On March 20, 2018, the Supreme Court unanimously ruled in Cyan, Inc. v. Beaver County Employees Retirement Fund, No. 15-1439, that securities plaintiffs could bring class actions under the Securities Act of 1933 (“Securities Act”) in state courts.[1] This decision resolves a split among several state and federal courts as to whether the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) prevented securities plaintiffs from seeking refuge in state court from the procedural impediments the Private Securities Litigation Reform Act of 1995 (the “Reform Act”) imposes on federal securities actions. The Supreme Court found that SLUSA’s statutory text makes clear that plaintiffs can bring some Securities Act class actions in state court.

Cyan will ignite a race to the state courthouse, where the Reform Act’s protections do not apply and judges have less experience with federal securities litigation.[2] Public companies and their directors and officers will soon face new and more complicated risks. Now more than ever, defense counsel and D&O insurers and brokers must devise new tools and resources to address it.

The Legislative History

Congress, the courts, and litigators have grappled with ever-changing currents in securities class action litigation for decades. One topic that has spurred debate in this area has been whether securities plaintiffs can bring claims under the Securities Act in state court. This option has never been available to securities plaintiffs bringing actions under the Securities Exchange Act of 1934 (“Exchange Act”). That Act has always granted exclusive jurisdiction to federal courts to preside over private rights of action. But securities plaintiffs could historically bring actions under the Securities Act in state court because, since its inception, the Securities Act provided that federal and state courts have concurrent jurisdiction to adjudicate such actions.

Congress’s enactment of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”)[3] put the Securities Act’s concurrent jurisdiction provision under the spotlight. The Reform Act imposes various restrictive measures, such as heightened pleading burdens and an automatic discovery stay, meant to deter frivolous federal securities class actions. As a result, securities plaintiffs began filing their Securities Act claims in state court to end-run around the Reform Act.

In response to this “shif[t] [of class actions] from Federal to State courts,”[4] Congress passed SLUSA.[5] Among other things, SLUSA amended the Securities Act’s concurrent jurisdiction provision to deprive state courts of jurisdiction to hear “covered class actions,”[6] which are actions with 50 or more prospective class members.[7] This amendment, however, sparked some confusion as to whether state courts retained jurisdiction to hear any covered class actions post-SLUSA. The majority of courts have held that state court jurisdiction did not survive SLUSA, relying chiefly on Congress’s intent to prevent securities plaintiffs to end-run around the Reform Act.

California state courts, however, have gone the other way. They uniformly find that SLUSA obviated state court jurisdiction only as to some covered class actions. Specifically, the Ninth Circuit Court of Appeals and California appellate court held in recent years that SLUSA continued state court jurisdiction over class actions that do not concern a “covered security”[8] based on its interpretation of the statutory text of the Securities Act’s concurrent jurisdiction provision.[9]

The Cyan Litigation

In Cyan, the plaintiff class sued Cyan, Inc., a telecommunications company, and its officers and directors (together, Cyan”) in California Superior Court after their Cyan stock declined in value. They allege that Cyan’s offering documents contained material misstatements in violation of the Securities Act.

Cyan moved to dismiss the Securities Act claims, arguing that the California court of first instance lacked jurisdiction to adjudicate them. The plaintiff class argued that precedent from the Ninth Circuit Court of Appeals and the California appellate court made clear that state courts retained jurisdiction post-SLUSA to adjudicate certain covered class actions under the Securities Act, such as the ones at issue in Cyan. The California Superior Court sided with the plaintiff class, ruling at oral argument and without issuing a written opinion that the aforementioned precedent permitted it to adjudicate these claims.[10]

The California appellate courts declined to review the lower court’s decision, leading to this appeal. At the Supreme Court, Cyan[11] and amici curiae supplemented their statutory interpretation arguments with extensive discussion of SLUSA’s place in federal securities legislation and the harm state court securities litigation causes, illustrated by the 1,400-percent spike in California state court securities class action filings. Amicus curiae Washington Legal Foundation, in a brief authored by BakerHostetler partner Doug Greene, laid out in detail how concurrent jurisdiction is antithetical to the Reform Act and SLUSA.[12] In response, the plaintiff class argued that the precedent from the Ninth Circuit Court of Appeals and the California state courts accurately interprets SLUSA’s text, which on its face appears to strip state courts of concurrent jurisdiction only as to covered class actions that concern covered securities.

During oral argument, the Supreme Court tried to make sense of the confusion as to how the SLUSA amendments affect the concurrent jurisdiction provisions under the Securities Act. Justices Sonia Sotomayor and Elena Kagan seemed to agree with the plaintiff class that the SLUSA amendments permit securities class actions to be brought under federal law without regard to venue. They also seemed unpersuaded by the defendant’s argument that it made little sense for Congress to prevent state courts to hear covered class actions under state law but to continue to allow them to hear such class actions under federal law. Justices Sotomayor and Kagan, as well as Justice Ruth Bader Ginsburg, noted that if Congress truly intended to confer exclusive jurisdiction over covered class actions pursuant to the Securities Act to federal courts, then it could have done so in a much clearer fashion, as it did under the Exchange Act.[13]

Other justices were concerned about how to interpret the plain text of the SLUSA amendments. For example, both Justices Samuel Alito and Neil Gorsuch characterized the text as “gibberish,”[14] and Justice Alito commented, “all the readings that everybody has given to all of these provisions are a stretch.”[15] That included the interpretation of the Acting Solicitor General, who submitted an amicus curiae brief arguing that the SLUSA amendments continued state court concurrent jurisdiction of covered class actions under the Securities Act, but also allowed for such class actions to be removed to federal court. Justices Stephen Breyer, Ginsburg, and Anthony Kennedy seemed sympathetic to the Acting Solicitor General’s interpretation of the text, but several Justices registered their view that the removal argument was not ripe because this removal issue was not at issue in Cyan.[16]

The Unanimous Supreme Court Decision

On March 20, 2018, in a unanimous decision authored by Justice Kagan, the Supreme Court held that state courts have jurisdiction to adjudicate class actions under the Securities Act that do not concern covered securities. The Supreme Court ruled that this was the more “straightforward[]” interpretation of the statutory text of the concurrent jurisdiction provision under the Securities Act.[17] Specifically, the Supreme Court noted that SLUSA framed its amendments to that provision as creating an exception to the general rule that state courts have concurrent jurisdiction. If Congress truly intended to deprive state courts of jurisdiction altogether, the Supreme Court reasoned, then it would not have created an exception to the concurrent jurisdiction provision—it would have just struck that provision in its entirety.

The Supreme Court acknowledged that it does “not know why Congress declined to require that 1933 Act class actions be brought in federal court,” as Congress had with claims under the Exchange Act.[18] But the Supreme Court held that it “will not revise that legislative choice,” noting that it “has no license to disregard clear language based on an intuition that Congress must have intended something broader.”[19]

What Cyan Means

Cyan significantly increases and complicates the risk public companies and their directors and officers face in securities litigation. It is incumbent upon the repeat players in securities litigation defense—defense counsel, insurers, and brokers—to devise new tools and resources to address it. Without significant changes, many issuers and their directors and officers and D&O insurers will suffer severe financial consequences.[20]

At the most basic level, Cyan will increase the overall number of unconsolidated securities class actions. In any case involving a registered offering, the defendants must brace themselves for Securities Act claims in state court and parallel claims in federal court. There is no ability to consolidate related state and federal cases. The only way to coordinate them is to file motions to stay and/or coordinate—an approach that is always unpredictable and often unsuccessful. So the sheer number of unconsolidated cases will increase.

This means that state court litigation will swamp related federal litigation in the lion’s share of cases. In federal court, the Reform Act’s procedural protections—the lead-plaintiff, consolidation, and motion-to-dismiss procedures—can take more than a year to play out. That is fine if it is the only case, or even the driver, since the chances of complete dismissal are relatively high. But state court cases are subject only to state procedural rules and can move much faster than Reform Act litigation.

The most significant difference in state court is the lack of a meaningful motion to dismiss procedure. In many state courts, the pleading standard for falsity is far lower than the particularity standard established by Federal Rule of Civil Procedure 9(b), requiring no more than notice pleading. Indeed, as in many states, California’s notice pleading standard does not even incorporate the “plausibility” requirement established by Bell Atlantic Corp. v. Twombly[21] and Ashcroft v. Iqbal.[22] Naturally, this means that significantly fewer Securities Act claims are dismissed at the pleading stage in state courts than in federal courts.

To make matters worse, with the state court case in the driver’s seat, the Reform Act’s procedural protections in the related federal court case will be weakened as a practical matter. For instance, the automatic stay of discovery in a securities fraud case under the Exchange Act becomes a weaker shield against abusive lawsuits when discovery can proceed full-bore in a closely related state court case. Likewise, plaintiffs who file their Securities Act claims in state court do not have to hand control of the lawsuit to the lead plaintiff who is the “most adequate” class representative. This means that a significant institutional investor in the federal court case will not control the prosecution of the overall litigation—a small retail shareholder plaintiff in the state court case could effectively run the related state and federal litigation.

These are just examples of the new world of securities litigation defense Cyan creates. Defense lawyers and D&O insurers and brokers have neither a map nor compass to navigate. For the past 20 years, the blueprint for defending securities class actions has been simple: move to dismiss the case at the pleading stage and, if unsuccessful, settle the case. But now, the most fundamental fights in the case will take place in state court, which will require a different way of litigating.

Of course, Congress may act here, similar to how it did two decades ago when it passed SLUSA, by abolishing concurrent jurisdiction to ensure that its vision for uniformity in securities litigation can (finally) become a reality. And an increasing number of companies may include federal-forum clauses in their articles of incorporation or bylaws, a solution proposed by Professor Joseph Grundfest – though time will tell whether they are enforceable. But until those or other structural solutions materialize, the repeat players in securities litigation defense will need to re-calibrate litigation strategies to address the perils that parallel claims create.

One thing is certain: securities litigation will involve more actual litigation, and it will force the development of new tools and resources among the securities litigation bar. Over the coming months, we will write and speak about the problem and potential solutions.