Opinion analysis: Justices affirm continued authority of state courts over securities class actions

The oral argument in Cyan, Inc. v. Beaver County Employees Retirement Fund was notable for the repeated expression by the justices of frustration at the “gibberish” Congress provided in the Securities Litigation Uniform Standards Act of 1998. I suggested in my post about the argument that it would be surprising if they went so far as to hold that the language has no meaning at all. But yesterday’s opinion by Justice Elena Kagan for a unanimous court comes pretty close to doing precisely that; a plain-language summary of this opinion would simply state that “if Congress wants to make any important changes to litigation of federal-law securities cases in state courts, it is going to have to be a lot more specific than it has been to date.”

As that summary suggests, Cyan involves the recurring tension between the strong federal interest in regulating national securities markets and the longstanding tradition under which federal and state courts have shared the task of adjudicating securities cases. Federal securities law starts from two New Deal statutes – the Securities Act of 1933 and the Securities Exchange Act of 1934. The 1933 Act requires companies that offer securities to the public to make accurate disclosures of relevant information. Violations of that statute traditionally have been actionable in state and federal court. Indeed, Congress so trusted the state courts with that litigation that it barred removal to federal court of actions filed under the 1933 Act in a state court. Ordinarily, because an action under the 1933 Act would “arise under federal law,” the defendant would have been able to remove it; the 1933 Act’s anti-removal provision is thus a notable feature of that statute. The 1934 Act, by contrast, regulates the trading of existing securities (typically on national exchanges); federal courts have exclusive jurisdiction over suits under the 1934 Act.

In the 1990s, Congress amended the securities laws twice, acting on both occasions to rein in perceived abuses involving securities class actions. The first revisions were in 1995, in the Private Securities Litigation Reform Act. That statute made both substantive changes (which would apply to federal-law actions wherever brought) and procedural changes (which would apply only in federal court). Predictably, plaintiffs responded by bringing actions in state court (thus avoiding the procedural hurdles of the PSLRA) or under state law (thus avoiding the substantive hurdles of the PSLRA) or both (avoiding the PSLRA entirely).

The PSLRA-driven rise of state-law and state-court class actions led to the second set of amendments, embodied in SLUSA. The central feature of SLUSA is a ban on “covered” class actions based on state law. (Section 77p(f) explains that a class action is “covered” if it has more than 50 plaintiffs.) Specifically, Section 77p(b) provides: “No covered class action based upon the statutory or common law of any State … may be maintained in any State or Federal court.” Congress added a new provision, Section 77p(c), permitting defendants to remove the now-forbidden state-law class actions to federal court: “Any covered class action brought in any State court, as set forth in subsection (b) of this section, shall be removable to the [local] Federal district court … and shall be subject to subsection (b) of this section.” As the Supreme Court held in an earlier case, the statement that the removed case “shall be subject to subsection (b)” has an obvious purpose: to ensure that the district court promptly dismisses the action.

This case involves what SLUSA describes as “conforming amendments” to the jurisdictional provisions of the 1933 Act (the provisions that permit state courts to hear actions under the 1933 Act and do not permit defendants to remove them). The amendment revises the jurisdiction provision (Section 77v(a)) to add the “except” clause in the following:

The district courts of the United States … shall have jurisdiction …, concurrent with State and Territorial courts, except as provided in section 77p of this title with respect to covered class actions, of all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter.

This case asks what Congress meant when it referred to the “covered class actions” in the “except” clause. The defendant – pointing to the definition of “covered” in Section 77p(f) – said the statute bars state courts from hearing any large class actions, whether they are based on state or federal law. The plaintiffs, on the other hand, argued that the statute bars state courts only from hearing the large state-law class actions banned by Section 77p(b).

Kagan’s answer is that the statute has no effect on the traditional power of states to hear class actions presenting claims under the 1933 Act: “State-court jurisdiction over 1933 Act claims thus continues undisturbed.” The opinion ranges widely through the detailed provisions of the federal securities laws to refute the defendant’s argument “that the except clause exempts all sizable class actions … from [the 1933 Act’s] conferral of jurisdiction on state courts.”

Kagan rests two narrow arguments directly on the text of the except clause. First, she notes, “the except clause points to ‘section 77p’ as a whole – not to paragraph 77p(f)(2),” the clause that defines “covered” class actions. As she sees it, the defendant “wants to cherry pick from the material covered by the statutory cross-reference. But if Congress had intended to refer to the definition in § 77(p)(f)(2) alone, it presumably would have done so—just by adding a letter, a number, and a few parentheticals.” Second, she points out that whatever purpose it might serve, “the definitional paragraph on which [the defendant] relies cannot be read to ‘provide[]’ an ‘except[ion]’ to the rule of concurrent jurisdiction.’” She explains that the defendant’s reading cannot work because “[a] definition does not provide an exception, but instead gives meaning to a term—and Congress well knows the difference between those two functions.”

Kagan turns quickly, though, from arguments about the except clause itself to arguments about the broader context of the securities laws.  For example, she discusses the text of the other conforming amendment in SLUSA, which qualifies the general bar on removal in the 33 Act by adding the phrase “[e]xcept as provided in section 77p(c).” Kagan notes that the removal amendment – “just four sentences down from the except clause central to this case” – “pinpointed a subsection of 77p, rather than citing the entire section for only one of its parts. Still more, that cross-referenced subsection contains an operative provision that could limit a rule, rather than a mere definition of a statutory term.”

Moving to more general policy arguments, Kagan emphasizes the oddity of a reading that “would prevent state courts from deciding any 1933 Act class suits seeking damages for more than 50 plaintiffs,” because that would bar suits even if they did not involve “covered” securities (defined in SLUSA to refer to securities traded on a national exchange). In prior cases, though, the Supreme Court had concluded that SLUSA “‘expresses no concern’ with ‘transactions in uncovered securities’” because they are “‘primarily of state concern,’ and SLUSA ‘maintains state legal authority’ to address them.” Those cases, of course, did not consider the statute at issue here, but Kagan deploys them to discount the idea that Congress intended to “strip state courts of jurisdiction over suits about securities raising no particular national interest. That result is out of line with SLUSA’s overall scope.”

Finally, Kagan emphasizes that the statute designates the except clause as a mere “conforming amendment”:

The change [the defendant] claims th[e except] clause made to state-court jurisdiction is the very opposite of a minor tweak. When Congress passed SLUSA, state courts had for 65 years adjudicated all manner of 1933 Act cases, including class actions. … To think [the defendant] right, we would have to believe that Congress ended that entrenched practice not by any direct means, but instead by way of a conforming amendment to § 77v(a) (linked, in its view, with only a definition).

In sum, borrowing a metaphor from an old opinion of the late Justice Antonin Scalia, she concludes that “Congress does not ‘hide elephants in mouseholes.’”

Having addressed the defendant’s textual argument so forcefully, Kagan can give more cursory treatment to the defendant’s “broad purposive argument” that Congress’ “principal intention in enacting SLUSA” requires “divesting state courts of jurisdiction over all sizable 1933 Act class actions.” For her, that argument “ignores a different way in which SLUSA served [the objectives of the PSLRA].” Pointing to the substantive rules in the PSLRA – which plaintiffs “could – and did – avoid … by bringing their complaints … under state law” – Kagan portrays “SLUSA’s bar on state-law class actions” as a “guarante[e] that the [PSLRA]’s heightened substantive standards would govern all future securities class litigation.”

Moreover, she points out, because the bar on state-law class actions affects claims that would fall under the 1934 Act as well as the 1933 Act, Kagan’s reading of SLUSA moves all large class litigation about the trading of securities into the federal courts (because the federal courts already had exclusive jurisdiction over federal-law claims of that type). Summarizing, she portrays her reading as implementing a compromise under which “all covered securities class actions must proceed under federal law; most (those alleging 1934 Act claims) must proceed in federal court; some (those alleging 1933 Act claims) may proceed in state court.”

Finally, the opinion takes on the defendant’s argument that “the except clause would serve no purpose at all” under Kagan’s reading. Remember, under her reading, Section 77p(b) categorically bars state and federal courts from hearing state-law class actions, and the jurisdiction provision states that the state and federal courts are to have concurrent jurisdiction over claims under the 1933 Act “except as provided in section 77p.” So what is needed to give any weight to the except clause is some type of action under the 1933 Act that can proceed only in federal court – but Kagan’s opinion has just explained that state courts retain their authority over 1933 Act class actions, large and small alike. Kagan acknowledges, “[t]ruth be told,” that the justices are “not sure” what “Congress had … in mind” when it wrote the except clause, but she concludes that:

In the end, the uncertainty surrounding Congress’s reasons for drafting that clause does not matter. … Because … we have no sound basis for giving the except clause a broader reading than its language can bear. … Whatever questions remain as to the except clause’s precise purpose … they do not give us permission to devise a statute (and at that, a transformative one) of our own.

Kagan goes on to reject a rather Solomonic argument presented by the government – though not raised by the facts of the case or supported by either party. The government’s idea – recognizing the difficulty of finding a jurisdictional bar on state-court adjudication of 1933 Act class actions – was to suggest that defendants should be able to remove those cases from state court. That argument, Kagan explains, flies in the face of the language of the removal provision relied on so heavily earlier in the opinion. Kagan notes that the Supreme Court already has held in earlier cases that the “straightforward reading” of the conforming amendment to the removal provision (Section 77p(c)) is that it calls for removal of exactly the cases barred by the adjacent preclusion provision (Section 77p(b)). As anybody who has read so far knows all too well, the preclusion provision bars only large state-law class actions. So the removal provision permits removal only of those same large state-law class actions – and it does so to give the federal court the ability to dismiss them promptly. In sum, Kagan explains that the justices are unwilling to accept that “Congress simply must have wanted 1933 Act class actions to be litigated in federal court. … If further steps are needed they are up to Congress.”

[Disclosure: Goldstein & Russell, P.C., whose attorneys contribute to this blog in various capacities, is among the counsel to the respondents in this case. The author of this post is not affiliated with the firm.]