In March 2018, when the U.S. Supreme Court held in the Cyan case that state courts retain jurisdiction for securities class action litigation under the ’33 Act, it set up the state courts and state court securities class action litigants for a host of practical problems. The first is that Cyan allowed the possibility of competing sets of plaintiffs’ lawyers to sue the same defendants in parallel state and federal lawsuits, in what can only be called inefficient and wasteful duplicative litigation. The second is that Cyan left unanswered many questions about the procedures applicable in the state court securities litigation, including questions having to do with the applicability of the procedural safeguards under the PSLRA. Among the many procedural questions that state courts now have to wrestle with is whether the PSLRA’s stay of discovery pending a ruling on the defendants’ motion to dismiss applies to state court proceedings.
The state court securities class action litigation that plaintiff shareholders filed against Pivotal Software in 2019 embodies all of these concerns. The state court suit is duplicative of a federal court securities class action that a different set of plaintiffs’ lawyers filed against the same defendants. The question of the applicability of the PSLRA’s discover stay also arose in the state court Pivotal Software proceeding, as after the federal court granted the defendants’ motion to dismiss in the parallel federal court lawsuit, the plaintiffs in the state court lawsuit undertook to conduct discovery in connection the state court suit. The state court denied the defendants’ motion for stay the discovery, subjecting the defendants to costly proceedings in connection with claims largely identical to the ones the federal court judge has already determined to be meritless.
The defendants in the Pivotal Software state court securities lawsuit filed a petition for a writ of certiorari to the U.S. Supreme Court seeking to have the Court determine whether or not the PSLRA’ s discover stay applies to actions in both federal court and in state court, or whether it applies only to federal court securities suits. On July 2, 2021, the U.S. Supreme Court granted the petition and agreed to take up the question of the applicability of the discovery stay to state court securities class action lawsuits. The Supreme Court’s July 2, 2021 order containing its grant of the defendants’ cert petition can be found here.
Background
Pivotal Software was a cloud-based application information technology and software company. Pivotal completed an IPO in April 24, 2018. Shortly after the IPO, Pivotal suffered several setbacks, as a result of which the company’s share price declined. In August 2019, the company announced a proposed merger with VMWare. The two companies completed the merger at the end of 2019.
As detailed here, in June 2019, a plaintiff shareholder filed the first of several federal court securities class action lawsuits in the Northern District of California against Pivotal Software, certain of its directors and officers, and its offering underwriters. The various federal court actions ultimately were consolidated in the Northern District of California. The plaintiffs’ Consolidated Amended Complaint (here) alleged violations of both the ’33 Act and of the ’34 Act. On July 21, 2020, Northern District of California Judge Charles Breyer granted the defendants’ motion to dismiss the federal court suit. The dismissal was without prejudice, but the parties subsequently filed a stipulation of dismissal.
In addition to the federal court lawsuit, in June 2019 a different set of plaintiffs lawyers filed a separate state court securities class action lawsuit against essentially the same defendants and involving many of the same allegations but alleging only violations of the ’33 Act. The parties to the state court lawsuit agreed to stay the state court proceedings pending the resolution of the defendants’ motion to dismiss in the federal court lawsuit.
After Judge Breyer granted the defendants’ motion to dismiss in the federal court lawsuit, the state court plaintiffs revitalized their state court suit, serving the defendants with a variety of discovery requests. The defendants sought to have the PSLRA’s discovery stay enforced pending the state court’s resolution of the defendants’ demurrer to the plaintiff’s complaint. The state court trial judge denied the defendants’ request for a stay. Both the intermediate California appellate court and the California Supreme Court denied the defendants’ request of a writ of mandate compelling the application of the stay, and the defendants filed a writ of certiorari to the U.S. Supreme Court.
The Cert Petition
In their cert petition, the defendants noted that this case represents a “prime example” of the problems that can arise when state courts ignore the provisions and protections of the PSLRA, commenting that even though that one court has already determined that the claims asserted are “meritless,” the state court refused to grant the defendants’ request for a stay based on its determination that the PSLRA’s stay applies only to federal court proceedings. The defendants’ characterized the plaintiffs’ discovery requests as “as broad and burdensome” as discovery requests come.
The defendants urged the Supreme Court to take up the question of the stay’s applicability in state court, arguing that the state courts generally have been split on the question of the applicability of the PSLRA’s discovery stay to state court proceedings, with little opportunity of appellate review of these decisions. The defendants emphasized that the state court had denied the discover stay requestion, despite the PSLRA’s application according to its own terms to “any private action” under the liability provisions in the U.S. securities laws.
In their opposition to the petition, the plaintiffs raised several counter arguments, contending among other things that the issues raised in the petition are moot, since the plaintiffs have agreed not to seek discovery until the state court ruled on the defendants’ demurer. The plaintiffs further argued that there is little evidence of state court confusion on the relevant issues or even that the state courts are split on the question of the stay’s applicability. Perhaps more importantly, the plaintiffs’ argued that the federal court procedural rules do not and cannot apply to state court proceedings, noting in particular that the PSLRA as a whole limits its provisions to actions under the Federal Rules of Civil Procedure.
A number of Amici Curiae filed briefs in support of the defendants’ cert petition. For example, in its amicus brief (here), the U.S. Chamber of Commerce noted the costliness of securities litigation generally, and noted further the “coercive effect” that the ability to impose discovery costs on defendants that the failure to implement the stay gives plaintiffs. The amicus brief also points out the costs associated with parallel state court litigation has caused the cost of D&O insurance for IPO companies to skyrocket and may even have operated to deter companies from going public.
Alison Frankel has a very good summary of the parties’ cert petition briefs in a June 24, 2021 article on her On the Case blog, here.
Discussion
Although I am frankly a little surprised that the U.S. Supreme Court has agreed to take up this case – I thought it would be too narrow of a procedural issue affecting too few cases overall to pique the interest of the Court – I am glad the Court has agreed to take it up. The question of the applicability of the discovery stay in state court may be “merely procedural” but it has significant real world practical consequences. The amicus brief is correct that the enormous costs associated with discovery give the plaintiffs’ coercive power; the availability of this kind of coercive power to the plaintiffs here, even though one court has already determined that the claims asserted are meritless, highlights the extreme injustice that the refusal to implement the stay can create.
But while I think the questions the defendants present unquestionably are important, the question of the applicability of the discover stay may already be less important than it once was and may become even less important over time.
The reason I say this is the practical self-help that many IPOs have adopted to try to protect themselves from pointless duplicative state court litigation. Most IPOs these days are adopting federal forum provisions in the by laws or corporate charters specifying that any ’33 Act litigation must be filed in federal court. These kinds of federal forum provisions have consistently been upheld and enforced by courts asked to apply their provisions. As a result of the widespread adoption of federal forum provisions, there is less state court securities class action litigation being file now than was the case in the immediate aftermath of the Cyan decision.
In addition to this practical observation, I have another concern about the U.S. Supreme Court’s agreement to take up the case. That is, if the Court is going to decide this question, it has to be recognized that the Court could decide that the stay does not apply to state court proceedings, which not only could impose costs on defendants that get dragged into state court, but also could encourage other plaintiffs in other cases to pursed Securities Act liability claims in state court.
To be sure, plaintiffs likely would not be able to file state court claims against companies with Federal Forum Provisions in their corporate charters, which is some assurance against the unleashing of a flood of state court securities litigation by claimants seeking to take advantage of the absence of stay to try to conduct discovery to bolster their claims and to coerce defendants into costly settlements.
I will say this – if the Supreme Court were to conclude that the discovery stay does not apply in state court, it would produce a practical result so obviously stupid that even our current distracted and divided Congress could not ignore it. It literally makes no sense for state court defendants to have to deal with discovery that federal court litigants do not have to face. The whole point of the PSLRA’s discovery stay was to prevent plaintiffs that have filed claims that in the end may be dismissed from being able to impose coercive expense on defendants in order to extract costly settlements. There is no good possible reason within the principles that the federal securities laws represent for state court plaintiffs to be permitted this coercive power unavailable in federal court, particularly when Congress expressly sought to prevent to suppress that type of coercion.
There one way in which this case is a particularly good vehicle for these issues, and that is that the federal court judge has already determined these claims to be meritless. This fact underscores the particular danger involved when plaintiffs’ lawyers asserting manifestly meritless claims attempt to use costly pressure in order to apply pressure to defendants.
It is in fact simply absurd that the state court lawsuit is even going forward at all. The federal judge already dismissed these claims. It is of course because of the absurd result of the Cyan decision that we are even having this discussion. In a rational universe, Congress would have already taken up the question and revised Section 22 of the ’33 Act in order to clarify that state courts do not have concurrent jurisdiction over ’33 Act liability claims. The Pivotal Software situation shows how ridiculous the whole situation has become. While the questions surrounding the discovery stay are interesting and important, the real problem is the existence of concurrent state court jurisdiction in the first place. All right-thinking people everywhere will continue to press their congressional representatives to address this situation and deal with the real problem here.