Enforcing The Discovery Stay

As part of the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), Congress mandated that “a court may stay discovery proceedings in any private action in state court, as necessary in aid of its jurisdiction, or to protect or effectuate its judgments, in an action subject to a stay of discovery pursuant to [the PSLRA].” One of the primary goals of this provision was to prevent plaintiffs from using a simultaneous state court action to circumvent the mandatory discovery stay imposed by the PSLRA in federal securities fraud cases. Exactly when, where, and under what circumstances a court should use this power, however, has been the subject of recent debate.

In City of Austin Police Ret. Sys. v. ITT Educational Services, Inc., 2005 WL 280345 (S.D. Ind. Feb. 2, 2005), the court addressed whether it should stay a related books and records action brought in Delaware state court. Plaintiff’s counsel in the books and records action had previously filed “several” of the federal securities cases consolidated by the court and had unsuccessfully sought to be named lead counsel. In addition, the books and records action sought company records directly related to the fraud allegations in the federal securities case, albeit as a stated precursor to bringing a derivative suit for breach of fiduciary duties.

While the plain language of SLUSA states that it is applicable to any private action in state court, the court found that an intent to evade the PSLRA’s stay of discovery “should probably be the biggest factor in deciding how far to extend SLUSA’s discovery stay provision beyond the securities fraud cases that are its principal target.” In the instant case, the court found that there was no convincing evidence of an intent to circumvent the PSLRA. The court also noted that plaintiff’s counsel had no further involvement in the federal litigation and was “willing to enter a protective order in the Delaware case that would bar them from sharing information with plaintiffs’ counsel in this case.” Under these circumstances, the court declined to enter the requested stay.

It did not take long for another federal district court to strongly disagree with the ITT Educational decision. In In re Cardinal Health, Inc. Sec. Litig., 2005 WL 894693 (S.D. Ohio March 1, 2005), the court addressed whether it should stay discovery in a state court derivative action relating to the same accounting issues raised in the pending federal securities class action. The court found that “[h]ad Congress intended to limit [the SLUSA discovery stay] to securities fraud actions, it could have done so.” Moreover, the plain language of the statue “includes no mention of a requisite intent to circumvent the PSLRA.” The court held that the imposition of a discovery stay in the derivative case was appropriate for three reasons: (1) trial in the derivative case was set to begin within a year, leading to a strong possibility that some form of discovery would reach the federal plaintiffs; (2) the derivative case involved the same subject matter as the federal securities class action, raising concerns that the courts might issue inconsistent rulings; and (3) complying with similar discovery requests would be duplicative and burdensome.

Addition: A similar situation arose in the El Paso Corp. securities litigation last year. In a post about an unsuccessful SLUSA discovery challenge brought by the defendants in state court, The 10b-5 Daily questioned whether the defendants would have been better off making the same arguments in federal court. The answer is provided in the ITT Educational decision – “After the Delaware court declined to stay the action under SLUSA, the district judge presiding over the Wyatt case in the Southern District of Texas issued a one-line order staying the Cohen Section 220 action. Wyatt v. El Paso Corp., No. H-02-2717 (S.D.Tex. Dec. 8, 2004).”

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