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State, Federal Courts Uniformity in Discovery Stays Remains Hazy After 'Cyan'

Authors: Robert L. Hickok, Jay A. Dubow and Benjamin J. Eichel

6/03/2019
State, Federal Courts Uniformity in Discovery Stays Remains Hazy After 'Cyan'

Reprinted with permission from the June 3, 2019 issue of The Legal Intelligencer. © 2019 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

The Private Securities Litigation Reform Act of 1995 (the PSLRA) brought much needed changes to securities litigation and was intended to limit frivolous lawsuits by curious and suspicious plaintiffs. Prior to the PSLRA, plaintiffs could file suit on minimal evidence and then use pretrial discovery to seek proof relating to the original alleged wrongdoing or relating to anything else subsequently discovered, causing a cycle of never-ending litigation. Due to the significant cost of defending these types of suits, defendants often found it cheaper to settle quickly, rather than fight and win. The PSLRA raised the bar for filing a securities claim and mandated that discovery could not proceed while a motion to dismiss is pending, significantly reducing the cost of defending, and possible exposure from, a frivolous suit. The reforms of the PSLRA also helped in supporting the uniformity of the federal securities laws, reducing any incentives for forum shopping.

Recently, securities litigators on the defense side have become concerned that some of the protections of the PSLRA might be vulnerable following the U.S. Supreme Court’s decision in Cyan v. Beaver County Employees Retirement Fund, No. 15-1439, 538 U.S. ____ (2018). In Cyan, the court resolved a split among state and federal courts on whether the Securities Litigation Uniform Standards Act (SLUSA) amendments to the Securities Act of 1933 (the 1933 Act) deprived state courts of jurisdiction over class actions alleging violations under the 1933 Act. The court held, in a unanimous ruling, that “SLUSA did nothing to strip state courts of their longstanding jurisdiction to adjudicate class actions alleging only 1933 Act violations.”

The result of the Cyan decision is that unless and until Congress acts, plaintiffs can file 1933 Act class actions in state court, and defendants will not be able to remove those cases to federal court. This result presents new questions for litigants as more and more plaintiffs are filing 1933 Act cases in state courts.

One particular reason that plaintiffs may choose state court over federal court is the possibility of avoiding the discovery stay set forth in the PSLRA while a motion to dismiss is pending. While the discovery stay rule unquestionably applies in federal court, following Cyan it is not clear whether state courts will similarly stay discovery while a motion to dismiss is pending. Since the court’s Cyan decision, very few state courts have had the opportunity to address this issue and determine whether the discovery stay equally applies in state court actions.

Recently, in City of Livonia Retiree Health and Disability Benefits Plan v. Pitney Bowes, No. X08 FST CV 18 6038160 S (Conn. Superior Ct.), Judge Charles T. Lee of the Connecticut Superior Court reasoned that the discovery stay applied equally in state court actions. In that case, the plaintiffs brought a securities class action against Pitney Bowes relating to an initial public offering and alleged misrepresentations and omissions contained in the registration statement and prospectus. Pitney Bowes filed a motion to strike the complaint and moved to stay discovery pending resolution of the motion to strike, arguing that the motion to strike under Connecticut law is equivalent to a motion to dismiss under Rule 12(b)(6) of the Federal Rules.

Lee interpreted the phrase “in any private action arising under this subchapter,” of the discovery stay rule (Section 77z-1(b)(1)) by comparing that language to Section 77z-1(a), which sets forth certain procedures for private class actions and which specifically limits its applicability to actions brought “pursuant to the Federal Rules of Civil Procedure.” He concluded that because Section 77z-1(a) includes the reference to the Federal Rules, but Section 77z-1(b)(1) does not, there is a strong inference that it is not similarly limited to federal court actions, see Pitney Bowes at 6 citing Clay v. United States, 537 U.S. 522, 528-29, 123 S. Ct. 1072, 1077, 155 L. Ed. 2d 88 (2003) (“When Congress includes particular language in one section of a statute but omits it in another section of the same Act, we have recognized, it is generally presumed that Congress acts intentionally and the plain language of the statute …”). The court accordingly held that Section 77z-1(b)(1) compels the stay of discovery during the pendency of a motion to dismiss for both state and federal court actions.

While Cyan opened the door for possible inconsistent results in state versus federal courts, the Pitney Bowes decision has taken the first step in ensuring that the federal securities practice will remain uniform nationwide.

While there have been other state court decisions on this issue since Cyan, they generally did not explain their reasoning like Pitney Bowes, which adhered closely to the statutory interpretation implemented in Cyan. For example, a California state court in Switzer v. W.R. Hambrecht & Co., (Cal. Super. Ct., Sept. 19, 2018), held in a one-paragraph ruling that the discovery stay applies only to actions pending in federal court; however, it does not appear that Cyan was brought to the court’s attention. Similarly, in In re Ally Financial Securities Litigation, No. 2016-013616- CB, slip op. at 3-4 (Aug. 1, 2018), a Michigan state court denied the defendant’s motion to stay discovery pending the motion to dismiss. While the court acknowledged Cyan, the court ultimately denied the motion to stay, relying on the second half of Section 77z-1(b)(1), which provides that the stay may be denied if the “particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.” One reason the court denied the stay was that due to a prior stay (while awaiting the Cyan decision), the underlying events were four years old and the court held that continued delay would “expose plaintiffs to faded memories and prejudices.”

It is expected that more state courts will weigh in on this issue in the coming months. One result of Cyan is that state court securities actions have significantly increased in the last year. With the increase in filings comes a real risk that different state courts will reach different conclusions on the stay issue, causing division among state courts, which could eventually lead to forum shopping.

Time will tell, but if significant differences in state rules on this issue develop, Congress may act to reestablish the uniformity in the application of the securities laws and securities litigation practice.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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