Resolving Disagreement Among Lower Courts, the US Supreme Court Allows Federal Securities Law Cases to be Heard in State Courts

By: Linda Martin, Tim Harkness, David Livshiz, Rob McCallum and Lauren Kaplin

Introduction

On March 20, 2018, the U.S. Supreme Court settled a question that had long divided state and federal courts when it unanimously held in Cyan Inc. v. Beaver County Employees Retirement Fund that state courts have concurrent jurisdiction with federal courts over class actions that solely allege claims under the Securities and Exchange Act of 1933 (1933 Act).

Corporate defendants may have hoped—and legal commentators may have expected—that the Court would limit jurisdiction over all cases involving federal securities laws to federal courts. Instead, the Court declined to read language into the law where it was not clearly written. As a result, state courts remain a viable option for 1933 Act class actions, where defendants do not benefit from the procedural safeguards that apply in similar actions brought in federal court.

Statutory Background

Unexpected by some, and unhoped for by others, Cyan nonetheless offered much-needed clarity on the interplay between three federal securities statutes—the 1933 Act, the Private Securities Litigation Reform Act of 1995 (the PSLRA), and the Securities Litigation Uniform Standards Act of 1998 (SLUSA).

The 1933 Act created a private right of action against issuers, directors, and underwriters for making materially false or misleading statements in registration statements or prospectuses. The 1933 Act provided for concurrent jurisdiction over these claims in both state and federal court, and plaintiffs thus had the option of filing claims in either court.[1]

In 1995, Congress enacted the PSLRA, which amended the 1933 Act (as well as the 1934 Act) in an attempt to end perceived abuses of securities class actions by class action plaintiffs. The PSLRA included both substantive and procedural changes to federal securities laws. The substantive changes applied regardless of whether a case was brought in state or federal court. The procedural changes, however, only applied to cases brought in federal court. To avoid the PSLRA’s new procedural safeguards—among them, a process for appointing lead plaintiff and counsel, as well as rules governing fee awards—plaintiffs increasingly brought securities class actions in state courts.

In 1998, to halt this end run around the PSLRA, Congress further amended the 1933 Act through the enactment of SLUSA. Relevant here, SLUSA included two operative provisions, two definitions, and two “conforming amendments”[2]—which collectively have confounded courts in the two decades since SLUSA’s enactment.

The “Gibberish” of SLUSA

The core operative provisions of SLUSA prohibited large securities class actions involving “covered securities” (i.e., those traded on national exchanges) from being pursued under state law. Congress thus ensured that all defendants would benefit from the PSLRA’s substantive amendments to the 1933 and 1934 Acts, which governed securities listed on national exchanges.

To achieve this, SLUSA defined “covered class actions” as securities class actions involving 50 or more plaintiffs.[3] The definition, which was included within a subsection of 77p, did not distinguish between state or federal law claims.

A separate subsection of 77p prohibited “covered class actions based upon the statutory or common law of any State”, and that involved covered securities, from being maintained in either state or federal court.[4] Under SLUSA, all such cases filed in state court could now be removed to federal court where they would be subject to dismissal.[5]

The 1933 Act did not previously allow removal of securities cases from state to federal court. And, as previously noted, the 1933 Act expressly provided for concurrent jurisdiction in both federal and state court. To effectuate the new prohibition of certain state law claims, SLUSA inserted language after the 1933 Act’s existing concurrent jurisdiction provision, through what the Supreme Court referred to as the “except clause.” The “except clause” stated that federal and state courts have concurrent jurisdiction over 1933 Act claims “except as provided in section 77p of this title with respect to covered class actions . . . .”[6]

While it was clear that securities class actions alleging only state-law claims were subject to removal to and dismissal in federal court under SLUSA, at issue in Cyan was whether the “except clause” also stripped state courts of the power to adjudicate cases involving only 1933 Act claims. In the twenty years since SLUSA’s enactment, courts in various states had come to different interpretations on this important question. Cyan provided the Supreme Court with an opportunity to resolve this longstanding conflict.

Factual and Procedural Background

In 2014, following a drop in the price of shares of Cyan Inc., a network support provider, three pension funds, and an individual who had purchased shares of stock in the May 2013 IPO of Cyan filed suit against Cyan alleging violations of only the 1933 Act. The lawsuit was filed in state court in California, but alleged no violations of state securities laws.

Cyan objected to the court’s subject matter jurisdiction, arguing that SLUSA’s “except clause” eliminated state court jurisdiction over all “covered class actions” (i.e., those involving more than 50 plaintiffs), regardless of whether the case was brought under state or federal law. Plaintiffs disagreed and argued that the “except clause” only applied to cases involving state law. The California court sided with plaintiffs and denied Cyan’s motion to dismiss. After Cyan’s state court appeals were all denied, it petitioned the U.S. Supreme Court for a writ of certiorari, a mechanism by which to request the review of a lower court decision. Cyan’s writ of certiorari was granted—thus teeing up the question of whether SLUSA stripped state courts of jurisdiction over large class actions alleging only 1933 Act claims.

The government, as amicus curiae, proposed an alternative interpretation of the amendments: that SLUSA enabled defendants to remove large class actions alleging violations of the 1933 Act from state to federal court for adjudication, as long as plaintiffs alleged the types of misconduct listed in § 77p(b): a material misstatement or omission, or the use of a manipulative or deceptive device, in connection with the purchase or sale of a listed security. Although Cyan had not sought removal to federal court, the Court considered this alternate interpretation as well.

The Decision 

Rejecting the positions of both Cyan and the government, the Court held that states continue to have jurisdiction over claims alleging violations of the 1933 Act—as was originally and expressly provided for in the original language of the Act—and (in the words of Justice Alito) the “gibberish” of SLUSA did nothing to divest state courts of concurrent jurisdiction over cases involving only 1933 Act claims. Nor were such claims subject to removal to federal court.

The decision was based on a highly technical parsing of SLUSA’s particularly opaque language. Cyan had argued that the “except clause” of § 77v(a)—which specified which cases were no longer within the jurisdiction of state courts—directed readers to § 77p(f)(2), which in turn defined “covered class actions” as suits involving more than fifty individuals, regardless of whether they were based on state or federal law. The Court disagreed, looking to the language of § 77p(b) and stating that “§77p bars certain securities class actions based on state law . . . [but] says nothing, and so does nothing, to deprive state courts of jurisdiction over class actions based on federal law.” Cyan Inc. v. Beaver County Employees Retirement Fund, 583 U. S. ____, ____ (2018) (slip op., at 8) (emphasis in original).

Not only did the Court quickly dispose of Cyan’s statutory interpretation argument, but it also addressed and dismissed Cyan’s arguments based on the statute’s purpose and legislative history. Cyan argued that its interpretation must be correct because Congress would have wanted to give effect to the PSLRA’s objective of moving securities class actions to federal courts. Id. at __ (slip op., at 13). As the Court noted, however, Congress drafted the 1933 Act so as to expressly confer concurrent jurisdiction in both state and federal courts (while it drafted the 1934 Act so as to create only federal jurisdiction). The Court upheld this “legislative choice,” id. at __ (slip op., at 15), in which all class actions involving “covered securities” must proceed under federal law, and most (i.e., those alleging 1934 Act claims) must proceed in federal court. Some, however, (i.e., those alleging 1933 Act claims) may proceed in either federal or state court. Id. at ___ (slip op., at 14-15). At the same time, the Court noted that PSLRA still benefited all defendants in class actions involving federal law: even if the PSLRA’s procedural changes only applied in federal courts, the PSLRA’s substantive changes to federal securities laws applied regardless of whether a case was pursued in state or federal court.

Finally, the Court also rejected the government’s interpretation of SLUSA (which the Court referred to as the “halfway house position”) and held that suits filed in state court that only alleged claims under the 1933 Act remained subject to the 1933 Act’s ban on removal to federal court. Id. at ___ (slip op., at 18).

Implications 

Many corporate defendants will know that state courts­—and particularly those in California, where plaintiffs here originally filed suit against Cyan—have been increasingly willing to entertain securities class actions. Since 2011, California courts have only dismissed 6% of 1933 Act class action complaints, whereas federal courts typically dismiss 32% of securities class actions at the pleadings stage. See Brief of the Securities Industry and Financial Markets Association, et al., as Amicus Curiae in Support of Petitioners (Sept. 5, 2017), at 9 (citation omitted). And while the PSLRA and SLUSA were drafted in part to protect defendants from abuses of class actions in state court lawsuits, SCOTUS was unwilling—absent clear legislative intent—to strip state courts of jurisdiction that they have exercised since 1933. Cyan, 583 U. S. at ___ (slip op., at 11).

As a result, plaintiffs will continue to bring 1933 Act claims in state courts, and can now do so in all states (including in New York and Delaware, where they had previously been barred). It is likely that the number of 1933 Act claims filed in state courts will increase. Moreover, the Supreme Court’s ruling exposes defendants to the possibility of simultaneous litigation in multiple states across the country, which will require counsel for defendants to closely coordinate (and, where possible, strategically consolidate) the various actions.

Of course, Congress may choose to address these inconsistencies by amending the 1933 Act to allow removal to federal courts, or to eliminate state court jurisdiction over 1933 Act claims. While such a change would come as a relief to defendants concerned about forum-shopping by plaintiffs, it may not be a priority on the legislative agenda of the current administration. 

[1] By contrast, only federal courts were granted jurisdiction over claims under the Securities and Exchange Act of 1934 (the 1934 Act), which created a private right of action related to misstatements in connection with trading securities listed on a national exchange.

[2] The purpose of the “conforming amendments” is to incorporate SLUSA’s operative provisions into the 1933 Act through specific amendments to the language of the 1933 Act.

[3] 15 U.S.C. § 77p(f)(2).

[4] 15 U.S.C. § 77p(b).

[5] 15 U.S.C. § 77p(c).

[6] 15 U.S.C. § 77(v)(a).