The Forum Wars of Section 11

Boris Feldman is a partner at Freshfields Bruckhaus Deringer LLP.

TL;DR: The battle over filing Section 11 lawsuits in state court may be approaching resolution. Multiple California courts have now upheld “Federal Forum Clauses,” which require shareholders to litigate Section 11 claims in Federal court. Judicial validation of such provisions has significant implications for companies going public and for the D&O insurance industry.

TROTS [The Rest of the Story]:

  1. Over the last decade, one of the hot topics in securities litigation has been The Forum Wars: may shareholder claims under Section 11 of the Securities Act of 1933 be brought in state and Federal courts, or only in Federal court alone?
  2. This post presumes familiarity with the basics of Section 11. For a reader innocent of such familiarity the two Supreme Court decisions cited below (one the United States Supreme Court, the other the Delaware Supreme Court) provide a useful statutory primer. The Section 11 for Dummies version is this: Section 11 gives shareholders a virtually no-fault claim against a public company for material misstatements or omissions in its IPO prospectus. The claims against the company’s directors, and against the underwriters of the offering, are nearly as potent. In the security-plaintiff bar’s armory, the Section 11 claim is a magic bullet.

  1. The statute that created this remedy provided that a shareholder could pursue it in Federal court or in state. For most of the statute’s history, Section 11 claims were rarely filed in state court. Beginning in about 2010, however, creative plaintiff lawyers began filing more Section 11 suits in state court. This was primarily for two reasons. First, many perceive that state courts are more hospitable to plaintiff claims than are Federal. In general, pleading requirements are more lenient in state court. Second, plaintiff lawyers developed a special fondness for one state court in particular: the California Superior Court for San Mateo County. San Mateo County contains a piece of Silicon Valley, by industry if not strictly by the map. The result was that Section 11 suits flocked to San Mateo Superior like birds to Bodega Bay. Thus began The Forum Wars.
  2. Based on a 1998 Federal statute that preempted state securities class actions, defense lawyers began removing Section 11 suits to Federal court. Securities Litigation Uniform Standards Act, 15 U.S.C. § 78bb. There ensued dozens of decisions as to the validity vel non of such removal. What resulted was a split between the Districts. Judges in the Northern District of California (which includes San Mateo County) consistently held that SLUSA changed nothing: Section 11 suits in state court remained proper. With the same degree of certainty, judges in the Southern District of New York reached the contrary conclusion: Section 11 suits could now be brought exclusively in Federal court. No appellate decisions addressed the issue, because the rules governing removal and remand precluded appellate review.
  3. Eventually one company, Cyan Corp., got the issue before the United States Supreme Court. In a 9 to 0 decision, the plaintiffs’ bar won. In Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), the Supreme Court held that SLUSA did not eliminate dual-forum jurisdiction over Section 11 claims. The impact of the ruling was immediate. Plaintiff firms unleased a volley of state law Section 11 suits against recently public companies. D&O insurance premiums for new public companies soared.
  4. But wait, there’s more!
  5. Largely based on the work of a Stanford law professor, Joseph Grundfest, pre-public companies began to adopt Federal Forum Clauses. These clauses (typically contained in the companies’ articles of incorporation) provided that any shareholder could bring Section 11 claims solely in Federal court.
  6. Litigation ensued.
  7. The first round was in Delaware. One plaintiff firm sued several companies that had adopted Federal Forum Clauses. The plaintiff, Sciabacucchi (pronounced “Sha-ba-cookie”) argued that the Clauses were improper under the Delaware Corporation Code. In the Court of Chancery, plaintiff prevailed. A Vice-Chancellor struck down the forum restrictions. D&O premiums kept climbing.
  8. On appeal, the plaintiff lost. The Delaware Supreme Court held that the Federal Forum Clauses were proper under Delaware law. Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020). Companies going public consistently adopted the clauses prior to their IPO’s.
  9. This was not checkmate.
  10. The plaintiffs made a tactical retreat to their forum of choice to attack the Clauses: that’s right, San Mateo Superior. Perhaps they thought that the court that had spawned the state Section 11 suits would be hostile to the attempt to exterminate them. To the surprise of many in the plaintiffs’ bar, San Mateo did not come to their rescue.
  11. In recent months, multiple decisions (in San Mateo Superior as well as in San Francisco Superior Court, next door) have upheld the Federal Forum Clauses against challenges based on state law, Federal law, and, yes, the California Constitution. The recent decisions involved various companies: Restoration Robotics; Uber; and Dropbox. Although one of the decisions poignantly reflected San Mateo’s angst at the whole development (and its disdain for the Delaware Supreme Court’s decision in Sciabacucchi), all three decisions rejected challenges to the Federal Forum Clause and dismissed the state suits. The fact that even San Mateo upheld the clauses sends a potent message that the end of The Forum Wars may be in sight.
  12. No doubt plaintiffs will appeal the three losses. But historically California appellate courts have been receptive to contractual provisions, comparable to the Federal Forum Clauses, that have specified the appropriate forum and venue for a civil claim. It is beyond my ken to predict the ultimate outcome in the California appeals. The forum issue may again end up in the United States Supreme Court. What is clear is that, in the interim, other Superior Courts are likely to read with close attention the extant caselaw, which is unanimous in upholding the Clauses.
  13. What do these recent developments mean?
  14. For companies about to go public, the lesson is simple: adopt a Federal Forum Clause in the charter prior to your IPO. There is no downside to doing so. The upside, if challenges to the Clauses continue to fail, is substantial: a more experienced, neutral forum in which to litigate shareholder claims of Prospectus fraud.
  15. The lesson for D&O carriers is similarly non-complex: the risk profile of companies going public has diminished substantially. D&O insurance for young public companies in the tech industry, which has suffered from reduced availability post-Cyan, should become easier to obtain. Players that exited that insurance market might reenter it. D&O premiums—which skyrocketed—might return to earth.
  16. Although it is premature to declare victory yet, companies and their carriers can take some comfort that The Forum Wars may be approaching…
  17. The End.
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One Comment

  1. Steve Diamond
    Posted Thursday, December 10, 2020 at 6:52 pm | Permalink