The Supreme Court Struggles to Interpret SLUSA and to Decide Whether Securities Act Claims May Proceed in State Court

On November 28, 2017, the Supreme Court heard oral argument in Cyan, Inc. v. Beaver County Employees Retirement Fund, et al. to address the conflict between the anti-removal language found in the Securities Act of 1933 (Securities Act) and the language of the Securities Litigation Uniform Standards Act (SLUSA), which sought to make federal courts the exclusive venue for most securities fraud class actions.¹

The Court faces the difficult task of reconciling the language of SLUSA which divests state courts of jurisdiction over covered class actions that allege only Securities Act claims and the anti-removal language of the Securities Act.

Like the lower courts, the Justices appeared to be perplexed by the language of SLUSA, with several Justices opining that it was "gibberish" or "obtuse," but how the issue will be ultimately be resolved was left unclear. The decision is expected to issue in early 2018.

Background

Both the Securities Act and the Securities Exchange Act of 1934 (Exchange Act) allow a private right of action for investors if they believe they have been defrauded. Securities Act claims are typically brought in conjunction with the purchase of public offerings (initial or secondary) based on false or misleading statements in a prospectus or registration statements. The Exchange Act allows claims based on a broad variety of investor communications. While the Exchange Act provides for exclusive federal court jurisdiction, the Securities Act provides that suits brought under the act may be filed in either state or federal courts and originally included a provision that prevented defendants from removing a case from state to federal court.²As a practical matter, the anti-removal provision meant that plaintiffs who brought their Securities Act claims in state court could evade federal court pleading requirements and other procedural requirements. In addition, the filing of Securities Act claims in both state and federal courts led to inconsistent interpretations of the Securities Act.

In 1998, Congress passed SLUSA, which sought to make federal court the "exclusive venue for most securities fraud class actions."³ To this end, SLUSA added two exceptions to state court jurisdiction for Securities Act claims. First, SLUSA states that there shall be concurrent jurisdiction for Securities Act claims "except as provided in section 77p of this title with respect to covered class actions."⁴ Section 77p(f), in turn, defines a "covered class action" as a Securities Act suit brought on behalf of more than 50 shareholders.⁵ Second, SLUSA states that "[e]xcept as provided in section 77p(c) of this title, no case arising under this subchapter and brought in any State court of competent jurisdiction shall be removed to any court of the United States." Section 77p(c), in turn, provides that "covered class actions" involving a "covered security," shall be removable to federal court.

In addition, Section 77p(b) precludes a class action based on state law that alleges untruth or deception in connection with the purchase or sale of a covered security from being maintained by a private party in either state or federal court.

Following the passage of SLUSA, district courts have issued conflicting decisions on the removability of suits alleging only violations of the Securities Act, and state courts have been divided over whether they retain subject matter jurisdiction over such cases. In the only appellate decision (either state or federal) to address the issue, the California Court of Appeal concluded that the SLUSA exception to concurrent jurisdiction is limited, and that under the facts before it, removal to federal court was not appropriate.⁶

In April 2014, plaintiffs filed suit in California state court alleging only federal Securities Act violations in Cyan's public offering documents. Cyan did not attempt to remove the case to federal court, and instead moved for judgment on the pleadings, arguing that SLUSA precludes state court jurisdiction over class actions alleging violations of the Securities Act. The court denied Cyan's motion and the Supreme Court eventually agreed to hear the case.

The Arguments on Appeal

During oral argument, the parties, along with the government, offered three competing interpretations of SLUSA's effect on the Securities Act's jurisdictional provision: (i) Cyan argued that SLUSA precludes state courts from having jurisdiction over any covered class actions asserting Securities Act claims; (ii) the government, which supported Cyan's overall position, argued that SLUSA does not strip state courts of authority to hear such cases but allows for removal to federal court; and (iii) the investors argued that SLUSA had no impact on state court actions alleging only Securities Act claims, but conceded that their action would have been removable if the suit included claims of both state and federal law violations relating to the purchase or sale of a covered security.⁷

The justices appeared to have difficulty with each of these interpretations and struggled to give meaning to the language in the statutes, with Justice Alito noting that SLUSA "is just gibberish," and asking whether there's "a certain point at which we say this means nothing, we can't figure out what it means, and, therefore, it has no effect."

A number of the justices noted the inconsistency in the investors' position which would allow state courts to hear cases alleging only federal Securities Act claims, but preclude cases alleging substantially similar state law claims. Justice Alito pointed out that the investors' interpretation produced the absurd result of giving state and federal courts concurrent jurisdiction over Securities Act claims "except if a lawyer is foolish enough to include in the state court complaint state claims that fall within the . . . prohibition" and expressed incredulity that Congress intended to preclude "a claim in state court under a state law cause of action that mirrors the '33Act'" but permit "the state court to be able to entertain the real thing, an actual '33 Act'" cause of action.

Both Justices Alito and Ginsburg raised concern that the plaintiffs' position would allow plaintiffs to evade the federal pleading requirements.

In contrast, Justices Kagan and Sotomayor expressed doubts that Cyan's interpretation, though consistent with SLUSA's purpose, gave full meaning to entirety of the text, with Justice Sotomayor opining that "when there's an ambiguity, that says we presume in favor of concurrent jurisdiction." Justice Kagan similarly noted that if Congress intended to preclude state court jurisdiction over these claims, it could have removed the existence of concurrent jurisdiction in the manner it did with respect to claims under the Securities Exchange Act.

Justice Gorsuch indicated a desire to take some action to "afford some meaning" to the words of SLUSA, which was enacted to curb state securities suits.

While the Court did not indicate an obvious path forward, its anticipated ruling should bring clarity regarding the appropriate jurisdiction for Securities Act claims. A decision limiting state court jurisdiction would have significant implications for issuers who currently face the possibility of defending Securities Act claims in both state and federal court, including the possibility of simultaneous federal and state court litigation of these claims. In states such as California, where Cyan originated, that have permitted Securities Act claims to proceed in state court, there has been a proliferation of state court suits. By bringing Securities Act claims in state court, plaintiffs are able to evade the heightened federal pleading requirements and other restrictions imposed by federal law, and as a result are more likely to avoid dismissal at the motion to dismiss stage. Filing in state court also allows plaintiffs to avoid the automatic stay of discovery that goes into effect in federal court when a motion to dismiss is pending. This means defendants in state court could be forced to settle frivolous suits in order to avoid unnecessary costly discovery.

If the Court does not act to restrict state court jurisdiction, it will be left to Congress to eliminate the non-removability language in the Securities Act.

© 2017 Arnold & Porter Kaye Scholer LLP. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.