Cyan V. Beaver County Employees Retirement Fund: Supreme Court Affirms State Court Jurisdiction Over Securities Act Class ActionsPrint Article
- Posted on: Mar 26 2018
On March 20, 2018, the United States Supreme Court decided Cyan, Inc. v. Beaver County Employees Retirement Fund, No. 15-1439, in which it unanimously held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) does not strip state courts of subject-matter jurisdiction over class actions involving claims exclusively brought under the Securities Act of 1933 (the “1933 Act”), and does not allow for the removal of those cases to federal court. (Here.)
The Court resolved a split among state and federal courts that has spanned nearly two decades concerning state court jurisdiction over securities class actions that exclusively allege claims under the 1933 Act. Some courts have held that, after SLUSA, federal courts have exclusive jurisdiction over class actions alleging only 1933 Act claims. Other courts, by contrast, have concluded that SLUSA did not remove state courts’ concurrent jurisdiction over such actions.
In the 1930s, Congress passed sweeping legislation to regulate the offer and sale of securities – the 1933 Act and the Securities Exchange Act of 1934 (the “Exchange Act”). Prior to the legislation, the states primarily regulated the purchase and sale of securities.
The 1933 Act requires companies that offer securities to the public (known as issuers) to make accurate disclosures of material information. Under the statute, violations of the 1933 Act are actionable in state and federal court. Notably, and relevant to the Court’s decision in Cyan, Congress barred removal of actions filed in state court to federal court. By contrast, the Exchange Act, which regulates the trading of securities (on the national exchanges), deprives the states of jurisdiction over claims arising under that statute.
In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”) over President Clinton’s veto. The PSLRA included a number of procedural and substantive provisions affecting the prosecution and defense of securities class action litigation. To avoid the application of these provisions, plaintiffs filed their class action lawsuits in state court, asserting claims under state law only. Congress passed SLUSA to pre-empt state court jurisdiction, requiring “covered” class action lawsuits (i.e., a lawsuit on behalf of 50 or more people) to proceed in federal court only.
In passing SLUSA, Congress amended Section 16(b) of the 1933 Act, which prohibits securities class actions based on state law in both state and federal courts that allege false or misleading practices in the purchase or sale of a covered security – i.e., a security traded on the national exchanges. That provision is known as the “state-law class-action bar.”
Congress added a new provision, Section 77p(c), which permits the removal of state-law class actions to federal court: “Any covered class action brought in any State court, as set forth in subsection (b) of this section, shall be removable to the [local] Federal district court … and shall be subject to subsection (b) of this section.” The purpose of this provision, as the Supreme Court concluded in another case, is to ensure that the district court promptly dismisses the action.
Finally, Congress made conforming amendments to Section 22(a) of the 1933 Act, making clear that the grant of concurrent jurisdiction over 1933 Act claims is limited: “except as provided in [Section 16] with respect to covered class actions.”
The district courts of the United States … shall have jurisdiction …, concurrent with State and Territorial courts, except as provided in section 77p of this title with respect to covered class actions, of all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter.
This provision is known as the “except clause.”
Cyan addressed the question what does SLUSA mean when it refers to “covered class actions” in the “except” clause. Cyan argued – relying on the definition of “covered” in Section 77p(f) – that SLUSA bars state courts from hearing large securities class actions (e.g., class actions having more than 50 class members), based on state or federal law. The plaintiffs, on the other hand, argued that SLUSA prohibits state courts from hearing securities class actions barred by Section 77p(b) only. Cyan also addressed the question whether a covered securities class action alleging only 1933 Act claims can be removed to federal court.
The case arose from the initial public offering (“IPO”) of Cyan, Inc. (“Cyan”) shares in May 2013. The plaintiffs/respondents, three pension funds and an individual (together, the “Investors”), purchased shares of Cyan stock in the IPO. After the stock declined in value, the Investors brought a damages class action against Cyan in California Superior Court. The Investors alleged that Cyan’s offering documents contained material misstatements in violation of the 1933 Act. The Investors did not assert any state law claims.
Cyan moved to dismiss the Investors’ suit for lack of subject matter jurisdiction. It argued that the “except clause”— i.e., the amendment made to §77v(a)’s concurrent-jurisdiction grant —stripped state courts of the power to adjudicate 1933 Act claims in “covered class actions.” The Investors did not dispute that their lawsuit qualified as such an action under SLUSA’s definition. But they maintained that SLUSA left intact state courts’ jurisdiction over all suits — including “covered class actions”— alleging only 1933 Act claims. The California Superior Court agreed with the Investors and denied Cyan’s motion to dismiss. The state appellate courts denied review of that ruling.
The Supreme Court granted Cyan’s petition for certiorari to resolve the split among state and federal courts about whether SLUSA deprived state courts of jurisdiction over “covered class actions” asserting only 1933 Act claims.
The Supreme Court’s Opinion
In a unanimous decision, the Court held that state courts have concurrent jurisdiction over federal securities class actions asserting claims exclusively brought under the 1933 Act. Although SLUSA bars certain securities class actions based on state law, and expressly authorizes removal of such actions so that they may be dismissed by federal courts applying SLUSA, the Court concluded that “SLUSA did nothing to strip state courts of their longstanding jurisdiction to adjudicate class actions alleging only 1933 Act violations.”
In reaching that conclusion, Justice Kagan noted that the language used by Congress was clear: “SLUSA’s text, read most straightforwardly, leaves in place state courts’ jurisdiction over 1933 Act claims, including when brought in class actions.” Put another way, said Justice Kagan, “[t]he statute says what it says—or perhaps better put here, does not say what it does not say. State-court jurisdiction over 1933 Act claims thus continues undisturbed.”
The Court made it clear that the “except clause” “does not” limit “state-court jurisdiction over class actions brought under the 1933 Act.” Section 16(b) “bars certain securities class actions based on state law … [a]nd as a corollary of that prohibition, it authorizes removal of those suits so that a federal court can dismiss them.” “But,” said Justice Kagan, “the section says nothing, and so does nothing, to deprive state courts of jurisdiction over class actions based on federal law. That means the background rule of §77v(a)—under which a state court may hear the Investors’ 1933 Act suit—continues to govern.” Citations omitted.
Justice Kagan rejected Cyan’s attempt to “cherry pick” a sub-paragraph in a larger section of the statute to reach a result that is incompatible with that larger provision:
… Cyan thus concludes that the except clause exempts all sizable class actions—including the Investors’ suit—from §77v(a)’s conferral of jurisdiction on state courts.
But that view cannot be squared with the except clause’s wording for two independent reasons. To start with, the except clause points to “section 77p” as a whole—not to paragraph 77p(f)(2). Cyan wants to cherry pick from the material covered by the statutory cross-reference. But if Congress had intended to refer to the definition in §77p(f)(2) alone, it presumably would have done so—just by adding a letter, a number, and a few parentheticals.… And “[w]hen Congress want[s] to refer only to a particular subsection or paragraph, it sa[ys] so.…” It said no such thing in the except clause.
Justice Kagan explained that Cyan’s reliance on the definitional paragraphs of the statute to give meaning to Section 77p(f)(2) could not withstand scrutiny because the former does not do latter:
In any event, the definitional paragraph on which Cyan relies cannot be read to “provide[ ]” an “except[ion]” to the rule of concurrent jurisdiction, in the way SLUSA’s except clause requires. A definition does not provide an exception, but instead gives meaning to a term—and Congress well knows the difference between those two functions.… If Congress had wanted to deprive state courts of jurisdiction over 1933 Act class actions, it had an easy way to do so: just insert into §77p an exclusive federal jurisdiction provision (like the 1934 Act’s) for such suits. That rule, when combined with the except clause, would have done the trick because it would have “provided” an “except[ion]” to §77v(a)’s grant of concurrent jurisdiction; by contrast, a mere definition of “covered class action” (as a damages suit on behalf of 50-plus people) does not so provide.
Finally, Justice Kagan rejected Cyan’s argument that the except clause was merely a “minor tweak” or a “conforming amendment”:
And finally, Cyan’s take on the except clause reads too much into a mere “conforming amendment.” The change Cyan claims that clause made to state court jurisdiction is the very opposite of a minor tweak. When Congress passed SLUSA, state courts had for 65 years adjudicated all manner of 1933 Act cases, including class actions. Indeed, defendants could not even remove those cases to federal court, as schemes of concurrent jurisdiction almost always allow. State courts thus had as much or more power over the 1933 Act’s enforcement as over any federal statute’s. To think Cyan right, we would have to believe that Congress upended that entrenched practice not by any direct means, but instead by way of a conforming amendment to §77v(a) (linked, in its view, with only a definition). But Congress does not make “radical—but entirely implicit—change[s]” through “technical and conforming amendments.”
In short, quoting a metaphor from an opinion written by Justice Antonin Scalia, Justice Kagan concluded that “Congress does not ‘hide elephants in mouseholes.’”
As to defendants’ ability to remove class actions alleging 1933 Act claims to federal court, the Court held that the removal provision applies to only “covered class actions,” which are “state-law class actions.”
Section 77p(b) does not preclude federal-law class actions. So under our decision, §77p(c) does not authorize their removal.
Class action plaintiffs asserting claims only under the 1933 Act will most likely file their complaints exclusively in state court. After Cyan, such exclusivity could subject defendants to litigating 1933 Act cases in state court while at the same time litigating in federal court Exchange Act claims arising under substantially the same facts and circumstances as the 1933 Act claims. Cornerstone Research recently noted that this phenomenon is already being played out, albeit on a small scale. See here (noting that there were seven 1933 Act actions pending in state court since 2014, all of which have parallel actions in federal court.)
[This Blog recently wrote about Cornerstone Research’s Report here.]
Class action defendants litigating in state court will likely find that the procedural safeguards of the PSLRA will not be available to them, unless the state court decides to apply them anyway. These safeguards include, among others, the lead plaintiff provisions, which are intended to ensure that investors with the largest financial interest in the litigation will direct the lawsuit. On the other hand, as the Cyan Court emphasized, the substantive provisions of the PSLRA, including the safe harbor protection for forward-looking statements, will apply in both federal and state courts. The Court did not, however, address whether other protections, such as the automatic stay of discovery during the pendency of a motion to dismiss, will apply in state court actions. The applicability of those protections will likely be litigated in the state courts.
After Cyan, companies may try to dictate the forum in which shareholders litigate their 1933 Act claims. This approach adds to the law in some states, notably Delaware, in which corporations are permitted to include in their by-laws a choice of forum provision establishing the state’s courts as the exclusive forum for litigation involving the internal affairs of the company. Stanford Law Professor Joseph Grundfest, for example, has advocated for forum-selection by-laws involving 1933 Act claims. The limitation imposed by that approach, however, might be prohibited by Section 14 of the 1933 Act. Section 14 provides that: “Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title … shall be void.” Whether the courts will consider a by-law designation of forum exclusivity to be the same as a waiver of compliance remains to be seen. Regardless, after Cyan, companies may be more inclined to include such forum selection designations in their by-laws.
In addition, companies may be inclined to adopt corporate by-laws requiring shareholder disputes, including those arising under the 1933 Act, to be arbitrated. For the past few years, companies have been adopting arbitration by-laws. In the few cases in which these by-laws have been addressed by the courts, they have been upheld. E.g., Delaware Cty. Employees Ret. Fund v. Portnoy, Civil Action No. 13-10405-DJC (D. Mass. Mar. 26, 2014). Just as the approach advocated by Professor Grundfest may be prohibited by Section 14 of the 1933 Act, so too may the foregoing solution.
This Blog will continue to watch for material developments after Cyan and report on the impact the decision has on class action litigation alleging claims arising under the 1933 Act.