Back to the Future: State Courts Can Hear Securities Act Class Actions

Earlier this week, the U.S. Supreme Court issued its highly anticipated ruling in Cyan, Inc. v. Beaver County Employees Retirement Fund, which addresses whether state courts have jurisdiction over securities class actions brought under federal law. Speaking for a unanimous court, Justice Kagan stated:

1. The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") did not strip state courts of jurisdiction over class actions alleging violations only of the federal Securities Act of 1933 (the "Securities Act"); and
2. SLUSA did not empower defendants to remove such actions from state to federal court.

The decision could encourage the filing of more Securities Act class actions in state courts, forcing issuers and underwriters of IPO equities and bond offerings to confront potentially duplicative class actions in multiple states without the procedural safeguards of SLUSA and the Private Securities Litigation Reform Act ("PSLRA").

SLUSA and the Federal Securities Laws

Cyan addressed longstanding uncertainty regarding how SLUSA modified the Securities Act. The Securities Act, one of two primary federal securities laws passed in the wake of the Great Depression, generally (1) requires the full and accurate disclosure to investors of information relevant to the public offering of securities and (2) prohibits deceit, misrepresentations, and other fraud in the sale of securities.

In order to curtail plaintiffs' abuse of the federal securities laws and protect American companies against so-called "strike suits," in 1995 Congress passed the PSLRA. The PSLRA instituted safeguards aimed at protecting defendants from baseless securities claims, including by strengthening the requirements for pleading a claim and creating a safe harbor for forward-looking statements. Quoting the Supreme Court's earlier decision in Merrill Lynch v. Dabit, Justice Kagan explained in her opinion that, "[r]ather than face the obstacles set in their path by the [PSLRA], plaintiffs and their representatives began bringing class actions under state law."

This "unintended consequence" in turn led Congress to pass SLUSA. SLUSA did a number of important things to bring uniformity to securities lawsuits, including prohibiting certain class actions based on disparate state securities laws and clarifying the means by which defendants could remove state court securities actions to federal court. At issue in Cyan, SLUSA also amended the Securities Act's grant of concurrent jurisdiction to state and federal courts over lawsuits brought under the Securities Act.

The Court's Decision in Cyan

In Cyan, investors purchased shares of Cyan, a telecommunications company, through an initial public offering. After the stock declined in value, the investors brought a class action in California Superior Court against Cyan and its officers and directors. The plaintiffs alleged that Cyan's offering documents contained material misstatements in violation of the Securities Act, but they did not allege any violations of state law. The defendants moved to dismiss the suit for lack of jurisdiction based on SLUSA's amendments to the Securities Act's concurrent jurisdiction provisions. The California Superior Court denied the motion to dismiss, and after the California Court of Appeals denied review, the Supreme Court granted Cyan's petition for certiorari.

Carefully examining the language of both SLUSA and the Securities Act, the Court in Cyan determined that although SLUSA bars state courts from hearing securities class actions based on state law, it does not limit their jurisdiction to hear securities class actions brought under the federal Securities Act. Justice Kagan stated that the SLUSA "says nothing, and so does nothing, to deprive state courts of jurisdiction over class actions based on federal law. That means the background rule [] – under which a state court may hear the Investors' [Securities] Act suit – continues to govern." In other words, state courts may hear certain class actions asserting claims under the Securities Act, but not class actions that allege federal and state law claims together.

The Court also held that where plaintiffs are alleging only federal Securities Act claims in federal court, SLUSA does not permit defendants to remove those claims to federal court. The Court stated that the "straightforward reading" of the provisions in question limits class action defendants' opportunity for removal to cases brought under state law or a combination of state and federal laws.

Key Takeaways

Cyan has potentially far-reaching effects both for issuers and underwriters, including:

• Increased Securities Act filing in state courts, which are typically more accommodating to plaintiffs than federal district courts. The PSLRA's protections do not apply in state court actions, and state court judges are often less willing to dismiss at the pleading stage, which is to say that defendants are more likely to face burdensome and expensive discovery. Previously, defendants could have sought removal to the relative uniformity of federal courts, but after Cyan they will be forced to reckon with litigation in fifty different and distinct forums.
• Increased filings generally. Issuers and underwriters (of both stock and bond offerings) will now likely face multiple, duplicative state court class actions predicated on the same allegations. Unlike in the federal system, there is no clear mechanism for consolidating related state court class actions brought in different states, so competing plaintiffs (and their counsel) will now be able to file identical class actions in different states, and push their case forward in the effort to control any settlement. Such multi-forum litigation is burdensome for even the most capable defendants, but would especially tax the resources of those without deep pockets or sophisticated legal experience.
• The inclusion of forum selection provisions. To mitigate the increased exposure resulting from Cyan, issuers and underwriters will likely begin including exclusive federal jurisdiction provisions in their offering materials and/or company bylaws, which are intended to limit potential shareholder litigants from filing Securities Act claims in state court. Of course, the enforceability of those provisions will need to be tested in each of the fifty states.

Congressional response. Given the potentially large downside Cyan could have on issuers and underwriters, there may likely be legislative response to the Cyan decision, including an amendment to the Securities Act's concurrent jurisdiction language.

By: James Kramer, Andrew Morris, Ellen Murphy, Robert Stern, Daniel Streim and Todd Scott