Each July, we look back on the Supreme Court’s recently-closed term for decisions of importance to institutional investors. This term, the Court issued four such decisions of note: limiting the time for bringing securities class actions; affirming investor access to state courts; pulling the rug out from under the U.S. Securities and Exchange Commission’s (“SEC” or “Commission”) Administrative Law Judge system; and refining the definition of a “corporate whistleblower.”
But first, we must address the elephant leaving the room: Justice Anthony Kennedy. After 30 years on the Court, Justice Kennedy announced his retirement. Whoever the Senate ultimately confirms to replace him (whether President Trump’s nominee for his seat, Judge Brett Kavanaugh, or someone else) has the potential to shift an already-divided Court substantially and substantively to the right. Just how far is anyone’s guess, though the change is less likely to upend investor actions and business litigation. While Justice Kennedy served as the crucial fifth vote in many significant decisions, when it came to those types of cases, he was a loyal member of the Court’s more conservative voting bloc, joining the majorities in Comcast, Iqbal, and ANZ Securities, just to name a few. In a future newsletter, we will be providing an analysis of Judge Kavanaugh. In the meantime, let us look back at the Court’s Spring Term:
China Agritech, Inc. v. Resh – More Limitations On Class Action Tolling
For the second year in a row, the Court addressed the issue of when pending class actions toll limitations periods. And, just like last year, the Court limited the tolling principles, cautioning investors to act sooner rather than later when pursuing litigation.
In China Agritech, a unanimous Court held that American Pipe’s equitable tolling doctrine does not apply to a putative class member who, after a judge denies class certification, brings a subsequent class action after the expiration of the applicable limitations periods. While the Court acknowledged that the long-held principles of American Pipe would toll the statute of limitations for individual claims during the pendency of a class action, it found that those same interests in “efficiency and economy of litigations” were not present when a follow-on or tag-along class action is filed.
The fact pattern in China Agritech was somewhat novel. Investors timely sued the company in two successive putative class actions alleging various securities-law violations. Class certification was denied in both actions. Then, a third action was filed by shareholder Michael Resh—based on the same facts and circumstances as the first two cases—but filed after the expiration of the limitations period. Resh argued that his time to file was tolled by the pendency of the first and second action.
The Supreme Court unanimously disagreed. In an opinion drafted by Justice Ginsburg, the Court concluded that “American Pipe does not permit a plaintiff who waits out the statute of limitations to piggyback on an earlier, timely filed class action.” Instead, the Court noted that federal rules and legislations favored “early assertion” and management of class claims. The Court noted that procedural rules governing class actions “evinces a preference for preclusion of untimely successive class actions by instructing that class certification should be resolved early on.” Moreover, the Court noted that the Private Securities Litigation Reform Act (“PSLRA”), which governs securities class actions, like Resh’s, “evinces a similar preference . . . for grouping class-representative filings at the outset of the litigation.” Importantly, Resh was a class member in both the first and second actions but did not step forward until after the limitations period had expired. The Court was critical of the delay, finding “little reason to allow plaintiffs who pass up opportunities to participate in the first (and second) round of class litigation to enter the fray several years after class proceedings first commenced.”
The successive class actions in China Agritech do not occur regularly, yet there are important lessons for institutional investors. First, China Agritech, like ANZ last term, underscores the need for institutional investors with significant exposure to weigh their decisions to bring or join securities litigation earlier, rather than later. Second, the Court places increasing pressure on representative plaintiffs and lead counsel to address any deficiencies in a class representative’s ability to represent a class at the outset of litigation, as the ability to substitute additional representatives later in the case may be more difficult. In fact, the Court expressed its hope that the decision “will propel putative class representatives to file suit well within the limitation period and seek certification promptly.” While sitting on the sidelines has long been a benefit of securities litigation, these recent decisions continually warn investors that their claims could be at risk.
Cyan, Inc. v. Beaver County Employees’ Retirement Fund – State Courts Are Still Open For Business
In March, the Supreme Court issued a decision affirming the right of investors to bring so-called “offering claims”—claims based on misstatements in offering materials—in state or federal court.
In Cyan, the Court unanimously held that the Securities Litigation Uniform Standards Act (“SLUSA”) does not strip state courts of jurisdiction to decide class actions alleging only the Securities Act of 1933 (“Securities Act”) violations—which typically involve misrepresentations in offering documents, such as prospectuses. In addition, SLUSA does not authorize removing such suits from state to federal court. Justice Kagan, writing for the Court, stated that SLUSA “says nothing, and so it does nothing, to deprive state courts of jurisdiction over class actions based on federal law.”
This decision provides much-needed clarity and ends long-standing debates about whether class actions asserting Securities Act claims may be maintained in state court. As we previously reported, during oral argument the Justices seemed flummoxed by the statutory language of SLUSA, referring to it as “gibberish,” as well as the varying interpretations of that language argued by the parties and the U.S. Solicitor General.
This weighty decision affirms California precedent (though it is in no way limited to California courts or law) that these matters may be brought in either state or federal court. And, if filed in state court, the matter may not be removed to federal court. While underwriters and newly-public companies may feel more comfortable defending themselves in a federal venue, they will now need to familiarize themselves with the local flavor of state court systems. As for plaintiffs, the Court has preserved and strengthened their ability to select the appropriate forum for this securities litigation.
Lucia v. SEC – Back To The Drawing Board For ALJ Cases
On June 21, 2018, the Supreme Court issued a decision striking a blow to the SEC’s Administrative Law Judges (“ALJs”) internal-adjudication program. The Lucia Court held that the SEC ALJs are not mere employees, but rather are “Officers of the United States” who are subject to the Appointments clause of the United States Constitution. Because the ALJ that heard the Lucia matter was not appointed, the Court remanded the decision. However, the Court’s limited instructions leave many unanswered questions about the impact and scope of the decision for the SEC and other agencies.
The case began when the Commission instituted an administrative proceeding against financial advisor Raymond Lucia and his investment company, Lucia Capital Group, under the Investment Advisers Act of 1940. The Commission alleged that Lucia and his company had promulgated misleading information about his “Buckets of Money” investment strategy. An ALJ found for the Commission, prompting Lucia to appeal, arguing that the ALJ had not been constitutionally appointed and, therefore, lacked authority to adjudicate the case. The D.C Circuit Court ruled against Lucia, but the Supreme Court took the appeal and ruled in his favor.
Writing for the majority in a 6-3 decision, Justice Kagan concluded that, due to the “significant discretion” wielded by the SEC’s ALJs, they qualify as “Officers” under the Appointments Clause and, therefore, could only have been appointed to their positions by either “The President of the United States,” “Courts of Law,” or “Heads of Department.” The decision relied almost entirely on prior precedent defining “Officer” under the Appointments Clause—in particular, the Court’s decision in Freytag v. Commissioner, which found that “special trial judges” (“STJs”) of the U.S. Tax Court were “Officers” under the Appointments Clause.
Noting that the SEC’s ALJs are “near carbon-copies” of STJs, the Court found the Freytag Court’s reasoning to be dispositive in Lucia. First, the Court observed that ALJs receive a career appointment and, therefore, hold a “continuing position established by law.” Second, ALJs exercise “significant authority” tantamount to that of a federal trial judge: receiving evidence, examining witnesses, conducting trials, ruling on the admissibility of evidence, and enforcing compliance with discovery orders. The Court further noted that, beyond the powers of STJs—who must have a “regular Tax Court judge” adopt their findings—an ALJ’s decision becomes final if the Commission opts against reviewing it. Based on these factors, the Court concluded that ALJs are Appointments Cause “Officers.”
The Court then went on to instruct that on remand, any subsequent hearing of Lucia’s case must be conducted by a different ALJ, even if the ALJ that originally heard his case subsequently received a proper appointment. According to Kagan, no judge could be “expected to adjudicate [a] matter as though he had not adjudicated it before.”
Ramifications of the Lucia decision on the Commission were immediate. The Commission suspended all ALJ proceedings pending an internal review of how best to comply with the Supreme Court’s decision. While the Commission ratified all ALJ appointments prior to the Lucia decision, the Court did not rule on whether such ratification cured the constitutional issues.
Beyond the impact at the SEC, questions remain as to how the decision will impact other federal agencies that regularly employ ALJs to resolve disputes within their sphere of regulatory jurisdiction. Without sufficient guidance from the Lucia Court, it seems inevitable that more litigation will ensue as appellate courts contend with the wider implications of this decision.
In the meantime, for investors concerned about vigorous enforcement of the securities laws, the procedural issues triggered by this decision could delay the SEC’s efforts to seek justice for aggrieved investors.
Digital Realty Trust, Inc v. Somers – Securities-Fraud Whistleblowers Should Run, Not Walk, To the SEC
On February 21, 2018, the Supreme Court unanimously decided that the anti-retaliation provision of the Dodd-Frank Wall Street Reform Act does not extend to employees who report securities-law violations solely to their employer and not to the SEC. The Court determined that, for Dodd-Frank’s anti-retaliation protections to apply, whistleblower employees must report suspected securities law violations directly to the SEC prior to suffering any retaliatory conduct. In no uncertain terms, this decision reinforces the need for potential securities-law whistleblowers to retain competent counsel to protect their rights.
For an in-depth analysis on the case, please refer to our previous article on Digital Realty Trust.
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Overall, this last term was an interesting one for investors. As always, we will be back in the fall with our preview of next year’s slate of cases and issues and, of course, an analysis of Justice Kennedy’s potential successor, Judge Brett Kavanaugh.
For now, the Justices can enjoy the summer and, perhaps, Justice Sotomayer will take in a few more Yankees’ games.