date of the Cyan decision and the present substantiates the conclusion that “relatively weak cases are filed in state court, and parallel litigation in state and federal court has become common and appears to pressure the defendants to settle.” In summarizing their analysis, the authors note that there has been a “dramatic increase” in the volume of state-filed ’33 Act cases – and in particular, cases litigated simultaneously in both state and federal courts.”
In support of their assertion that weaker cases are filed in state court, the authors report that their analysis shows that plaintiffs in state cases recover a lower percentage of statutory losses than do plaintiffs in federal court. The mean and median recoveries in federal cases were 37.3 percent and 20 percent, respectively, and in state cases the mean and median recoveries were 12.6 percent and 11 percent. The difference is particularly stark for settlements reached after a motion to dismiss was denied. The authors’ analysis suggest “not only that weaker cases are filed in state court” but also that “state court rulings on motions to dismiss do not screen out weak cases as well as federal court rulings do.”
The “most wasteful consequence of Cyan” is the increase in parallel state and federal Section 11 litigation. Between the U.S. Supreme Court’s Cyan decision and the end of 2019, nearly half of all ’33 Act litigation consisted of parallel pairs of cases in state and federal court. (This figure may understate the situation, as there may still be cases in which a parallel counterpart my yet be filed.)
Not only is this “inefficient,” but it also “increases the pressure on defendants to settle a non-meritorious cases.” Between 2011 and 2018, 84 parallel cases were filed (51 post-Cyan), and 28 pairs have been resolved in federal and state court. Of the 28, only five were dismissed or dropped in both state and federal court. The remaining 23 settled in one or both courts. That is, “82 percent of parallel pairs settled, compared to 67 percent of cases filed solely in state court and 65 percent of cases filed solely in federal court.”
Looking Ahead to Section 11 Litigation in the Future
Following the Delaware Supreme Court’s decision in the Sciabacucchi case, there was some hope that the Cyan problem could be averted, as companies could adopt federal forum provisions designated federal court as the forum in which Section 11 lawsuits must be litigated.
However, the authors suggest that Sciabacucchi “does not spell the end of Section 11 litigation in state courts.” First, the Delaware Supreme Court only upheld the facial validity of the federal forum provision at issue in that case; this “left open the possibility that Delaware courts will find [federal forum provisions] invalid in particular contexts” – that is, it might be facially valid but invalid as applied.
Second, there is “no assurance that other states will accept the validity of [federal forum provisions] in the charters of Delaware corporations, facially or as applied,” which could mean that we could “find ourselves back in the pre-Cyan situation, where some states recognize [federal forum provisions] as valid and some do not – and where plaintiffs’ attorneys understandably try to file cases in states that find them invalid.”
Third, the value of Sciabacucci at this point is limited only to corporations organized under the laws of Delaware; federal forum provisions “have not been validated for companies incorporated in states other than Delaware.”
While Sciabacucchi could help to reduce Section 11 litigation, “it remains to be seen how much.” However, in the meantime, “there are hopeful signs that at least some state courts will manage Section 11 cases in ways that mitigate their cost.” For example, in California, where state courts have denied motions to dismiss in 88 percent of cases, at least one court has recognized that in light of Cyan, state courts should treat motions to dismiss “as would a federal court,” as the concurrent jurisdiction of state and federal courts “would appear to call for some consistency and uniformity in the handling of such cases.”
There are also “rays of hope” with respect to the question whether the stays of discovery applicable to federal court securities actions while dismissal motions are pending are recognized by the state courts. The authors note that as of the end of 2019, New York courts have granted four out of eight motions to stay discovery. The authors also note that about half of the state courts have granted stays either pending resolution of the parallel federal cases or pending resolution of the motion to dismiss in the federal cases.
But while Sciabacucchi may help at least for Delaware corporations, and while there have been the positive procedural developments noted, the “most effective way for address the problems … when Section 11 cases are litigated in federal court” would be federal legislation addressing the concurrent jurisdiction issue.
I share many of the authors’ concerns about the limitations on the beneficial impact of the Delaware Supreme Court’s decision in Sciabacucchi. In my initial post discussing the ruling, I noted some of the same concerns. For that reason, in several posts discussing the question of whether it is time for another round of securities class action litigation reform (for example, here), my first suggestion has been Congressional legislation amending Section 22 of the ’33 Act to eliminate state court jurisdiction. A recent guest post on this site further detailed the case for reform legislation to address the Cyan problem.
While I share many of the authors’ concerns about the inefficiencies associated with parallel state and federal court litigation, there have been some promising state court litigation developments in addition to the procedural items the authors note. Thus, for example, there have been several state court dismissal motion rulings that suggest that at least some state courts can and will take a disciplined and thorough approach to dismissal motions. State courts in New York (as discussed here), Connecticut (here), and Texas (here), among others, have granted dismissal motions in state court securities class action lawsuits. While these decisions alone are not sufficient to remedy the situation, they do suggest that at least some of the state courts that find themselves presiding over federal securities class action litigation will afford defendants appropriate opportunities to test the plaintiffs’ pleadings.
However, while there are reasons to suggest that there are things that mitigate the parallel litigation problem, as the authors note in their paper, “Federal legislation to withdraw state jurisdiction over Securities Act cases is still warranted.” Readers can judge for themselves how likely it is that the current divided and distracted Congress, with the November elections pending, are likely to take up these issues.