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Ruling allowing securities litigation in state courts could spur additional lawsuits

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Last week’s unanimous U.S. Supreme Court ruling holding that securities-offerings litigation can be heard in state court and defendants may not move state-filed cases to federal court certainly will lead to increased litigation against companies and possibly increase directors and officers liability rates as well, say experts.

The high court ruled unanimously in Cyan Inc. et al. v. Beaver County Employees Retirement Fund et al. that amendments to the federal Securities Act of 1933 do not give federal courts exclusive jurisdiction over these cases.

Several pieces of legislation form the background for the ruling. The Securities Act of 1933 created private rights of action related to the enforcement of securities offerings, while the Securities Exchange Act of 1934 regulated subsequent trading, according to the ruling.

In 1995, the Private Securities Litigation Reform Act amended both acts to stem perceived abuse of the class actions in securities litigation and included substantive reforms applicable to both state and federal courts. 

It also introduced procedural reforms applicable only in federal court. To avoid these, plaintiffs began filing securities class actions under state law. In response, Congress passed the Securities Litigation Uniform Standards Act of 1998, according to the ruling.

Mead, Washington-based Cyan, a video game company that had been sued in state court in connection with its initial public offering, argued that a clause in the SLUSA stripped state courts of the power to decide claims under the 1933 Act.

A California state appellate court ruled against Cyan, and after the California Supreme Court did not accept the case for review, it was appealed to the U.S. Supreme Court.

The high court held that state courts retain concurrent jurisdiction over class action suits alleging violation of the Securities Act of 1933.

“SLUSA did nothing to strip state courts of their longstanding jurisdiction to adjudicate class actions alleging only 1933 Act violations,” said the ruling delivered by Justice Elena Kagan. “Neither did SLUSA authorize removing such suits from state to federal court. We accordingly affirm the judgment below,” the ruling said.

The ruling reverses the PSRL’s reforms, said John D. Donovan, a partner with Ropes & Gray L.L.P. in Boston. That law was enacted to address abuses in litigation, including essentially replacing “a regime where there was a race to the courthouse by always trying to make a case with a regime where sophisticated investors acted on behalf of a class.”

Under Cyan, “because you can now go to state court on a ’33 Act case, all those reforms go by the boards,” Mr. Donovan said.

Cases may now be filed in both state and federal court, and there may be multiple state court claims, experts say.

“The whole point of class actions” is supposed to be efficiency because cases are consolidated, said Kevin LaCroix, executive vice president of RT ProExec, a division of R-T Specialty L.L.C., in Beachwood, Ohio.

Enabling plaintiffs to file multiple suits eliminates that, he said.

“I could easily see a situation” where a plaintiffs counsel who fails to be named lead counsel in federal court then files in state court, he said.

It is also possible that in cases where there are claims under the 1934 law — which can only be filed in federal court — as well as the 1933 law, the 1933 claims would be sliced off and filed in state court, which “incurs some transaction costs as the defense tries to get rid of the litigation,” Mr. LaCroix said.

Experts say the plaintiffs bar favors state courts hearing their cases.

“Plaintiffs perceive state courts as more favorable for them than federal courts. Defendants take the opposite view,” said Daniel H. Gold, a partner with Haynes and Boone L.L.P. in Dallas. “The Supreme Court ruling is certainly a favorable decision for plaintiffs in terms of having their choice of forum.”

“We’re seeing more filings already in San Mateo Superior Court in California,” said Marc J. Sonnenfeld, a partner with Morgan, Lewis & Bockius L.L.P. in Philadelphia.

“It’s going to be harder for the defense bar to get the cases dismissed in state courts,” although defense attorneys can still move to have cases removed to federal court on different grounds, said Ivan J. Dolowich, co-managing partner at Kaufman Dolowich & Voluck L.L.P. in Woodbury, New York.

Furthermore, different rules may apply in state courts that could lead to increased costs. Carolyn G. Nussbaum, a partner with Nixon Peabody L.L.P. in Rochester, New York, said under the PSRL, when a motion to dismiss — which can take six months to resolve — is filed, discovery is stayed unless the court orders otherwise. The rules may be different in state courts, she said.

There is some sentiment, also, that state court judges, which consider a wide variety of issues, are less knowledgeable than federal judges, said Mr. LaCroix.

In some states “you don’t want to be” in state court, “just because in some cases there’s not as much experience for these kinds of issues,” Ms. Nussbaum said.

“There may be less predictability and less emphasis on issues such as e-discovery and class certification, which are traditionally handled by federal courts,” she said.

Mr. Donovan said, “State court judges don’t do securities cases ordinarily. They have been pretty rare, so now if you’re a plaintiff you can not only escape all those PSLR reforms, but you can put a securities case in front of a rookie judge.”

Plaintiffs “are likely to have a judge who, even if he’s smart and conscientious and diligent, he’s inexperienced,” Mr. Donovan said.

The ruling could lead to increased D&O liability rates, observers say.

D&O rates for initial public offerings have already increased in California because state court filings have been permitted there, said Mr. LaCroix. Now that these cases can be filed in other states’ courts as well, it could lead to higher insurance costs elsewhere, too, he said.

“It’s intuitive,” said Mr. Donovan. “If settlement cost and defense costs increase, premiums are likely to follow.”

“We’ll have to see how D&O insurers react and whether they perceive this as increasing the risk with these types of claims,” said Mr. Gold. “I think we may see increased claims.”

“I think it’s something D&O insurers are already looking at,” although its short-term impact is unclear, said Mr. Dolowich. “I do think it’s going to require D&O insurers and claims professionals to work more closely with the defense bar on defense strategies on how these cases are going to get defended in state court.”