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.

Wolf Popper LLP is a preeminent law firm that has protected the rights of defrauded investors for over 70 years.  Concerned that your investments may be exposed to securities fraud?  Contact us, or monitor our ongoing investigations into potential securities fraud here

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.