The U.S. Supreme Court has ruled that class action plaintiffs can bring claims under the Securities Act of 1933 in either state or federal court. Over the last several years, IPO-related class actions against issuers, directors and underwriters have increasingly been filed in state courts, where plaintiffs can circumvent many of the procedural and pleading requirements applicable in federal court. In Cyan v. Beaver County Employees Retirement Fund, the Supreme Court ruled unanimously that plaintiffs are free to litigate such claims in state court and cannot be compelled to proceed in a federal forum. The Court rejected arguments that the Securities Litigation Uniform Standards Act of 1998 strips state courts of jurisdiction over class actions brought under the Securities Act and requires those actions to be removed to federal court. The practical result of this ruling is that—absent Congressional action or enforcement of forum selection provisions in corporate charter documents—class action plaintiffs asserting Securities Act claims may continue to avoid federal court.
PSLRA, SLUSA and the Securities Act
In 1995, Congress passed the Private Securities Litigation Reform Act to address abusive securities class actions. It imposed heightened substantive and procedural requirements, including an automatic stay of discovery, demanding pleading standards and limitations on attorneys’ fees. Soon thereafter, plaintiffs hoping to avoid the PSLRA began filing securities class actions in state court and under state law. In response, Congress enacted SLUSA in 1998 for the stated purpose of vesting federal courts with the exclusive authority to decide certain types of securities class actions. SLUSA provides for the removal of certain “covered class actions” to federal court, and bars “covered class actions” based on state laws from being maintained in state or federal court.
With regard to securities class actions that solely assert claims under federal laws, the effect of SLUSA prior to Cyan was not clear. Certain types of shareholder suits—for example, securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934—may only be brought in federal court. By contrast, the Securities Act provides for concurrent state and federal jurisdiction. Thus, courts grappled with whether Securities Act suits—such as those alleging material misstatements in an IPO registration statement or prospectus—were subject to the provisions of SLUSA. The California Court of Appeal provided an answer in 2011 in Luther v. Countrywide Financial, holding that SLUSA did not nullify the provisions of the Securities Act that granted state courts concurrent jurisdiction to adjudicate such claims.
It did not take long for the plaintiffs’ bar to respond to Luther. As the Cyan petitioners noted, in the five years following the Luther decision, Securities Act class actions in California state courts rose 1400 percent. By bringing Securities Act claims in California state court, plaintiffs were able to avoid the procedural safeguards imposed by the PSLRA—most notably, the provision that all discovery is automatically stayed until and unless a plaintiff is able to survive a motion to dismiss.
Issues Presented in Cyan and the Supreme Court’s Decision
Cyan, its directors and its IPO underwriters were sued in California Superior Court by investors who purchased stock in the IPO and alleged that the offering documents were materially misleading. Cyan moved to dismiss for lack of subject matter jurisdiction on the grounds that SLUSA stripped state courts of jurisdiction over “covered” Securities Act class actions. The investors did not dispute that they brought a class action “covered” by SLUSA, but argued that the statute did not alter a state court’s concurrent jurisdiction over class actions asserting only Securities Act claims. The court denied Cyan’s motion and the California appellate court declined review. At Cyan’s request, the Supreme Court granted review.
Following briefing and oral argument (during which Justice Samuel Alito memorably described portions of SLUSA as “gibberish”), the Supreme Court held unanimously that SLUSA does not change the concurrent jurisdiction provisions of the Securities Act. In other words, while SLUSA affects the ability of investors to assert certain claims under state law, it does not prevent them from choosing whether to bring Securities Act claims in either federal or state court. The Court also found that SLUSA’s removal provision applies only to state law class actions, and not to suits brought solely under the Securities Act.
Impact and What Companies Can Do
Plaintiffs’ lawyers will understandably look to Cyan as license to continue filing IPO-related class actions in state courts, where the strict procedural safeguards imposed by the PSLRA can be avoided. While we wait to see whether Congress will take action to require Securities Act class actions to be filed in federal court (or permitting defendants to remove such actions), companies should consider adding forum selection provisions to their charter documents. Specifically, companies can amend their certificates of incorporation or bylaws to specify that any claim under the Securities Act must be brought in federal court—or, at the very least, in a specific state court, such as the Superior Court in the county where the company is headquartered (to prevent lawyers from “forum-shopping” by filing suit in another state court perceived as more plaintiff-friendly). While the validity of these forum selection provisions are being challenged by the plaintiffs’ bar, there are strong arguments—especially for Delaware corporations—that those provisions are enforceable and binding on all shareholders.