In re Trulia and Cyan, Inc.: Will Cyan Undo the Progress of Trulia?
By Ryan Lewis
Last year the Delaware Court of Chancery handed down a landmark opinion in the fight against abusive class-action merger litigation. Chancellor Bouchard held in In re Trulia that strike suit litigation settlement approvals will have to meet a higher standard to pass muster, with the intended result, which was in fact supported by statistical evidence, that the plaintiff’s bar would stop bringing claims that were clearly frivolous. All in all, I consider Trulia a win, but the Supreme Court of the United States just handed down a ruling earlier this week in Cyan, Inc. that has the potential to undo the policy gains achieved in Trulia. While Cyan seems to me to be soundly reasoned, and even properly held, it will truly be unfortunate if Cyan reopens the floodgates for meritless strike suits. Hopefully the limits of the Cyan holding will prevent this outcome.
Trulia: A Delaware state corporate law decision with Federal securities law implications.
Earlier this year I published a note in the BYU Law Review arguing that Trulia is more about abusive federal securities law litigation than it is a question of the state corporate law of the State of Delaware. The general line of the argument goes like this:
In the early days, class action securities litigation was easy to bring (both because the laws were very permissive and because public disclosure by reporting companies give the plaintiff’s bar easy access to fuel for litigation), and as a result, fell prey to abuse. Plaintiff’s lawyers would hastily draft a complaint and certify a class of shareholders which they would use as leverage to reach a settlement with corporate managers eager to avoid bad publicity and delay to operations and acquisitions.
Congress stepped in in 1995 with the PSLRA, a law that applied substantive reform to state and federal securities law actions, and procedural reform to federal securities law actions. Plaintiff’s chose to avoid the substantive reforms by filing securities class action under state securities law, and the problem persisted, albeit aided by the now inescapable procedural reforms applicable in all fora.
Again, Congress stepped in, this time in 1998 with the SLUSA. The SLUSA did away with class action securities litigation in state or federal court for nationally listed securities where damages were sought on behalf of more than 50 people. It also provided for all securities class-action lawsuits brought in state court to be removed to federal court where they would be subject to dismissal. Or so we thought, but more on that later.
The effect of the PSLRA and the SLUSA (and to an extent, another piece of legislation in 2005 called the CAFA) was to make class-action securities litigation more costly, difficult, and time consuming. The plaintiff’s bar had a novel reaction. Coinciding with the passing of these three statutes was a migration of class-action litigation focusing on mergers by public companies away from Federal courts under federal securities law, and into state courts under state corporate law, primarily Delaware.
Delaware law allows class-action litigation when a board of directors breaches its fiduciary duties to shareholders. One example of this is by proposing and approving a merger without giving shareholders adequate or accurate information about the merger. The typical channel for directors to provide shareholders with information is through filings with the SEC pursuant to federal securities law. The plaintiff’s bar in Delaware began using public filings to fuel law suits following 95% of all merger announcements, often times within hours of the announcement being made, claiming that the securities filings contained misleading or incomplete information. What this all starts to add up to are claims that sounds exactly like those that used to brought as 10b-5 fraud actions under the 1934 Securities and Exchange Act, but are instead being brought as fiduciary claims under Delaware corporate law.
Last year’s decision in Trulia said that the Court of Chancery would no longer approve settlements (a requirement in class-action litigation) when the only thing the company was offering to the plaintiffs (in addition to attorney’s fees) was to provide additional information to correct the alleged deficit in the disclosures unless that additional information is “plainly material.” In the vast majority of cases, management had simply been providing shareholders with a few pieces of mostly useless information, but the new standard disallows this. Plaintiff’s lawyers now have a much harder job of getting settlements approved, and as a result, strike suit merger litigation has declined in Delaware (though to be fair, it has increased in other fora, but hopefully forum selection clauses in corporate charters will continue to be upheld, which could bolster Delaware as the primary venue for these actions).
In my note, I argue that Tulia represents a win against abusive securities law class-action litigation because the types of claims at issue in Trulia are really federal securities law claims masquerading as state corporate law claims. Unfortunately, in Cyan, the Supreme Court interpreted the removal provision in the SLUSA in a way that upsets traditional thinking about securities class-action litigation.
Cyan Court says that SLUSA does allow state courts to hear claims arising under the 1933 Act, and does not allow 1933 Act claims to be removed to Federal Court.
The question at issue in Cyan is whether claims arising purely under the 1933 Act can be heard in state court at all, and if so, whether it can be removed to federal court.
In Cyan, plaintiffs brought claims against an issuer after buying shares in an IPO and then seeing the value of those shares drop significantly. The plaintiffs brought only claims arising under the 1933 Act, and no claims arising under any other federal law, or under any state securities law.
The Court held:
1. That the SLUSA does not limit a state court’s authority to rule on claims under the 1933 Act; and
2. That the provision in SLUSA allowing removal of claims to federal court does not apply to claims under the 1933 Act.
Since the late 90’s when SLUSA was enacted, plaintiff’s lawyers have broadly assumed that any federal securities law class action suit brought in state court would either be dismissed for lack of jurisdiction, or removable to federal court where it would be either dismissed or subject to both the procedural and substantive heightened requirements imposed by the PSLRA. This was the primary driver of the emigration from securities law claims to state corporate law fiduciary duty claims. Now it seems that the plaintiff’s bar was mistakenly over-cautious.
Cyan has potential to undue the positive effects of Trulia.
The great success in Trulia was that, in a way, it represented a closing down of the final safe-haven for abusive securities litigation in the public merger context. These claims couldn’t survive under state securities laws, so they migrated to federal securities laws, and when that well dried up, they migrated to Delaware corporate law. When Chancellor Bouchard plugged that well, there was hope that illegitimate claims had run out of options.
Now it seems that state courts are again fora amenable to federal securities law claims. Could this undue the promise of Trulia? Potentially yes, but hopefully no.
Yes, a plaintiff’s bar looking to bring strike suit securities litigation in an effort to force a settlement may be emboldened to bring claims in state court. To the extent that this come to pass, Trulia is weakened.
However, Cyan is not so broad as to allow a return to the status quo ante. Keep in mind that the primary weapon in abusive securities litigation is the 10b-5 fraud action. This arises under the 1934 Act which means that Cyan does not put 10b-5’s back on the table. The 1933 Act applies to the original sale of securities by an issuer. Subsequent resale falls under the purview of the 1934 Act. In reality, this means that relatively few security sales (taken a percentage of total security sales) fall under the 1933 Act. The market for securities typically has issuers selling to a single underwriter, or perhaps a small group of underwriters, or to limited numbers of institutional investors, and to a much smaller degree, to individual accredited investors. The larger and more active the bank underwriter or investor is in the securities market, the less likely it will be to agree to join a class-action as plaintiff. This kind of behavior would erode issuer confidence and be disastrous to reputation. Hopefully, this market dynamic will serve as a natural limiter on the number of 1933 Act claims the plaintiff’s bar will serve up.
Additionally, keep in mind that while the PSLRA ultimately proved ineffective at stamping out strike suits, it did apply substantive reform to actions in both state and federal court. This means that plaintiff’s will still have to satisfy the heightened substantive requirements of the PSLRA for pleading, discovery, liability, class representation and fee and-expense awards.
Finally, Trulia is limited to settlement proposals involving additional disclosure in the public merger context. While this problem is huge (remember that before Tulia, public merger announcements were followed by litigation 95% of the time), it is by no means as expansive as the entire universe of abusive securities litigation. However, Trulia may still remain an effective deterrent to merger litigation to the extent that the facts of the merger in question do not implicate the 1933 Act. In an all-cash merger, for example, where no shares are issued, it seems unlikely that a 1933 Act claim would be germane.
Prognosis: Mostly optimistic
The Supreme Court’s decision in Cyan comes as a blow to issuers. Beginning with the PSLRA in 1995 and culminating with Trulia in 2017, it finally seemed as though meaningful progress had been made towards stamping out meritless litigation, even if only confined to the public merger context.
Undoubtedly Cyan will encourage meritless litigation. Hopefully, the effect will be small. The combination of Cyan’s limitation to claims arising only under the 1933 Act, the unchanged procedural requirements of the PSLRA, and the ken of the public merger context in Trulia being often distinct from the reach of the 1933 Act will still allow Trulia to retain its bite.