The Securities Act of 1933 provides for concurrent jurisdiction in federal or state courts for any lawsuit asserting claims for false or misleading statements in a registration statement or a prospectus issued in connection with a registered offering of securities. Since a decision of the US Supreme Court in 2018, state courts have seen a dramatic increase in those lawsuits because the ability to remove them to federal court was essentially eliminated.

Earlier this week, however, the Delaware Supreme Court ruled that issuers incorporated in Delaware can elect a federal forum for Securities Act claims as a matter of Delaware corporate law. The decision was issued in Salzberg v. Sciabacucchi. We expect the Sciabacucchi holding to spur many Delaware corporations to seek to amend their articles of incorporation adding such a federal forum provision.

Background

An explanation of the potential significance of the Sciabacucchi decision requires a brief discussion of the recent history of securities class actions and congressional efforts to rein in perceived abuses in that type of collective litigation.

The Securities Act was the first federal securities law enacted in response to problems in the issuance of publicly traded securities exposed as the result of the Great Depression. Unlike the later enacted, and better known, Securities Exchange Act of 1934, the Securities Act created private rights of action for investors in registered securities offerings based on strict liability or negligence rather than fraud.

Private claims under the Securities Act can be more difficult to dismiss at the pleadings stage because they are subject to more lenient pleading standards regarding the defendants’ state of mind. Nevertheless, only limited categories of investors can sue under the statute’s remedial provisions (for this discussion, primarily §§ 11(a), 12(a)(2), and 15), and, until recent years, this meant that Securities Act class actions were far less common than class actions asserting securities fraud claims under the Exchange Act.

The federal courts created the private right of action for securities fraud under § 10(b) of the Exchange Act, and the requirements for such claims have developed through judicial decisions at the Supreme Court and other federal courts. Federal courts have exclusive jurisdiction over such actions. In contrast, a provision in the Securities Act provides for concurrent jurisdiction in both federal and state courts for claims brought under §§ 11 and 12.

In 1995, Congress responded to concerns about the proliferation of securities fraud class actions, and the perception that these suits often were filed after sudden stock price declines in an effort to extract unwarranted settlements, by enacting the Private Securities Litigation Reform Act (PSLRA). The PSLRA imposed more demanding pleading requirements for class actions asserting securities fraud claims, provided for an automatic stay of discovery until a complaint survives a motion to dismiss, required competition among plaintiffs for leadership of a case, and enacted other procedural requirements. These statutory changes resulted in an increase in the number of complaints that were dismissed and greatly reduced the number of cases that were settled shortly after a complaint was filed.

One unanticipated side effect of the PSLRA, however, was a sudden increase in the number of lawsuits filed in state courts that asserted claims for alleged violations of state securities laws. This, in turn, led Congress to enact additional procedural reforms in the Securities Litigation Uniform Standards Act of 1998 (SLUSA), which effectively brought an end to state law securities class actions.

The provisions added to the federal securities laws in SLUSA were focused primarily on eliminating state court class actions asserting claims under state-enacted versions of the securities laws. But SLUSA’s jurisdictional provisions were read by some courts as permitting the defendants in Securities Act class actions to remove those actions from state court to federal court. Other courts disagreed with that reading, leading to a patchwork of judicial decisions concerning the continuing viability of concurrent jurisdiction for investor claims under the Securities Act.

In 2018, the US Supreme Court resolved this split of authority in Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), in which it held that SLUSA did not alter the Securities Act provision allowing claims to be filed in state or federal courts.

Federal forum provisions and the Delaware Court’s decision in Sciabacucchi

The Cyan ruling resulted in a dramatic increase in the number of Securities Act class actions that were filed in state courts. In 2019, a record number of Securities Act class actions were filed, and more than half of them were filed in state courts. California courts have seen an especially high volume of filings because of the lenient standards under California rules for permitting actions to proceed into discovery, where the prospects for settlement increase dramatically.

Even before Cyan, at least 20 public companies had adopted charter provisions requiring Securities Act claims to be brought exclusively in federal court. In 2017, three Delaware corporations preparing for their initial public offerings included provisions in their articles of incorporation specifying a federal forum for any action involving their own securities offerings under the Securities Act.

The plaintiff in Sciabacucchi filed an action in the Delaware Court of Chancery seeking a declaratory judgment that such federal forum provisions were invalid. The Chancery Court agreed, holding that those provisions fall outside the scope of permissible (rather than mandatory) charter provisions allowed for a Delaware corporation by section 102(b) of the Delaware General Corporation Law.

In its opinion and order issued on March 18, 2020, the Delaware Supreme Court reversed, holding that a provision specifying a federal forum for Securities Act claims could “easily” fall within the list of permissible provisions in section 102(b). That list permits charter provisions for, among other things, “the management of the business and for the conduct of the affairs of the corporation” and for “creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders.” The Delaware Court also concluded that such a forum provision could have a salutary purpose because it would provide for “certain efficiencies in managing the procedural aspects of securities litigation following” the Supreme Court’s decision in Cyan.

The court also rejected the plaintiff’s argument that federal forum provisions would violate public policy. Under Delaware law, the relevant statute is broad and flexible and “stockholder-approved charter amendments are given great respect.” As for federal policy, the Court noted, the US Supreme Court already had permitted contract provisions that precluded state court litigation of Securities Act claims in favor of arbitration, which the Delaware Court characterized as “in effect, a specialized kind of forum selection clause.”

Practical implication: issuers should decide whether to adopt a federal forum selection provision

The most immediate implication of the Sciabacucchi decision is for corporations organized under Delaware law that have issued registered securities or that might do so in the future. Those companies should consider adopting a federal forum selection provision in their articles of incorporation. We expect that many Delaware corporations will adopt or seek to adopt such provisions after concluding that the elimination of dual track state and federal litigation under the Securities Act provides a clear benefit to the corporation and its stockholders. (Existing Delaware corporations would need to obtain stockholder approval for such a charter amendment.)

Corporations incorporated in jurisdictions other than Delaware will need to determine whether the statutes and case law of their home jurisdiction would permit such a provision given the ruling in Sciabacucchi as to Delaware law.

It also must be noted that the opinion in Sciabacucchi will not end the debate even when an issuer organized under Delaware law has adopted such a provision. The crucial test will arise in the application of such provisions. Open questions include:

• Will state courts outside of Delaware abide by the Sciabacucchi decision as a definitive articulation of the governing law?

• Will federal courts confronted with removal petitions conclude that an issuer’s choice of forum is sufficient to override the concurrent jurisdiction in state courts that is expressly provided for in the Securities Act?

• Will the US Supreme Court look for an opportunity to clarify the possible tension between a rule concerning the internal affairs of a Delaware corporation and a jurisdictional provision in a federal statute?

• Finally, even if enforceable, must a federal forum selection provision be included in a corporation’s articles of incorporation, or is a provision contained in corporate bylaws sufficient?

We expect all of these questions to be addressed in Securities Act cases over the coming years.