The most important statutes in US securities cases are the Securities Act of 1933 (the ’33 Act) and the Securities Exchange Act of 1934 (the ’34 Act). Whereas the ’33 Act regulates issuers making an initial public offering (IPO), the ’34 Act regulates the secondary market. Thus, largely due to trade volume and investor exposure, the ’34 Act in many respects has much greater reach than the ’33 Act.
Nonetheless, following the March 20, 2018 Supreme Court decision in Cyan, inv. V. Beaver County, we must consider ’33 Act claims in a slightly different light. As mentioned previously, because it regulates the secondary market, the ’34 Act reaches many more claims than the ’33 Act. However, historically, whereas ’34 Act claims have always been limited to federal courts, this has not been so for ’33 Act claims. Since its inception, plaintiffs have been able to pursue ’33 Act claims in either federal or state court (a situation known as concurrent jurisdiction). In fact, congress further empowered ‘33 Act plaintiffs to select their forum by specifically precluding defendants in ’33 Act claims from using the procedural device known as “removal” (whereby the defendant moves the case from state to federal court).
Following a series of statutory reforms in the 1990s, in Cyan, the Supreme Court resolved a difference of opinion as to whether state courts had retained their historic concurrent jurisdiction of ’33 Act claims. The first of these ‘90s reforms happened in 1995, when the US Congress passed the Private Securities Litigation Reform Act (the PSLRA). The express rationale behind PSLRA was to curtail perceived excesses from plaintiffs and their attorneys in class action lawsuits, as well as specifically in the securities suits field. Some of the PSLRA changes specifically amended both the ’33 and ’34 Acts themselves—for example, by providing a safe harbor for forward-looking statements made by the defendant. By contrast, some of the PSLRA modifications affected not just securities cases, but all civil cases filed in federal court. For example, the PSLRA made several modifications to the Federal Rules of Civil Procedure.
Following PSLRA, in response to the same sort of wrongdoing that previously would have led investors to filing suit in federal court based on the ’33 Act or the ‘34 Act, clever plaintiffs’ attorneys adopted a new strategy. Rather than face the perceived added difficulty PSLRA imposed, plaintiffs began filing class actions in state court and pled state-law causes of action. By doing so, they avoided both the PSLRA general procedural modifications to civil suits, as well as avoided the substantive PSLRA modifications to the ’33 and ‘34 Acts (by abandoning these claims in favor of state-law claims). By pleading state-law claims, the plaintiffs could also proceed in state court for claims arising out of the alleged wrongdoing in the secondary market—something that they had never been able to do under the ’34 Act (because of its exclusive grant of jurisdiction to federal courts).
For plaintiffs, the good times were not to last. In 1998, congress passed Securities Litigation Uniform Standards Act (SLUSA). One of the biggest SLUSA reforms was to unambiguously prohibit class action securities claims based on state law with fifty or more plaintiffs. SLUSA leaves in place state-law fraud claims, but makes it all but impossible for plaintiffs to meaningfully rely on state law in the class action investor recovery context. Nonetheless, as it relates to ’33 Act claims, the full extent of the impact of SLUSA is the subject of the Supreme Court’s opinion in Cyan.
Coming full circle, the plaintiffs’ position in Cyan was that although in the investor recovery context SLUSA prohibits class actions pleading state-law claims (in both federal and state court), that SLUSA does nothing to disturb the original grants of jurisdiction for federal law claims as outlined in the ’33 Act. In litigating Cyan, the parties made a lot of complex statutory interpretation arguments. Although the defendants had some canons of statutory interpretation to support their position, the Supreme Court found for the plaintiffs. Justice Kagan wrote the opinion for a unanimous Court. In short, the Court held that nothing has overturned the historic concurrent jurisdiction over ’33 Act claims. Further, the Court held that ’33 Act claims remain exempt from removal. The Court’s opinion was an example of the plain meaning of the statute prevailing over legitimate contrary arguments.
In its Cyan opinion, the Court has already given hints as to the implications of its ruling. Firstly, although this topic has certainly piqued interest among securities practitioners and investors alike—it is important to remember that the Court’s opinion in Cyan will only be felt in the context of ’33 Act claims—in other words for securities claims springing from IPOs. Secondly, if plaintiffs want to move forward in state court, they are only able to do so if they exclusively plead ’33 Act claims. Therefore, plaintiffs with claims arising under multiple securities laws are going to have to think very carefully about when they plead which claims in which court. This could lead to plaintiffs pursuing ’33 Act claims in state court while pursuing ’34 Act claims in federal court. By extension, this could lead to defendants responding to lawsuits arising out of the same alleged wrongdoing in multiple forums.
Perhaps most interestingly, the court illustrates some examples of how ’33 Act claims pursued in federal versus state court would proceed similarly, as well as examples of how those claims would proceed differently. The main distinction the court makes is between procedure and substance. This distinction was perhaps most famously made by the Supreme Court in its case, Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938). The Erie case led to what is known as the Erie Doctrine, where when a federal court hears a state-law claim, the federal court employs federal procedural law but state substantive law. Because federal courts have a constitutional grant to hear certain state-law claims, federal courts employ the Erie doctrine regularly. However, with respect to ’33 Act claims proceeding in state court, we have the opposite scenario. Under these circumstances, state courts employ their own procedural law but federal substantive law. This is known as the Reverse Erie Doctrine—and it is far less common than the standard Erie Doctrine. The Reverse Erie Doctrine can only arise when a federal statute grants state courts concurrent jurisdiction over federal claims that the state courts would otherwise not be competent to hear (such as in the ’33 Act).
The results of the Reverse Erie Doctrine for investors are at least twofold: First, because the Reverse Erie Doctrine is a far less common scenario, state courts systems are likely less familiar with federal securities laws. The lack of state court experience could lead to lead less predictable results. State court judges may also be less inclined to dismiss cases in the early stages. Secondly, although “substantive” aspects of the ’33 Act, PSLRA and SLUSA will apply equally in state court, procedural rules will not. Thus, the distinction between “procedure” and “substance” will become more important for ’33 Act claims. Although substantive law should remain the same in all courts, plaintiffs are likely to favor states with procedural rules perceived to be more plaintiff friendly. Additionally, because they wish to contest which law controls, one can expect parties to more frequently litigate whether something is “procedural” or “substantive” in nature.