Welcome to S&C's podcast series, S&C's Critical
Insights.
My name is Julia Malkina.
I'm a Partner in the Litigation Group.
I'm here today with my litigation partner,
Jeff Scott.
Today we will discuss recent trends and emerging
issues in private securities litigation.
Julia, let's start by looking at some recent
numerical trends in private securities litigation.
Now, notwithstanding the existence of the
Private Securities Litigation Reform Act,
which was designed to eliminate frivolous
securities litigation, we saw a record number
of securities class actions filed in 2019.
The plaintiff of this bar filed 428 securities
class actions in 2019, which is the most on
record, up slightly from 420 from 2018 and
413 in 2017.
And this greatly exceeded the twenty-year
average of 2015, from 1997 to 2018.
So we have seen in the last few years a very
significant increase in the filing of securities class actions.
And putting aside M&A-related litigation,
new federal filings against technology companies
have more than doubled since 2017 from 14
to 29, while federal filings against companies
in the financial sector remain below the twenty-year
historical average.
In 2019, non-M&A federal filings against communications companies
reached their highest number since 2002 at 37.
One of the reasons for the increase in securities
class actions is undoubtedly the Supreme Court's
2018 decision in Cyan v Beaver County Employees
Retirement Fund.
In Cyan, the Supreme Court held that Plaintiff's
neighboring claims under the Securities Act
of 1933 in state court, and that Defendants
may not remove those claims to Federal Court.
The '33 Act encompasses claims that a registration
statement, or prospectus, contain material
misstatements or omissions.
Since Cyan, there has been significant growth
in the filing of '33 Act claims in state court.
In 2019, there were in fact more '33 Act claims
filed in state court than in federal court,
contributing to the growth in securities class
actions generally.
There were 18 '33 Act class action filings
in New York leading the pack.
There were 15 such filings in California and
16 in other states.
This is up from only 6 in other states in
2018.
We're also seeing a significant amount of
duplicative litigation.
In approximately 45% of 2019 state court '33
Act cases, there was a parallel federal court case.
Julie, with the spike in state '33 Act cases,
post Cyan, I think you'd agree with me that
there are several important issues regarding
how those suits will be conducted in state courts.
For example in '33 Act cases in Federal court,
it is well settled that the Private Securities
Litigation Reform Act (or "PSLRA") stays all
discovery pending a motion to dismiss barring
exceptional circumstances.
In the post-Cyan cases being filed in state
court, an important question is currently
being litigated across the country in state
courts is whether the PSLRA discovery stay
is applicable to these state court actions.
I agree, Jeff.
In New York, judges in the state trial courts
have split on the issue, and there is no Appellate
guidance as of yet.
One New York State judge has held in two cases
that the stay does not apply, briefly noting
without further explanation that to hold that
the PSLRA automatic stay applies to state
court actions would undermine Cyan's holding
that '33 Act cases can proceed in state court.
At least one California court also has held
that the stay does not apply, stating that
the PSLRA's provision for a discovery stay,
is of procedural nature, and therefore only
applies to actions filed in Federal court.
By contrast Julia, another New York State
judge has held that the stay applies under
the plain text of the statute.
The court noted that the simple, plain and
unambiguous language expressly provides that
discovery is stayed during a pending motion
to dismiss in any private action arising under
this sub chapter, of which Section 11 is one.
And contrasted this with other PSLRA provisions
which specifically refer to actions brought
pursuant to the Federal rules of civil procedures.
A Connecticut court also has held that the
stay applies under an essentially identical
statutory analysis.
And we also have a pre-Cyan California ruling
which relied a similar textual analysis to
find that the stay applies.
Another New York State court judge expressed
some skepticism that a stay is required by
the language of the PSLRA.
But the judge nonetheless stayed discovery
because of policy concerns behind the PSLRA
stay, which is primarily ensuring that cases
have merit at the outset.
I expect that the applicability of the PSLRA
discovery stay to state court actions bringing
'33 Act claims will continue to be vigorously
litigated in state courts.
As we have discussed, Jeff, the increase in
parallel filings in state courts also raises
the issue of when state proceedings should
be stayed in favor of the Federal cases.
New York courts have looked to the general
stay factors in determining whether the stay
'33 Act state cases in favor of Federal proceedings.
Those factors are: whether the Federal action
was commenced first and the stage of litigation;
whether there is substantial overlap between
the parties, issues and relief requested where
a more complete disposition of issues may
be obtained; whether a stay will avoid duplication
of effort (a waste of judicial resources and
a risk of inconsistent rulings); whether plaintiffs
have demonstrated how they would be prejudiced
by a stay; and which court possesses a greater
familiarity with trial-such issues.
Julie, among the factors you just listed,
it appears to me that the factor that seems
to be doing the most work is: which action
is first filed?
Indeed, several New York courts have state
actions filed after a similar Federal proceeding.
I agree with that, Jeff.
The New York courts are significantly less
likely to stay a state court action when the
Federal action was later filed.
Unlike the '33 Act, the Securities Exchange
Act of 1934, which governs the sale of securities
on the secondary market, gives exclusive jurisdiction
to the Federal courts, allowing for the disposition
of both the '33 Act and '34 Act claims in
one forum, appears to motivate some of these
decisions to stay state cases in favor of
a Federal action, as well.
Let's turn to the pleading standards that
may apply to state court.
In Federal court, Section 11 claims are subject
to, at a minimum, the Twombly Iqbal Plausibility Pleading Standard.
They also may be subject to the Heightened
Rule 9(b) Pleading Standard, which requires
Plaintiffs to state, with particularity, the
circumstances constituting fraud if the allegations
in the complaint sound in fraud.
However, there is more variability in state
court pleading standards,
many of which are more lenient.
For example, California has a particularly
lenient requirement, which requires only a
statement of the facts constituting the cause
of action in ordinary and concise language.
Given the large volume of Section 11 cases
in California, this likely is one reason why
motions to dismiss Section 11 claims in state
court cases have been granted at a lower rate
at 28% versus the grant rate of 39% in Federal
court cases over the period of 2011-2019.
Like Federal court, some state courts also
have heightened pleading standards for claims
that sound in misrepresentation or fraud even
if the cause of action does not have fraud
as a component.
Recently one New York State court applied
New York's heightened pleading standard for
misrepresentations to a Section 11 claim under
the '33 Act.
However, another New York State judge decided
only a few weeks later that New York's heightened
pleading standard for misrepresentations does
not apply, briefing that the standard for
liability in '33 Act cases is negligence and
New York's heightened pleading standard generally
does not apply to negligence cases.
With additional burdens, risks and uncertainties
a state court '33 Act claims, some companies
have added Federal form provisions to their
charters or by-laws.
Such provisions provide that all '33 Act claims
against the company must be brought in Federal court.
The Delaware Supreme Court recently held that
such provisions are valid as a matter of Delaware
corporate law.
This is an important decision that may curb
the rise of state '33 Act claims.
But it remains to be seen whether other state
courts will enforce Federal form provisions.
This is important because state '33 Act claims
are mostly brought outside of Delaware, and
efficacy of Federal form provisions will depend
on whether the state courts, in which the
'33 Act claims are brought, enforce them.
Julie, let's address another important issue
that continues to be litigated in securities
class actions.
And that concerns what standard applies to
a defendant's burden to rebut the basic presumption
left open by the Supreme Court's well-known
decision in Halliburton II.
Now by invoking the basic presumption, securities
plaintiffs need not show direct reliance on
alleged misstatements as long as the statements
were public in material, the stock was traded
in an efficient market and the Plaintiff traded
in the stock during the relevant period.
The presumption is based on what is called
the "fraud on the market" theory.
And that is that the market price of the security
traded in an efficient market incorporates
all public material information.
It is the basic presumption that allows most
securities fraud lawsuits to proceed as class actions.
In Halliburton II, the Supreme Court declined
to overrule Basic.
But the Court held that the defendant may
rebut the basic presumption at the class certification
stage by showing a lack of price impact from
the alleged misrepresentation.
However, the Supreme Court did not set out
what standard the defendant has to satisfy
for rebutting the presumption.
Federal Rule of Evidence 301 provides a general
standard for presumption in civil cases.
That is "the party against whom a presumption
is directed has the burden of producing evidence
to rebut the presumption.
But this rule does not shift the burden of
persuasion."
Julie, as you're aware, a circuit split has
developed between the Eighth Circuit, which
has held that defendants have only the burdened
come forward with evidence showing a lack
of price impact under Federal Rule of Evidence
301,
and the Second Circuit, which has stated that
defendants must rebut the basic presumption
by disproving reliance by a preponderance
of the evidence at the class certifications
stage, and that's in a case called Wagner
v. Barclays PLC.
Now there are very strong arguments that Federal
Rule of Evidence 301 should govern a Defendant's
rebuttal right under Halliburton II, instead
of the preponderance of the evidence standard.
Ultimately, I believe that this debate will
likely need to be resolved by the Supreme Court.
Shifting gears away from class certification,
we should highlight that we are beginning
to see COVID-19-related securities litigation.
These cases involve responses to COVID-19,
such as statements about vaccines or testing,
alleged attempts to downplay the impact of
COVID-19 on continuing operations, such as
for cruise operators and rental property,
and issues allegedly exposed to the heightened
use of certain products following the outbreak
of COVID-19, such as supposed securities flaws
in Zoom's video chat products.
We've seen multiple cases against cruise lines
pending in the Southern District of Florida
based on alleged misstatements regarding their
positive outlook in COVID-19 preventative measures.
There's a case out in the Eastern District
of Pennsylvania alleging that a pharmaceutical
company made misleading statements regarding
a development of a COVID-19 vaccine.
Multiple complaints have also been filed against
Zoom in the Northern District of California
alleging a failure to disclose data privacy
issues, which caused its stock price to climb
when revealed following the COVID-19 outbreak.
There's a case in the Southern District of
New York regarding a January 2020 ADS offering
by a real estate management company with holdings
in China, including Wuhan, alleging the company
failed to disclose the extent to which it
was already suffering from the impact of COVID-19
on the rental market in China.
Similarly in the Southern District of New
York, we have a case alleging that a defendant's
disclosures about distributing an anticipated
large order of COVID-19 diagnostic tests were
overstated or entirely fabricated.
Julia, the COVID-related cases that you just
referred to are largely related to the initial
impact of the crisis.
It really remains to be seen what types of
securities litigation may arise from the continuing
effects of the crisis and the associated shutdown
orders.
But several categories of suits come to mind
when you think about this issue.
First, there may be cases involving companies
with day-to-day operations directly impacted
by travel restrictions and social distancing,
such as cruise operators and airlines, where
there could be potentially inadequate risk
disclosures or misstatements regarding the
estimated impact of the pandemic to the core
business.
There also may be cases concerning companies
involved in the immediate response to the
pandemic based on potentially misleading statements
about their response.
Companies that come to mind are pharmaceutical
companies, or manufacturers, for example,
of protective equipment.
There also may be cases where underlying weaknesses
in finances, supply chains, products, etc.
are revealed by the crisis, leading to allegations
of prior insufficient risk disclosures.
Now, in light of the risks of such claims
being brought, companies really should be
very careful in reviewing their disclosures
with the assistance of both internal and external
counsel, to make sure they are adequately
disclosing any material impact that the ongoing
COVID pandemic is having on the companies'
financial performance, business operations
and activities that concern material business
lines or units of those companies.
The SEC has issued multiple pieces of guidance
on COVID-19 disclosures which could be helpful
to companies, to the extent they can argue
in COVID-19-related securities litigation
that their disclosures followed the SEC guidance.
Conversely, plaintiffs may supplement securities
litigations with allegations that companies
violated the SEC's guidance, such as guidance
of April 8th, which suggests that companies
disclose "where the company stands today operationally
and financially, how the company's COVID-19
response, including it's efforts to protect
the health and wellbeing of its workforce
and its customers, is progressing and how
its operations and financial condition may
change as all of our efforts to fight COVID-19
progress."
That's all we have for today concerning emerging
issues in private securities litigation.
Thank you for listening to S&C's Critical
Insights.
For more information about our practice, please
visit us on the web at www.sullcrom.com.
Please also join Julia and me for our S&C
Critical Insights on the priorities of the
SEC's enforcement division and recent securities
enforcement trends.
