New securities class action issue at SCOTUS: Does PSLRA discovery stay apply in state court?

The U.S. Supreme Court is seen in Washington, U.S., June 14, 2021. REUTERS/Carlos Barria

(Reuters) - In case the U.S. Supreme Court hasn’t sated its appetite for securities class action controversy after this week’s big decision in Goldman Sachs Group Inc v. Arkansas Teacher Retirement System, a onetime cloud computing company called Pivotal Software Inc is offering the justices a new shareholder litigation puzzle: Does the federal law staying discovery in securities class actions until investors have survived defendants’ dismissal motions also apply to cases in state court?

The Supreme Court is scheduled to consider Pivotal’s petition for clarification of the reach of the Private Securities Litigation Reform Act at its conference on Thursday. It seems to me quite unlikely that the justices will grant review, despite an amicus brief backing Pivotal and its underwriters from the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association. Shareholders gave the court a good reason to skip the case, arguing in their brief in opposition to the Pivotal petition that the dispute is moot because they have agreed not to seek discovery until after the San Francisco Superior Court judge overseeing the class action rules on Pivotal’s dismissal motion. That ruling, they said, is expected before the Supreme Court begins hearing cases next fall.

But the issue raised by Pivotal and its high-powered underwriters, including Goldman, Morgan Stanley and Citibank, is an interesting corollary to the Supreme Court’s 2018 ruling in Cyan Inc v. Beaver County Employees Retirement Fund. In Cyan, as you know, the justices held that shareholders can bring claims under the 1933 Securities Act in both state and federal court. That decision, predictably, led to a boom in Securities Act class actions in state courts, where pleading standards aren’t necessarily as high as the federal court standard.

The defense bar was sufficiently alarmed about the effects of the Cyan decision to devise forum selection clauses for companies conducting IPOs, mandating that Securities Act cases be filed in federal court. The Delaware Supreme Court confirmed last year that federal-court forum-selection clauses are valid under Delaware corporate law and federal law and policy. Those clauses have since proliferated among companies going public, including those accessing capital markets through special purpose acquisition vehicles. But, as Pivotal told the Supreme Court, there’s still uncertainty about whether other states will accept Delaware’s interpretation and enforce federal forum provisions.

Pivotal’s lawyers at Morrison & Foerster argued that the state court class action against the company vividly illustrates why shareholders prefer to litigate Securities Act suits in state court. Pivotal went public at $15 per share in 2018. Its share price plunged by 41% in May 2019, after a quarterly financial report that analysts called “disastrous” and “a train wreck.” A few months later, it merged with VMWare Inc at $15 per share.

Investors sued the company and its underwriters in both state and federal court in San Francisco, agreeing to stay the state case until a dismissal ruling in federal court. Last July, Pivotal and the banks won dismissal of the federal class action.

Plaintiffs lawyers from Hagens Berman, Scott + Scott and Hedin Hall resumed litigation in the state case. Pivotal and the banks tried to stay discovery until after the court ruled on its motion to dismiss (called a demurrer in California state court), citing the discovery stay Congress mandated in the PSLRA. The trial judge not only refused to stay discovery but also extended the timeline on the defendants’ dismissal motion. Pivotal sought review in state appellate courts, to no avail.

Investors served Pivotal and the banks with discovery demands “as broad and burdensome as they come,” MoFo wrote in the company’s petition, putting defendants on the hook for the cost of wide-ranging production before the court has even determined whether shareholders have a claim.

According to Pivotal, its underwriters and its amici, the Supreme Court must step in to block state courts from providing such lopsided advantages to shareholders. “The increased costs associated with securities litigation have significant consequences,” the defendants’ petition said. “Securities Act defendants are coerced into settling meritless claims. Premiums for directors' and officers' liability insurance have skyrocketed. Some U.S. companies may avoid going public altogether, depriving the public of valuable investment opportunities.”

And according to Pivotal, that’s all because some state judges have rejected the most obvious reading of the PSLRA, which says on its face that discovery “shall be stayed” until resolution of a dismissal motion “in any private action” under the Securities Act.

Shareholders, represented at the Supreme Court by Thomas Goldstein of Goldstein & Russell, had plenty of arguments against Supreme Court review, in addition to mootness and their merits argument that PSLRA doesn’t apply in state cases. There’s no split in the federal circuits – and scant case law even from state courts, including the California courts that didn’t publish opinions in this case. (Pivotal said there’s a split among the state courts that have issued opinions.) And the issue, investors argued in their opposition brief, isn’t important, since it involves a temporary stay of discovery that affects only a few dozen state-court cases a year.

“Although the issue may have some intellectual interest, we don’t think it’s important in how cases actually get litigated,” said shareholder lawyer Thomas Laughlin of Scott + Scott, who said defendants often “slow-roll” document production in cases in which state judges have authorized early discovery, hoping to delay until a dismissal ruling. “From a real-world standpoint,” he added, “this just isn’t an issue that’s deciding the outcome.”

Morrison & Foerster declined to provide a response, but Pivotal’s reply brief suggested that shareholders’ own actions in the San Francisco state court case belie their insistence that the issue doesn’t matter. Investors only agreed to drop their discovery demands in the class action after Pivotal and the banks filed their Supreme Court petition, apparently in order to moot the petition.

“Plaintiffs and their counsel would not abandon the discovery opportunity (and settlement leverage) they fought tooth and nail to obtain unless this court's decision would have far-reaching significance,” Pivotal said.

We should know by Monday if the justices agree.

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Securities class action defendants counting on SCOTUS’ Goldman ruling

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Alison Frankel has covered high-stakes commercial litigation as a columnist for Reuters since 2011. A Dartmouth college graduate, she has worked as a journalist in New York covering the legal industry and the law for more than three decades. Before joining Reuters, she was a writer and editor at The American Lawyer. Frankel is the author of Double Eagle: The Epic Story of the World’s Most Valuable Coin.