Dealing a blow to businesses with initial public offerings in their future or recent past, the U.S. Supreme Court unanimously held that state courts may exercise jurisdiction over class action cases filed solely under the Securities Act of 1933.

Because the state courts are generally considered more plaintiff-friendly and lack some of the procedural mechanisms available only in the federal courts, the ruling is likely to result in a rash of state court actions under the 1933 law.

Roadmap to the Issue

The issue decided in the March 20 ruling in Cyan, Inc. v. Beaver County Employees Retirement Fund sits at the end of a complex maze of statutory provisions. The case involved two New Deal-era statutes that serve as the touchstones of securities law: the Securities Act of 1933 (the 1933 Act), which regulates initial stock offerings, and the Securities Exchange Act of 1934 (the 1934 Act), which regulates trading and other post-issuance activities.

While both provide for private causes of action, the 1933 Act gave jurisdiction to both state and federal courts, while the 1934 Act vests jurisdiction solely in federal courts. To accomplish the aims of concurrent jurisdiction, the 1933 Act forbade removal to federal court since any claim brought thereunder would otherwise “arise under federal law.”

In 1995, Congress enacted the Private Securities Litigation Reform Act of 1995 (PSLRA) with an eye toward curbing perceived abuses in securities class actions. The PSLRA enacted both substantive and procedural reforms. Of course, the procedural reforms, unlike the substantive reforms, did not apply in state court. Unsurprisingly, plaintiffs began filing securities class actions in state court to avoid the PSLRA’s procedural reforms.

In 1998, Congress tried to stop the state-court flight by passing the Securities Litigation Uniform Standards Act of 1998 (SLUSA). The most notable provision of the SLUSA, in Section 77p(b), bans “covered class actions based on state law.” To further this provision, Section 77p(c) permits the removal of forbidden state-law class actions to federal court, where they will be dismissed.

The SLUSA also amended the concurrent jurisdiction provision of the 1933 Act. Specifically, concurrent jurisdiction now exists “except as provided in section 77p … with respect to covered class actions.” The issue before the Supreme Court in Cyan was precisely what Congress meant when it referred to “covered class actions” in this subsection.

In the securities context, there are three types of class actions:

• pure state-law actions
• mixed (federal and state) law actions
• purely federal (i.e. 1933 Act) actions

A pure state-law claim is categorically barred and can be removed to federal court (and then dismissed) under Section 77p(c). Mixed claims can also be removed to federal court under Section 77v(a). Cyan involved the last category: purely federal actions brought in state court.

The Court’s Decision

Against this backdrop, the Beaver County Employees Retirement Fund and related investors purchased Cyan stock during its IPO. After Cyan’s stock value decreased, the investors filed suit against Cyan in the California Superior Court under the 1933 Act alleging a failure to disclose. Importantly, there were no state law claims. Cyan moved for judgment on the pleadings, arguing that the SLUSA amendment precluded state courts from exercising subject matter jurisdiction. After the California Superior Court denied Cyan’s Motion, and the California appellate courts declined review, the United States Supreme Court granted certiorari.

Cyan relied upon the definition of “covered” in Section 77p(f) to argue that the SLUSA bars state courts from hearing any securities class action involving over 50 plaintiffs. The investors, in contrast, argued that the statute bars state courts only from hearing class actions forbidden by Section 77p(b) – that is, those “based on state-law.”

At oral argument, the justices were clearly frustrated by the language of the SLUSA, with Justice Alito calling it “gibberish.” Ultimately, though, the Court’s holding was largely based on a textual analysis. To that end, Justice Kagan, writing for a unanimous Court, held that “state-court jurisdiction over 1933 Act claims thus continues undisturbed.”

Walking through federal securities law, Justice Kagan dispatched with the notion that the SLUSA forbid “all sizable class actions.” After grounding the Court’s holding in the text of the statute, Justice Kagan further noted that it was unlikely Congress would disturb the decades-long practice of concurrent jurisdiction “not by any direct means, but instead by way of a conforming amendment to 77v(a) (linked, in its view, with only a definition).”

The current state of the law, as described by Justice Kagan, is one in which “all covered securities class actions must proceed under federal law; most (those alleging 1934 Act claims) must proceed in federal court; some (those alleging 1933 Act claims) may proceed in state court.” In closing, Justice Kagan seemed to echo Justice Alito’s statement at oral argument, but ultimately concluded that “the uncertainty surrounding Congress’s reasons” for drafting the SLUSA were of no moment because there was no basis to broadly foreclose concurrent jurisdiction.

Effect of the Court’s Holding

The Court’s holding is undoubtedly a setback for businesses that are planning or have recently held an initial public offering. In the context of 1933 Act claims, numerous statistical analyses have established that state courts are significantly more plaintiff-friendly than their federal counterparts. This is unsurprising given that the PSLRA enacted procedural protections unavailable to defendants in state court.

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