“Cyan,” Reverse-“Erie,” and the PSLRA Discovery Stay in State Court

In the wake of the Supreme Court’s holding in Cyan, Inc. v. Beaver County Employees Retirement Fund[1] that state courts have concurrent jurisdiction over Securities Act claims, even if asserted as class actions, there has been an influx of Securities Act class actions filed in state courts. A key question has divided courts and commentators: Does the Private Securities Litigation Reform Act (“PSLRA”) discovery stay apply in state court? For example, in September 2018, a Superior Court in California held that the stay did not apply in state court,[2] while in May 2019 a Superior Court in Connecticut held that it did.[3]

The issue implicates the so-called “reverse-Erie” doctrine. As explained by Kevin M. Clermont in his seminal article, Reverse-Erie, this doctrine governs the very issue posed here: “In state court, when does state law apply and when does federal law apply?”[4] Drawing from Supreme Court case law and scholarly commentary on the reverse-Erie doctrine, I argue that the PSLRA discovery stay does not apply in state court.

When applying the reverse-Erie doctrine to potentially displace state rules that are procedural in nature (like discovery rules), two presumptions weigh against that displacement. First, there is a “normal presumption against pre-emption.”[5] Second, there is a “general rule, ‘bottomed deeply in belief in the importance of state control of state procedure,’ . . . that ‘federal law takes the state courts as it finds them.’”[6] And yet, pursuant to the reverse-Erie doctrine, federal law sometimes displaces state rules that are procedural in nature when federal claims are heard in state court.

First, I argue that the PSLRA does not expressly preempt states’ permissive discovery rules. The PSLRA provisions in the Securities Act contain explicit statements about the scope of their applicability. Some of those provisions, such as the one covering the appointment of a lead plaintiff, apply only to “each private action arising under this Act that is brought as a plaintiff class action pursuant to the Federal Rules of Civil Procedure” and thus do not purport to apply in state court.[7] Other provisions, including the one covering a discovery stay, apply “[i]n any private action arising under this Act.”[8] Relying on this different language, some courts and commentators have concluded that the PSLRA expressly preempts states’ permissive discovery rules. I argue, however, that a more reasonable interpretation of this language is that Congress intended for some provisions to apply only to class actions (e.g., the appointment of lead plaintiff provisions) and other provisions to apply to both individual and class actions (e.g., the discovery stay). Indeed, all of the provisions preceded by the more restrictive-scope language relate to procedures that only make sense in the context of class actions. Thus, I contend that such language is not intended to differentiate between provisions that apply in state court and those that do not; rather, it is intended to differentiate between provisions that apply only in class actions and those that apply in both individual and class actions.

Second, I argue that, whether under a preemption analysis or a judicial choice-of-law analysis (which the Supreme Court sometimes merges in the reverse-Erie context), the PSLRA discovery stay does not apply in state court. Drawing on the key Supreme Court precedent and scholarly commentary thereon, I identify eight considerations applicable to the reverse-Erie analysis, absent express preemption: (1) the state’s interest in applying its own procedure; (2) whether the state procedure applies to all like claims or singles out the federal claim; (3) whether the state procedure applies to both parties or singles out one party; (4) the degree to which the state procedure undercuts federal policy; (5) whether the federal procedure is internally-sourced or externally-sourced; (6) the degree to which the choice of procedure is potentially outcome-determinative; (7) if outcome-determinative, the risk of forum-shopping; and (8) if outcome-determinative, the risk of treating similarly situated parties differently based on access to different fora.

Applying these considerations, I argue that the following four weigh against applying the PSLRA discovery stay in state court: (1) each state has both normative and administrative interests in applying its own discovery rules, which are at the core of state procedure; (2) states’ permissive discovery rules apply to all like claims and do not single out Securities Act claims; (3) states’ permissive discovery rules apply to both parties, rather than singling out one party, although they admittedly are more likely to benefit Securities Act plaintiffs in practice; and (4) states’ permissive discovery rules do not undercut the federal policy of providing a remedy for meritorious Securities Act claims, although they do admittedly undercut the specific policies supporting the PSLRA discovery stay of preventing fishing-expedition discovery and extortive discovery.

I contend that the following four considerations weigh in favor of applying the PSRLA discovery stay in state court: (1) the PSLRA discovery stay is internal to the Securities Act; (2) the application of states’ permissive discovery rules to Securities Act claims has the potential, in practice, to indirectly affect the ultimate disposition of a subset of cases where the plaintiff uncovers facts in discovery that enable the plaintiff to amend an otherwise deficient complaint so as to avoid dismissal; (3) the outcome-determinative impact of states’ permissive discovery rules in these cases has the potential to contribute to forum-shopping, although that impact is marginal in light of the other reasons that plaintiffs might elect to proceed in state court; and (4) the defendant, which is the party potentially harmed by the outcome-determinative impact of states’ permissive discovery rules, does not have the right to remove the case to federal court.

On balance, although these considerations are mixed, I contend that they weigh against applying the PSLRA discovery stay in state court, especially against the backdrop of the presumption against preemption and the general rule that federal law takes state courts as it finds them.

ENDNOTES

[1] 138 S. Ct. 1061 (2018).

[2] Order Denying Defendants’ Motion to Stay Further Discovery Pending Ruling on Demurrer, Switzer v. W.R. Hambrecht & Co., Nos. CGC-18-564904, CGC-18-565324, 2018 WL 4704776, at *1 (Cal. Super. Ct. Sept. 19, 2018).

[3] Memorandum of Decision Re Defendants’ Motions for Protective Order Staying Discovery Pursuant to 15 U.S.C. Section 77z-1(b)(1), City of Livonia Retiree Health & Disability Benefits Plan v. Pitney Bowes Inc., No. X08-FST-CV-186038160-S, 2019 WL 2293924 (Conn. Super. Ct. May 15, 2019).

[4] Kevin M. Clermont, Reverse-Erie, 82 Notre Dame L. Rev. 1, 4 (2006).

[5] Johnson v. Fankell, 520 U.S. 911, 918 (1997).

[6] Id. at 919 (quoting Hart, The Relations Between State and Federal Law, 54 Colum. L. Rev. 489, 508 (1954)).

[7] 15 U.S.C. § 77z-1(a).

[8] 15 U.S.C. § 77z-1(b)(1).

This post comes to us from Professor Wendy Gerwick Couture at the University of Idaho College of Law. It is based on her recent paper, “Cyan, Reverse-Erie, and the PSLRA Discovery Stay in State Court,” available here.

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