In Cyan v. Beaver County Employees' Retirement Fund, 138 S. Ct. 1061 (2018), the Supreme Court unanimously held that state courts have jurisdiction over class actions alleging only violations of the Securities Act of 1933 (1933 Act). The court did not address whether all of the procedural protections of the Private Securities Litigation Reform Act (PSLRA) apply with equal force when plaintiffs bring 1933 Act suits in state court. It is exceedingly unlikely, however, that the Cyan court intended to permit plaintiffs to circumvent the PSLRA's limitations by bringing class actions asserting 1933 Act claims in state court rather than federal court.

One of the PSLRA's key procedural protections is the automatic stay of discovery during the pendency of a motion to dismiss. This serves "to protect defendants … from the burden and expense of premature discovery … until the court sustains the sufficiency of the complaint." ATSI Communications v. Shaar Fund, Ltd., 2003 WL 1877227, at *2 (S.D.N.Y. April 2, 2003). "The legislative history of the PSLRA indicates that Congress enacted the discovery stay to prevent plaintiffs from filing securities class actions with the intent of using the discovery process to force a coercive settlement." In re LaBranche Sec. Litig., 333 F. Supp. 2d 178, 181 (S.D.N.Y. 2004). Congress also aimed "to prevent plaintiffs from … using [a meritless lawsuit] as a vehicle 'in order to conduct discovery in the hopes of finding a sustainable claim not alleged in the complaint.'" In re Vivendi Universal, S.A. Sec. Litig., 381 F. Supp. 2d 129, 129-30 (S.D.N.Y. 2003) (quoting S. Rep. No. 104-98, at 14 (1995)).

Post-Cyan courts are divided on whether the PSLRA's discovery stay applies in state court actions asserting 1933 Act claims. Two New York state court judges—Justice Saliann Scarpulla and Justice Andrew Borrok—have reached opposite conclusions on this question. But both the language and the purpose of the PSLRA's discovery stay demonstrate that it reaches state court actions as well as federal court actions.

A Connecticut Court Holds the PSLRA's Discovery Stay Applies in State Court Actions. The PSLRA provides: "In any private action arising under this subchapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds, upon the motion of any party, that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." 15 U.S.C. §77z-1(b)(1).

In City of Livonia Retiree Health and Disability Benefits Plan v. Pitney Bowes, 2019 WL 2293924 (Conn. Super. Ct. May 15, 2019), a Connecticut state court found that the "plain meaning" of 15 U.S.C. §77z-1(b)(1) "compels the conclusion that [it] … applies to actions commenced in state court under the [1933] Act, as well as such actions commenced in federal court." Id. at *4. The court found that the phrase "[t]his subchapter" in §77z-1(b)(1) refers to the 1933 Act, which "confers concurrent jurisdiction on state and federal courts." Id. at *3. The court further determined that the phrase "any private action arising under this subchapter" encompasses actions commenced in state court as well as federal court. Id. at *4. The court found it significant that a different provision of the same statute—§77z-1(a)(1)—specifically states that it "shall apply to each private action arising under this subchapter that is brought as a plaintiff class action pursuant to the Federal Rules of Civil Procedure." Id. The court reasoned that "[b]ecause 77z-1(b)(1) does not contain the same language, the inference is strong that it is not limited to actions … in federal court." Id.

The Connecticut court pointed out that in Cyan, the Supreme Court observed that the safe harbor provisions set forth in 15 U.S.C. §77z-2 "applied even when a 1933 Act suit was brought in state court." Id. The court further noted that one provision of that statute, §77z-2(c)(1), also uses the phrase "in any private action arising under this subchapter." Id. The court found that "[b]ecause the Supreme Court held that language identical to that at issue here applies to both state and federal actions commenced under the [1933] Act, the inference is strong that Section 77-1(b)(1) was meant to apply to actions pending in state court as well as in federal court." Id. The court considered it significant that §77z-2, "which the Supreme Court expressly held applies to state as well as federal actions, also contains [a provision providing for] a stay of discovery during the pendency of a motion relevant to a determination of the merits of the action." Id. (citing 15 U.S.C. §77z-2(f)). The court explained that it is "bound by the decision in Cyan approving the application to a state court action of a provision of the [1933] Act that stays discovery during the pendency of a substantive pretrial motion." Id. at *5.

Despite the fact that several months earlier a California state court found that "the PSLRA's provision for a discovery stay is of a procedural nature, and therefore only applies to actions filed in federal court, not state court," Switzer v. Hambrecht & Co., 2018 WL 4704776, at *1 (Cal. Super. Ct. Sept. 19, 2018), the Connecticut court specifically rejected plaintiffs' contention that "state law should govern whether a stay of discovery is to be granted because it is a procedural issue and not a substantive one." City of Livonia, 2019 WL 2293924, at *5.

New York State Courts Are Divided on the Applicability of the PSLRA's Discovery Stay. In Matter of PPDAI Group Securities Litigation, 2019 WL 2751278 (N.Y. Sup. Ct. July 1, 2019), Justice Scarpulla found that "[a]pplication of the federal PSLRA automatic discovery stay would undermine Cyan's holding that [1933] Act cases may be heard in state courts." Id. at *7. She therefore determined that "the PSLRA's automatic discovery stay is not applicable to an action brought in New York State court." Id. She also noted that "in the Commercial Division discovery generally continues during motion practice." Id. Justice Scarpulla reached the same conclusion in In re Dentsply Sirona Shareholders Litigation, 2019 WL 3526142 (N.Y. Sup. Ct. Aug. 2, 2019).

In In re Everquote Securities Litigation, 65 Misc. 3d 226 (N.Y. Sup. Ct. 2019), however, Justice Borrok took the opposite approach and applied the PSLRA's discovery stay during a pending motion to dismiss an action alleging 1933 Act claims. He explained that "[t]he simple, plain, and unambiguous language [of §77z-1(b)(1)] expressly provides that discovery is stayed during a pending motion to dismiss 'in any private action arising under this subchapter.'" Id. at 236. He observed that "[t]he statute simply does not say that the automatic stay is limited to claims brought pursuant to the 1933 Act in federal court." Id. at 237.

Justice Borrok rejected plaintiffs' contention that "state court practices and procedures would be constrained" if the PSLRA's discovery stay were to apply in state court actions. Id. at 239. He explained that "[t]his is not an issue of federal common law being applied to supply a rule of decision." Id. Rather, "[i]t was Congress that created the specific rights covered by the 1933 Act including affording concurrent jurisdiction to state courts to adjudicate claims brought under the 1933 Act." Id. He found that "the critical issue is not how a stay of discovery squares in the abstract with either Commercial Division rule 11 or CPLR 3214 or case assignment." Id. at 240. Instead, "the controlling issue is how this court implements the congressional mandate regarding how it is to manage 1933 Act claims that find their way into state courts." Id. He held that this "mandate requires a stay" during a pending motion to dismiss when plaintiffs bring 1933 Act claims in state courts. Id.

Justice Borrok correctly reasoned that holding otherwise would "run afoul of the well-recognized purpose of [the PSLRA]." Id. He found that "Congress enacted the automatic stay of discovery during a pending motion to dismiss to address [the] concern" of plaintiffs "making significant discovery requests in otherwise meritless lawsuits … in the hope of encouraging early settlement." Id. He determined that there "simply is no basis to find that Congress intended for this provision to only apply to actions brought in federal court." Id.

Justice Borrok observed that "a divergence in the application of the [PSLRA] discovery stay in state and federal court would create the undesirable … and absurd incentive for lawsuits brought under the 1933 Act to be brought in state court as opposed to federal court to avoid the very protection supporting the enactment of the [PSLRA]." Id. He explained that this would "confound[] Congress' acknowledged intention that the lion's share of securities litigation would occur in the federal courts." Id.

Pending guidance from state appellate courts, defendants in state court actions asserting 1933 Act claims should rely on the detailed reasoning in City of Livonia and Everquote in moving to stay discovery pending the resolution of a motion to dismiss.

Craig S. Waldman is a litigation partner at Simpson Thacher & Bartlett.