In 2018, the Supreme Court issued its decision in Cyan v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), which held that claims under the Securities Act of 1933 (the “Securities Act”) could proceed in state court and thereby evade certain defendant-friendly restrictions that are otherwise mandated in federal court. Since that time, securities issuers have attempted to get around the Court’s decision in Cyan, utilizing various strategies both to prevent the filing of state court claims under the Securities Act and to ensure that state courts provide the same protections that are available in federal court. This article explores the treatment of those actions when challenged in state court and anticipated trends in state court securities litigation going forward.
The Securities Act of 1933 and the Supreme Court’s Decision in Cyan
The Securities Act provides certain private rights of action for materially false or misleading statements contained in securities registration statements, which claims may be brought in either federal or state court. 15 U.S.C. § 77k. In 1995, recognizing and seeking to curb abuses of the federal securities laws, Congress enacted the Private Securities Litigation Reform Act (the “PSLRA”). Among other things, the PSLRA mandates sanctions for frivolous litigation, imposes a heightened pleading standard for certain claims, creates a “safe harbor” for forward looking statements and prohibits discovery until after a complaint has survived a motion to dismiss. 15 U.S.C. § 77z-1.
Following the enactment of the PSLRA, securities plaintiffs flocked to state court with their securities claims, seeking to avoid the strictures of that legislation. Congress addressed this trend in 1998 with the passage of the Securities Litigation Uniform Standards Act (“SLUSA”), which made federal court the exclusive forum for all fraud-based securities class actions. In doing so, however, Congress left open the ability of plaintiffs to file certain Securities Act claims (among them, Sections 11, 12 and 15) in state court, as those claims require a plaintiff to prove only a misrepresentation, not fraud. And although the defense bar subsequently attempted to extend the benefits of the PSLRA to these claims, those attempts were addressed—and rejected—by the Supreme Court in Cyan, which acknowledged that if Securities Act claims proceed in state court, plaintiffs can evade some of the PSLRA’s requirements, contrary to the policy rationale underlying SLUSA, but held regardless that SLUSA neither deprived state courts of jurisdiction over these actions nor granted defendants the right to remove.
Federal Forum Selection Clauses
A predictable influx of state court Securities Act litigation followed in the wake of the Supreme Court’s ruling in Cyan. In response, issuers of securities began amending their articles of incorporation to require that Securities Act claims be brought only in federal court. Plaintiffs, in turn, challenged the legality of these decisions. In 2020, the Delaware Supreme Court—reversing the Chancery Court —, held that such provisions re valid under the Delaware statutes governing certificates of incorporation, and that they violated neither Delaware nor federal law or policy.” Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020). The court recognized, however, a question “down the road” as to whether federal forum selection provisions would “be respected and enforced” by other states, observing that the “question of enforceability is a separate, subsequent analysis that should not drive the initial facial validity inquiry.” Id.
Wong v. Restoration Robotics, Inc., 78 Cal. App. 5th 48 (1st Dist. 2022), issued on April 28, 2022 by the California Court of Appeals, provides the first authoritative answer to this question in a California appellate court. In particular, the Court of Appeal in Wong agreed with the Delaware Supreme Court in finding that federal forum selection provisions are valid and enforceable, that they do not violate the Securities Act, and that they do not represent an “unconscionable” act by a party with superior bargaining power. The Court of Appeal reached the same result 15 days later in Simonton v. Dropbox, Inc.¸No. A161603 (Cal. Ct. App. May 13, 2022), a case in which the firm was involved. Although not binding on other states, the decisions by the California Court of Appeal, in what some view as a pro-plaintiff jurisdiction, may signal that federal forum provisions will be enforced by state courts around the country, ultimately leading to a significant decrease in state court Securities Act claims.
Applicability of PSLRA Discovery Stay to Securities Act Litigation in State Court
One of the main benefits of the PSLRA to defendants is that it imposes an automatic stay of discovery during the pendency of a motion to dismiss, in “any private action arising under” the Securities Act. § 77z-1(b). This prevents plaintiffs from coercing defendants into early settlement of unmeritorious claims rather than bearing steep discovery costs. While the stay applies undisputedly to claims brought in federal courts, state courts across the country have reached conflicting conclusions on this issue. See In re Greensky, Inc. Sec. Litig., 2019 WL 6310525, at *1 (N.Y. Sup. Ct. Nov. 25, 2019) (“Courts, even in this County, are split on whether the stay set forth in the Private Securities Litigation Reform Act of 1995 (the PSLRA) necessarily applies to state proceedings.”).
Several courts have concluded that the stay applies in both federal and state court. See, e.g., id.; City of Livonia Retiree Health and Disability Benefits Plan v. Pitney Bowes inc., 2019 WL 2293924, at *4 (Conn. Super. May 15, 2019); In re Everquote, Inc. Sec. Litig., 106 N.Y.S.3d 828, 828 (N.Y. Sup. Ct. 2019). A majority of state courts, however, have refused to apply the discovery stay to state court actions—including California, generally considered a plaintiff-friendly jurisdiction whose state courts have primarily rejected attempts by litigants to apply the PSLRA’s discovery stay. See, e.g., In re Pivotal Software, Inc. Securities Litigation, Case No CG19576750 (San Fran. Super. Ct. Mar. 4, 2021); Switzer v. Hambrecht & Co., L.L.C., 2018 WL 4704776, at *1 (San Fran. Super. Ct. Sept. 18, 2018); Plymouth Cnty. Contributory v. Adams Pharms., Inc., No. RG19018715 (Alameda Super. Ct. July 26, 2019); see also In re Dentsply Sirona, Inc., 2019 WL 3526142, at *6 (N.Y. Sup. Ct. Aug. 2, 2019); In re PPDAI Group Sec. Litig, 116 N.Y.S.3d 865, at *6-7 (N.Y. Sup. Ct. 2019).
However, on July 25, 2022, as what appears part of a growing trend, a California state court held that the PSLRA’s automatic discovery stay does apply to claims filed in state court under the Securities Act. See Ocampo v. Williams, 21-CIV-03843 (San Mateo Super. Ct. July 25, 2022). In doing so, the court in Ocampo recognized that giving the phrase “any private action arising under this subchapter” its “ordinary meaning” meant that the stay should apply in state court actions. The court then considered statutory context, ultimately determining that the Supreme Court has held that similarly worded provisions (i.e., the safe harbor) operate in both state and federal court, and thus the discovery stay should as well. Finally, the Ocampo court urged the US Supreme Court to provide the “last word” on this issue “as soon as possible.” The import of this decision is clear: ultimately, if state courts continue to follow suit, or if the Supreme Court takes up the issue and agrees, securities plaintiffs would possess less settlement leverage in state court actions.
Notably, the Supreme Court has previously attempted to resolve this issue, granting certiorari to review a decision by the California Superior Court denying a request to apply the stay in Pivotal Software, Inc. v. Superior Court, 141 S. Ct. 2884 (2021). However, prior to completion of merits briefing, the case settled, leaving the issue open and ripe for consideration in another case. Given this, it is plausible that the Supreme Court may be willing to grant review again should the opportunity arise.
Anticipated 2023 Trends
Following the Supreme Court’s decision in Cyan, in 2019 there were 52 state court Securities Act claims filed. See Cornerstone Research: Securities Class Action Filings, https://securities.stanford.edu/research-reports/1996-2022/Securities-Class-Action-Filings-2022-Midyear-Assessment.pdf, at 15, Figure 14 (“Cornerstone Report”). However, from 2019 to 2021, the year following the Delaware Supreme Court’s decision in Sciabacucchi, the number of Securities Act claims filed in state court dropped 77% to 12. Id. at 4. “If H1 trends continue, state [Securities Act] filings [in 2022] will be only around 23% of their 2019 levels.” Id. “Only 27% of total [Securities Act] filings were brought in state court in [the first half of 2022], with or without a parallel filing. This is the lowest level since [the second half of 2014] and continues the decline since its peak at 86% in [the second half of 2018].” Id. at 17. Notably, three of the six state Securities Act claims filed in the first half of 2022 were in California, and were filed prior to the Restoration Robotics and Ocampo decisions. Id. at 15, Figure 14. Given the recent receptiveness of courts—California courts in particular—to issuers’ attempts to limit their exposure to state court securities actions and to extend the protections afforded in federal court under the PSLRA, it is likely that these trends will continue, with the number of actions filed in state court continuing to decline.