A Pivotal Moment for the PSLRA's Discovery Stay? Not So Fast.

POMERANTZ MONITOR | NOVEMBER DECEMBER 2021

The Supreme Court’s unanimous 2018 opinion in Cyan, Inc. v. Beaver County Employees Retirement Fund held that (i) state courts have jurisdiction to hear class actions brought under the federal Securities Act of 1933 (the “Securities Act”) and (ii) the Securities Litigation Uniform Standards Act (SLUSA) does not empower defendants to remove class actions alleging only Securities Act claims from state court to federal court. While these resolved previously-disputed matters, Cyan opened the door to another issue of great importance: Does the provision in the Private Securities Litigation Reform Act (PSLRA), which requires that “in any private action arising under” the Securities Act, “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss,” apply to Securities Act cases brought in state court, or is its application limited solely to such cases brought in federal court?

On July 2, 2021, the Supreme Court granted the petition for writ of certiorari in Pivotal Software v. Tran to address precisely this question. Pivotal was named in a federal securities class action relating to alleged misrepresentations made in connection with its IPO. The federal suit against Pivotal was dismissed for failure to state a claim, but plaintiffs in parallel state proceedings then sought discovery from Pivotal, leading the company to seek resolution from the Supreme Court.

The PSLRA, enacted by Congress in 1995, established a “stay of discovery provisions” until after a complaint is sustained over defendants’ motion to dismiss or defendants answer the complaint, whichever comes first. Congress reasoned that “discovery should be permitted in securities class actions only after the court has sustained the legal sufficiency of the complaint,” except “in the exceptional circumstance where particularized discovery is necessary to preserve evidence or to prevent undue prejudice to a party.” This broad stay of discovery was supposedly intended to prevent plaintiffs from leveraging the threat of damaging and costly discovery to achieve favorable settlements, especially where a complaint was meritless and unlikely to survive a motion to dismiss.

While the PSLRA’s discovery stay, on its face, applies to “any private action” arising under subchapter 2A of Title 15 of the US Code, which includes the Securities Act, some state trial courts have concluded that the discovery stay is a procedural rule that does not apply to them. Other courts have determined that applying the stay would undermine Cyan’s recognition of state court jurisdiction over the Securities Act. Still other courts have reasoned that SLUSA’s guidance that “a court may stay discovery proceedings in any private action in a State Court” would be superfluous if the PSLRA stay of discovery applied to state court actions. In Cyan’s wake, with more plaintiffs bringing Securities Act claims in state court, the divide has only deepened between these courts and those that interpret the PSLRA’s “any private action” language as requiring them to enforce the discovery stay.

In support of universalizing the PSLRA discovery stay, defendants have argued that state courts are generally more lenient than federal courts in their pleading standards for fraud; that state court judges typically have less experience with securities claims, thus giving rise to increased uncertainty; and that state courts frequently allow shareholders to assert discovery demands before judges have ruled on dismissal motions.

Yet objections to a lack of uniformity between state and federal Securities Act litigation seem more redolent of an invitation to revisit Cyan rather than to focus on the comparatively narrow discovery stay issue. Indeed, the fact that state courts can – and do – decide whether to permit early discovery on a case-by-case basis muddies the claim that state courts are a free-for-all, discovery-wise. Nor is the discovery stay sacrosanct in federal court; to cite one example, in Blitz v. AgFeed, litigated in the Middle District of Tennessee, Pomerantz attorneys successfully moved to lift the stay in order to depose a director who oversaw an investigation into the same accounting misconduct at issue in the lawsuit. Defendants’ post-Cyan cri de coeur elides cases like AgFeed and others where some discretion would make sense: for example, federal securities defendants seeking dismissal routinely point to plaintiffs’ failure to cite damning internal reports as a basis to get rid of the suit. No doubt such defendants are also big fans of the PSLRA discovery stay that prevents plaintiffs from actually obtaining such documents at the pleading stage.

In Pivotal, after the federal action was dismissed, plaintiffs pursued discovery in a parallel securities class action in state court. Pivotal argued, to no avail, that the PSLRA’s discovery stay applied to both the state trial and appellate courts. Pivotal sought review by the Supreme Court, with its petition for certiorari arguing that “[i]t is time for this Court to step in” and suggesting that, absent Supreme Court review, the split among state trial courts was unlikely to be resolved.

On August 26, 2021, just as the Supreme Court was close to hearing arguments in Pivotal, the parties informed the Court that they had “reached an agreement in principle to settle the case ... subject to approval by the Superior Court of California.” When that happens – as seems likely as of this writing – the parties will move for dismissal of the Supreme Court case, leaving the dispute where it was when the Pivotal defendants moved for certiorari, i.e., at square one. Moreover, in the current political climate, it seems unlikely that Congress will enter the securities law fray as it did over 25 years ago via the PSLRA.

Even without a Supreme Court decision mandating that the stay be applied across the board, the much-discussed increase in state court Securities Act filings after Cyan may have been stanched by a less direct tactic favored by issuers. In 2020, the Delaware Supreme Court held, in Salzberg v. Sciabacucchi, that Securities Act forum selection clauses included in companies’ offering documents are facially valid. Unsurprisingly, given the Delaware Supreme Court’s outsized influence on corporate law (itself a by-product of Delaware’s dominance of the corporate incorporation business), state court Securities Act filings have decreased since Salzberg, as companies preemptively divert potential securities suits to federal court.

Assuming that most companies adopt the federal forum provisions as part of the process of going public, the scope of the PSLRA discovery stay may ultimately prove to be a moot point. However, in the event that state court filings increase post-pandemic, or if the holding of Salzberg is somehow limited, then the likely settlement in Pivotal will not prevent another aggrieved defendant from seeking review all over again.