Preparing for lawsuits challenging a company’s sale of securities

Welcome to the inaugural column in our new quarterly series discussing key topics of interest for general counsel (GCs) in California! Below we discuss ways GCs can think ahead prior to their company being challenged for sale of securities, and how GCs can plan the forum for such a lawsuit.

The GC’s primer: Securities litigation and the PSLRA

The Securities Act of 1933 (Securities Act) provides a cause of action for plaintiffs claiming deficiencies in a company’s offering of securities.

The Private Securities Litigation Reform Act (PSLRA) is a federal statute designed to curb abusive securities lawsuits, including those brought under the Securities Act.

Crucially, the PSLRA mandates that a securities plaintiff cannot serve any discovery (discovery is “stayed”) until a motion to dismiss is decided. This helps companies avoid high expenses associated with discovery before the merits of the claim are even considered. It also protects companies from needing to settle a non-meritorious case early merely to avoid the higher expenses of discovery.

Does the stay apply to all cases in California courts, state or federal? The answer is maybe. It largely depends on if your company is facing a Securities Act lawsuit in state or federal court. The PSLRA is a federal statute, meaning that it applies in federal cases. But whether the federal PSLRA discovery stay applies in state courts is an open question.

California courts are split, with no binding authority dictating whether a defendant can rely on a PSLRA discovery stay in state court. Several California superior court decisions have held that the PSLRA discovery stay does not apply to securities claims brought in state court. These cases include: In re Pivotal Software, Inc. Securities Litigation, No. CGC19576750 (S.F. Super. Ct. Mar. 4, 2021); Plymouth v. Adamas Pharms., Inc., No. RG190181715 (Alameda Super. Ct. July 16, 2019); Switzer v. W.R. Hambrecht & Co., LLC, 2018 Cal. Super. LEXIS 2429, *1-2 (S.F. Super. Ct. Sept. 16, 2018); and In re Pac. Biosciences of Cal. Inc. Secs. Litig., 2012 Cal. Super. LEXIS 20578, *13 (San Mateo Super. Ct. May 25, 2012).

In In re Pivotal, for example, the San Francisco Superior Court held that “there is no legal authority for the proposition” that the PSLRA discovery stay applies in state actions, and that the PSLRA’s plain language does not support application to state court. No. CGC19576750 (Slip Op. at 4).

On the other hand, several California superior court decisions have held that the PSLRA discovery stay applies in state court. These cases include: Ocampo v. Dfinity USA Research LLC, No. 21-CIV-03843 (San Mateo Sup. Ct. July 25, 2022); In re Pronai Therapeutics, Inc. S’holder Litig., No. 16CIV02473 (San Mateo Super. Ct. Mar. 14, 2018); and Milano v. Auhll, No. SB 213 476, 1996 WL 33398997, at *4 (Super. Ct. Oct. 2, 1996).

The court in Ocampo, for instance, applied statutory construction principles to find that the discovery provision of PSLRA applies to “any private action arising under” the PSLRA. No. 23-CIV-03843 at 3 (emphasis in opinion).

The Supreme Court was set to decide the split in Pivotal Software, Inc. v. Superior Court, 141 S.Ct. 2884 (2001), but the case settled before the Supreme Court could reach a decision. Thus, this split remains ripe for decision.

What California GCs need to know about invoking PSLRA in state court

Following the Supreme Court’s decision in Cyan v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), state courts saw an influx of Securities Act decisions. The critical question for California GCs, therefore, is what can be done to be protected by the PSLRA if exposed to a securities lawsuit. Some initial suggestions are below:

Check your FFPs. Whether your company is private or public, you should consider whether your company has a federal forum provision (FFP) in place. These clauses are often included in a company’s bylaws or articles of incorporation, and they mandate that certain types of claims against the company must be brought in federal – rather than state – court. FFPs help companies assert some control over litigation brought against them, helping them avoid the uncertainties and complexities of litigating securities claims in state court.

If you do not have an FFP for Securities Act claims, you should consider adding one, particularly if you are a private company considering going public – IPOs are a fertile source of Securities Act claims.

If you have an FFP in place, now is a good time to revisit the FFP to make sure it is valid and enforceable. Consider whether the provision was properly enacted (for example, if the FFP is contained in your bylaws, whether the bylaws were properly approved), and whether the FFP has – or is in a document that has – a jury waiver or other challengeable provision.

Aim for federal court. If you are litigating in state court, there is a good chance you are also facing parallel federal litigation. If so, you may give serious thought to whether to immediately seek a stay of the state case. This type of stay is discretionary, but if granted by the court, could help stave off early, expensive discovery.

Invoke the PSLRA. Some GCs may incorrectly assume that if they are litigating in California state court, they cannot invoke the PSLRA. But, as discussed above, there is no binding authority in California holding either way – either that the PSLRA applies, or it does not. Thus, if confronted with early-case discovery (i.e., before any motion to dismiss is decided), GCs should consider moving to quash on grounds that the PSLRA discovery stay applies.

The bottom line is that it is never too early to plan ahead for potential Securities Act claims leveled against your company. And California companies would be wise to start strategically considering how to reduce the burden and expense of such claims in the future.