State Courts Remain Open for Federal Claims in Public Securities Offerings

By Sean Zaroogian

On March 20, 2018, the Supreme Court decided Cyan, Inc. v. Beaver County Employees Retirement Fund, unanimously confirming that state courts have jurisdiction to hear class actions arising under the Securities Act of 1933 (the “Securities Act”).  The Supreme Court further held that these type of class action cannot be removed from state to federal court.

Background on State Court Jurisdiction under Federal Securities Laws

The Securities Act regulates a public offering of securities (such as an initial public offering), while the Securities and Exchange Act of 1934 (the “Exchange Act”) regulates the trading of securities on national exchanges (such as the New York Stock Exchange).  Together, these two acts provide the foundation of the federal securities laws.  Congress provided federal courts with exclusive jurisdiction over Exchange Act claims.  However, it provided a rare grant of concurrent jurisdiction to state and federal courts over Securities Act claims.  Investors could therefore bring federal securities claims arising out of public offerings in either state or federal court.  Moreover, the Securities Act prevented a corporate-defendant from removing claims properly brought in state court to federal court.

In 1995, as a result of perceived abuses of the federal securities laws, Congress passed the Private Securities Litigation Reform Act (the “PSLRA”).  With the aim of eliminating lawsuits that appeared to be frivolous, the PSLRA made significant amendments to the securities laws, including, inter alia, a safe harbor for forward-looking statements, heightened pleading requirements, and an automatic stay of discovery pending a motion to dismiss.  As a consequence of (presumed) legislative oversight, litigants were free to avoid the PSLRA by bringing securities class actions in state courts under state statutory and common laws (blue sky laws), which do not offer corporate-defendants the same protections afforded by the PSLRA.

In response to an increase in state court filings as a workaround for the PSLRA, Congress passed the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”).  SLUSA reinforced the PSLRA’s protections against potentially frivolous securities litigation by amending Section 16 of the Securities Act (15 U.S.C. § 77p) to prohibit “covered class actions” (those involving more than 50 investors) arising under state blue sky laws (e.g., actions involving false statements or deceptive devices in the sale of securities).  SLUSA also required any action in violation of the Section 16 prohibition to be removed from state to federal court, thereby ensuring dismissal of the state law action.  Furthermore, in what the Supreme Court theorized may have been a bout of hypersensitivity by Congress, SLUSA amended the Securities Act’s jurisdictional provision (§77v(a)) to grant concurrent jurisdiction between state and federal courts, “except as provided in section 77p [Section 16] of this title with respect to covered class actions . . .” (the “Section 16 exception”).  In other words, the grant of concurrent jurisdiction under the Securities Act became limited by Section 16’s prohibition of covered class actions.

State Court Jurisdiction is Disputed and Resolved

Following the passage of SLUSA, state and federal courts around the country were split as to whether the Section 16 exception prevented state courts from hearing federal securities claims.  In cases such as Knox v. Agria Corp., courts held that the Section 16 exception applied to any “covered class action” brought in state court, i.e., any securities claim on behalf of more than 50 investors.  This interpretation effectively granted federal courts exclusive jurisdiction over securities class actions, including federal claims arising under the Securities Act.  In contrast, in cases such as Luther v. Countrywide Financial Corp., courts held that the Section 16 exception applied only to covered class actions arising under state blue sky laws, and not federal Securities Act claims brought in state courts. This interpretation preserved the existence of concurrent jurisdiction between state and federal courts under the Securities Act.

Enter Cyan.  In Cyan, the Supreme Court resolved the split by affirming a California Superior Court ruling that relied upon Luther to find that state courts had jurisdiction to hear Securities Act claims.  Justice Kagan, on behalf of a unanimous Supreme Court, focused on the plain text of the Section 16 exception and found that, “by its terms,” it has no effect on Congress’s grant of concurrent jurisdiction for Securities Act claims.  Specifically, Justice Kagan declared that the Section 16 exception applies only to securities class actions arising under state blue sky laws.  Justice Kagan then responded to an argument raised by the United States Government in an amicus curiae brief (although not at issue in the underlying Cyan case) and held that SLUSA did not alter the Securities Act’s prohibition on removing actions from state to federal court.  As such, corporate-defendants called into state court for violations of the Securities Act continue to be barred from removing the case to federal court. 

By way of Cyan, the Supreme Court has upheld investors’ rights to bring class actions for violations of the Securities Act in either state or federal court.  This is welcome news to investors seeking to keep open options for protecting their investments.


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SCOTUS Case To Clarify Use Of State Venue For Securities Cases

On behalf of Wolf Popper LLP

The Securities Act governs the issuance of stock and bonds by companies, such as IPOs, and prohibits, among other things, the company, as well as other designated persons, from making "untrue statement[s] of a material fact or omit[ing] a material fact required to be stated therein or necessary to make the statements therein not misleading." If a company violates this provision, then investors may sue for damages. (The Securities Act itself provided that cases could be brought in either state or federal court.)

The number of class actions that allege violations of the Securities Act filed in California state court increased from 5 in 2014 to 18 in 2016. Why the increase? According to some critics of filing these cases in state court, the reason is that only 6 percent of such cases filed in California state court are involuntarily dismissed, while the dismissal rate in U.S. federal courts is 31 percent. Therefore, the critics contend, state venues are more favorable to plaintiffs. (Plaintiffs contend that the uptick in 2016 was an isolated event and that the average number of such cases filed annually was only 6 and in the first half of 2017 there were only 4 such cases.)

Critics also contend that the federal securities laws require that these cases be brought in federal court, and filing these cases in state court is improper. On November 28, 2017, the Supreme Court will hear oral argument in Cyan, Inc. v. Beaver County Employees Retirement Fund, a case that will likely determine whether Securities Act class actions can be brought in state court.

A bit of history, how does securities law apply in these matters?

In 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA). One of the reasons the PSLRA was enacted was that there was concern, founded or unfounded, that a large number of filed securities class actions were meritless and abusive. Among other things, the PSLRA increases the pleading and proof standards for securities class actions, requiring, among other things, specific allegations concerning falsity and a strong inference of intent.

Shortly after passage of the PSLRA, Congress noticed an increase in class actions concerning securities and alleging state law claims, instead of federal securities law claims, being filed in state courts. To combat this trend, Congress enacted the Securities Litigation Uniform Standards Act of 1998 (SLUSA). SLUSA prohibits state law class actions on behalf of more than 50 people alleging misrepresentations, omissions, or the use of manipulative or deceptive devices in connection with the purchase or sale of a securities traded nationally and listed on a regulated national exchange (i.e. the NYSE or NASDAQ). In sum, SLUSA prohibits state law class actions alleging claims identical to the federal securities laws. SLUSA also allows the removal, or transfer, of these cases from state court to federal court.

How does this apply to Cyan?

The plaintiffs in Cyan brought their case in California State Court, and alleged claims under the Securities Act. They claim that Cyan's IPO documents misrepresented Cyan's customer base and likely future sales. Once the truth was revealed, Cyan's stock price lost more than half its value. Defendants want the case dismissed, arguing that SLUSA and the Securities Act required the case to be brought in federal court. The plaintiff shareholders argue that neither SLUSA nor the Securities Act preclude state jurisdiction in their matter. They state that as long as the case does not involve "mixed cases that assert prohibited state law claims in connection with the purchase or sale of covered securities, combined with a Securities Act claim," state jurisdiction is allowed. Since their claim does not involve any of these issues, it can move forward in a state venue. The lower court agreed with and found in favor of the plaintiff shareholders.

Impact of the Supreme Court's decision?

The Supreme Court will most likely issue its decision by the end of June 2018. The holding will be significant for those with similar securities issues. A holding in favor of state venues is often one in favor of plaintiffs, while one opposed to state venues would often weigh in favor of defendants.

Beware Statutes Of Repose, They Can Sneak In And Cost You Your Case

By Patricia I. Avery and Joshua W. Ruthizer

Anyone who has watched law or crime television shows probably has heard of the term "statute of limitations," which protects a defendant from facing a lawsuit or prosecution based on old events. In civil litigation, a "statute of limitations" is the fixed time period that starts to run once the plaintiff can file a lawsuit, an event known as "accrual." "Accrual" typically occurs when the plaintiff is injured, or when the plaintiff discovers, or should have discovered, the injury. A statute of limitations is different from a "statute of repose," which imposes an absolute bar to a lawsuit after the expiration of a fixed time period. For example, in order to ensure fairness, a statute of limitations may sometimes be "tolled" (i.e. the court may "stop the clock from running"). A statute of repose, however, cannot be tolled. Indeed, a statute of repose may expire before an injury is even discovered.

The difference between these two concepts was recently explored by the U.S. Supreme Court in California Public Employees Retirement System v. ANZ Securities, Inc., 137 S. Ct. 2042, (June 26, 2017), which concerned litigation over the demise of Lehman Brothers. In 2007 and 2008, Lehman Brothers raised capital through a number of securities offerings, and the California Public Employees Retirement System ("CalPERS"), the largest pension fund in the United States, purchased securities in some of these offerings. In September 2008, Lehman Brothers filed for bankruptcy, and a class action was filed against the underwriters of the offerings for violating Section 11 of the Securities Act of 1933.

The Securities Act requires companies issuing stock or bonds to fully disclose information relevant to the securities offering in a registration statement filed with the U.S. Securities and Exchange Commission. Under Section 11 of the Securities Act, if the company or other designated individuals, including underwriters, make an "untrue statement of a material fact or omit [] a material fact required to be stated therein or necessary to make the statements therein not misleading," then investors may sue for damages.

Section 13 of the Securities Act includes a statute of limitations, requiring an action under Section 11 to be brought within one year after the discovery of the untrue statement or omission or when such untrue statement or omission should have been discovered. Section 13 also includes a statue of repose, which provides that "in no event shall any such action be brought . . . more than three years after the security [was sold]...."

The class action at issue here was filed within one year of the discovery of the untrue statements and omissions and within the three year statute of repose. In February 2011, more than three years after the relevant securities offerings and while the Lehman class action was pending, CalPERS filed an individual lawsuit against the underwriters, raising claims nearly identical to those alleged in the class action. A settlement of the class action was later reached, and CalPERS opted out of participation in the settlement, seeking to pursue its own individual claims against the underwriters.

The underwriters moved to dismiss the CalPERS suit, claiming it was time-barred under Section 13's three year statute of repose. CalPERS opposed the motion, observing that a 40-year old Supreme Court precedent, American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), held that the filing of a class action tolls the statute of limitations on behalf of all members of a class. The District Court for the Southern District of New York and the Second Circuit Court of Appeals agreed with the underwriters and dismissed the complaint, finding that the CalPERS suit was untimely, and that American Pipe tolling was inapplicable to Section 13's statue of repose.

The Supreme Court affirmed, pointing to the policy differences between statutes of limitations and statutes of repose. While statutes of limitations are designed to encourage plaintiffs to diligently pursue their claims (and therefore begin to run when the injury occurred or was discovered), statues of repose are designed to completely shield a defendant from liability after a certain period of time set by lawmakers. Because of this legislative judgment, the Court held, a statute of repose cannot be tolled unless the legislature (in this case, Congress) specifically enacts an exception to, or provides for tolling of, the statute of repose. As the Securities Act's statute of repose did not have such an exception, it could not be tolled.

The Supreme Court's decision may well have impact beyond the Securities Act, as many other laws contain statutes of repose. For example, the antifraud provisions of the federal securities laws, Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which make it unlawful, among other things, to use the mail, wire, or internet to make materially false and misleading statements and omissions concerning publicly traded securities, are subject to a five year statute of repose, commencing from the date the false statement is made. At least one federal district court and one federal appeals court have already relied on ANZ Securities to find that the five year statute of repose for these securities fraud claims is not subject to tolling by the filing of a class action within the relevant timeframe.

The primary lesson to be learned from the ANZ Securities case is that investors who have suffered losses due to a potential violation of the securities laws must be aware of the date the relevant statute of repose will expire, regardless of whether or not a related securities class action has been filed by another investor. Also, investors can no longer wait until a settlement is reached in a securities class action before deciding whether to opt out and prosecute an individual claim. Investors should analyze their damages and claims before the statute of repose expires so that they may, if warranted, file a complaint to protect individual claims. Reasons an investor would file an individual claim include: i) protecting significant potential individual damages, and ii) guarding against the danger that a class is not certified, a class is later "decertified," or, in the investor's view, an inadequate class settlement is reached. In addition, investors should examine the statute of repose before determining whether to opt out of a securities class action.

Do You Know What A Repeal Of Dodd-Frank Would Mean For Securities Law?

On behalf of Wolf Popper LLP

The Dodd-Frank Act was passed in 2010 to address the problems that led to the 2008 economic meltdown. This sweeping piece of legislation has had far-reaching effects on matters relating to securities litigation and regulation. However, the newly elected president Trump has consistently reiterated his intention to repeal the law, and some members of Congress have been intent on at least altering it.

The Securities and Exchange Commission. 

In the Obama administration, the chairwoman of the SEC, Mary Jo White, has taken a prosecutorial role and enforced rules that required companies to admit wrongdoing with regards to SEC settlements. Trump has nominated Walter J. "Jay" Clayton replace her. With a career as a lawyer to Goldman Sachs and other Wall Street players, Clayton's focus will likely be on capital formation instead of enforcement. Dodd Frank also included additional incentives for whistleblowers to come forward and report misdeeds to the SEC without fear of retaliation by their employers. Many observers predict, however, that the Trump administration will require whistleblowers to report potential violations internally before they come to the SEC. It is also likely that several public company disclosure requirements, such as those related to executive compensation, will be weakened or removed. If the Trump administration makes good on the promises made during the campaign, we can expect a rollback in the rule-making process under the Act at the very least.

The potential for fraud

With limited regulation and supervision on banks, together with the gutting of the Consumer Financial Protection Bureau, this opens the door to fraud in the financial sector. With the recently revealed Wells Fargo scandal, there is ongoing need to enforce the necessary actions against abuses as well as enhance consumer protections.

The Supreme Court

The United States Supreme Court has played a major role in determining securities cases. The court has redefined the jurisdictional impact of securities laws, redefined the standards of pleading and class certification as well as addressed questions relating to causation, materiality, and the statute of limitations.

With one of the Supreme Court Justices having passed away, it will be the prerogative of the new president to choose a nominee to replace the Justice. Therefore, the next nominee is likely to increase the likelihood of limiting class actions and/or securities litigation.

Repealing Dodd-Frank is bound to affect securities litigation and consumer law in many ways. U.S. stock market investors need to understand and protect their rights, which in some cases requires working with a qualified securities litigation attorney

Consumer Financial Protection Bureau

Although the exact changes in store for the law may be difficult to predict, in the current political climate we might expect a significant decrease in restrictions on banks' investment and lending activities. Moreover, the rule-making process of the relevant agencies will likely be slowed down, with serious efforts aimed at controlling, defunding or completely doing away with the Consumer Financial Protection Bureau.