On July 2, 2021, the US Supreme Court granted the Petition for a Writ of Certiorari filed in Pivotal Software,1 to address one of the many questions stemming from the Court's decision in Cyan2, which permitted state courts to retain concurrent jurisdiction over Securities Act claims.3 Now the Court will turn to the inquiry of whether the discovery-stay provision of the Private Securities Litigation Reform Act of 1995 (the "PSLRA") applies to Securities Act lawsuits brought in state court. This matter joins the estimated less than 2% of cases over which the Supreme Court will grant certiorari this year. Notably, the Supreme Court agreed to review the case notwithstanding that the issue was mooted in the underlying action when plaintiffs in that case agreed to stay discovery. This suggests that the current Supreme Court justices recognize (and may be seeking to address) the significant practical implications of allowing discovery to proceed in state court securities actions pending a motion to dismiss and the leverage it provides to plaintiffs in settlement negotiations.
Background on the PSLRA Stay of Discovery
The PSLRA was enacted in 1995 to eliminate frivolous and unsubstantiated securities claims that were a tax on the business community. In adopting the PSLRA, "[t]he House and Senate Committees heard evidence that abusive practices committed in private securities litigation include[d] [inter alia,] the routine filing of lawsuits against issuers of securities ... with only faint hope that the discovery process might lead eventually to some plausible cause of action."4 The Congressional record reflects that "discovery in securities class actions resembles a fishing expedition"5 and that"[t]he cost of discovery often forces defendants to settle abusive securities class actions."6 Accordingly, through the PSLRA, Congress established "stay of discovery provisions [] intended to prevent unnecessary imposition of discovery costs on defendants," based on such abusive litigation tactics.7 Congress reasoned that "discovery should be permitted in securities class actions only after the court has sustained the legal sufficiency of the complaint," except "in the exceptional circumstance where particularized discovery is necessary to preserve evidence or to prevent undue prejudice to a party."8 The broad stay of discovery was intended to prevent plaintiffs from using the cost of discovery to leverage favorable settlements even where a complaint was meritless and would likely be dismissed at the motion to dismiss stage.
The PSLRA's stay of discovery applies, in the words of the statute, to any private action arising under subchapter 2A of Title 15 of the US Code, which includes the Securities Act of 1933.9 However, while the PSLRA's stay of discovery appears on a literal reading of its language to apply to all actions arising under the Securities Act of 1933, regardless of whether they are filed in state or federal court, state courts have split on the issue of the applicability of this discovery stay.
SLUSA
State courts that have held that the PSLRA's stay does not apply in state court, in our view, mistakenly interpret language in the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), which states that "a court may stay discovery proceedings in any private action in a State Court," arguing that such language would be superfluous if the PSLRA stay of discovery applied to state court actions. We believe they are missing the correct reconciliation of the PSLRA's mandatory stay of discovery in class actions under the 1933 and 1934 Acts with the stay language in SLUSA (a statute which was adopted to curb the influx of state law securities fraud filings following the adoption of the PSLRA). The PSLRA stay of discovery of federal securities claims is mandatory no matter where it is filed. However, it does not apply to state law securities fraud claims filed in state court. The stay provision in SLUSA is permissive and allows state courts to stay state law securities claims. The mandatory discovery stay in the PSLRA of federal securities claims was not changed by SLUSA and applies wherever they are filed.
Pivotal Software Inc, et al. v. Zhung Tran, et al.,
Following a 41% stock drop in response to a negative quarterly financial report, two sets of plaintiffs, investors in the defendant corporation, filed parallel actions in state and federal court in California against Pivotal Software, Inc. ("Pivotal"), along with its directors and officers and offering underwriters alleging violations of the Securities Act and the Securities Exchange Act of 1934. In July 2020, Pivotal won dismissal of the federal class action, at which point, the state court plaintiffs pushed what defendants described as broad and burdensome discovery in the state court action. The California state court complex division rejected Pivotal's request to stay discovery pursuant to the PSLRA while its demurrer in state court was pending, joining the courts that have concluded that the PSLRA's automatic discovery stay applies in federal court only. The state court complex division did so even though the federal court had already determined that the underlying claims were meritless.Despite the state complex divisions court's ruling, the plaintiffs agreed to stay discovery pending a decision on PSLRA's demurrer, perhaps in an effort to avoid Supreme Court review and render the issue moot. Still, as Petitioners explained in their plea to the Supreme Court, no matter how the state court rules on the demurrer it will either be followed by another demurrer, during the pendency of which the trial court would allow the plaintiff to seek discovery or the issue would remain "capable of repetition, yet evading review" because it necessarily arises during a brief period at the commencement of all state litigation involving the Securities Act. In short, this issue is not going away. The Supreme Court no doubt understood this reality and the deleterious "sharply divided" outcomes in state courts that will continue without a ruling on this issue.
Conclusion
The Supreme Court's forthcoming analysis of the issue is likely to underscore the balance of legislative purpose, statutory construction, and deference to state courts. Above all, the Supreme Court cannot ignore the practical implications of their impending decision, such that resolving the issue in plaintiffs' favor to allow discovery in state court actions, regardless of the reasoning, will foster state forum shopping where plaintiffs would have free reign to engage in the very "fishing expeditions" that the PSLRA aimed to eliminate. While the Supreme Court could place their trust in the state judicial system, relying on Section 77z-1(b)(4), which expressly provides for state courts to use their discretion in staying discovery, this reliance would not resolve the inconsistency across jurisdictions. By contrast, a "plain reading" of the statute, holding that discovery should be stayed in any private action arising under the Securities Act, whether filed in state or federal court, would establish clarity and consistency across all courts-thereby tackling the first of many questions provoked by Pandora's box of state securities litigation-that is, Cyan.
Footnotes
1 Pivotal Software Inc, et al. v. Zhung Tran, et al., Case No. 20-1514, in the Supreme Court of the United States, cert. granted (copy of Petition available at: https://www.supremecourt.gov/DocketPDF/20/20-1541/177169/20210503164123452_FinaLPivotal_Cert__Petition.pdf)
2 Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018).
3 For more background information about the Cyan decision, please read Seyfarth's prior coverage available here.
4 H.R. CONF. REP. 104-369, 31, 1995 U.S.C.C.A.N. 730 (the "House Report").
5 S. REP. 104-98, 14, 1995 U.S.C.C.A.N. 679, 693 (the "Senate Report").
6 See id.
7 See House Report; 15 U.S.C. § 77z-1(b)(1).
8 See Senate Report.
9 See 15 U.S.C.A. § 77z-1(b)(1); 15 U.S.C. § 77a.
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