The New York Law Journal has a column (via law.com – free regist. req’d) on the hazards of cooperating with government investigations. Among the possible consequences is that securities plaintiffs may be able to lift the PSLRA’s mandatory discovery stay. The 10b-5 Daily has covered the district court spit on this issue extensively, most recently in a post from last September entitled “The ‘Government Investigation’ Exception.”
Quote of note: “Recently, some courts have been moved by the argument that sustaining the mandatory stay would unduly prejudice or unfairly disadvantage plaintiffs otherwise unable to gain access to documents already produced to government agencies conducting investigations that mirror plaintiffs’ claims. Reasoning that securities plaintiffs would be unfairly kept out of the judicial loop without access to the documents already held by those agencies while parallel investigations and prosecutions proceeded, these courts have determined that plaintiffs are entitled to have these same documents.”
The Court of Chancery of Delaware has issued an opinion on the interaction between the PSLRA’s discovery stay and 8 Del. C. Sec. 220, which allows shareholders to inspect certain books and records of a corporation. In Cohen v. El Paso Corp., 2004 WL 2340046 (Del. Ch. Oct. 18, 2004), the court addressed whether the discovery stay in effect in a federal securities class action brought against El Paso preempted the court from hearing Cohen’s Sec. 220 action.
Although the court conceded that Cohen’s complaint relied on similar facts to those forming the basis of the federal securities fraud claims, it found that nothing supported El Paso’s assertion that Cohen was attempting to aid the class action plaintiffs. Moreover, the records sought by Cohen did not “pertain directly to a federal securities law claim asserted in a pending federal action,” but rather to “state law claims of waste, mismanagement and breach of fiduciary duty.” The court therefore held that the PSLRA did not “operate to preempt or otherwise interrupt Cohen’s Sec. 220 action.”
Holding: Motion to stay or dismiss denied.
Quote of note: “Neither the PSLRA nor SLUSA prevents a state court from considering a books and records demand, or similar state corporate law claims, merely because one of the parties to the state action is protected by a PSLRA automatic discovery stay in an unrelated federal securities class action.”
Addition: An open question (or so it would appear) is whether El Paso might have more success arguing to the federal judge presiding over the securities class action that he/she should stay the Section 220 action pursuant to SLUSA, which states 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 judgements, in an action subject to a stay of discovery pursuant to [the PSLRA].”
Thanks to Jesse Weiss for sending the opinion to The 10b-5 Daily.
The PSLRA provides that “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.” A district court split has developed over whether this provision allows for the discovery, prior to a decision on a motion to dismiss, of documents that have been produced to government entities.
In In re LaBranche Sec. Litig., 2004 WL 1924541 (S.D.N.Y. Aug. 27, 2004), Senior Judge Sweet agreed with those courts holding that not allowing plaintiffs access to documents previously produced to government entities would cause “undue prejudice.” LaBranche had already settled with the SEC and NYSE and the court found that the plaintiffs needed the documents produced to those organizations “to make informed decisions about their litigation strategy in this rapidly shifting landscape.” The New York Law Journal has an article (via law.com – free regist. req’d) discussing the decision.
The PSLRA provides that “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss” unless the court determines “that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.” The exact meaning of “necessary to preserve evidence” and “prevent undue prejudice” has been the subject of frequent litigation.
As discussed in The 10b-5 Daily, two recurring issues are: (a) whether defendants should be required to produce documents that previously have been produced to governmental entities; and (b) whether the discovery stay should also apply to related federal cases that do not allege securities law claims. District courts have come to markedly different conclusions.
In In re Royal Ahold N.V. Sec. & ERISA Litig., 2004 WL 502558 (D. Md. March 12, 2004), the court addressed both issues at the same time. Advantage: the plaintiffs.
The court held that Royal Ahold must produce any documents it had previously given to governmental entities and the reports of various internal investigations conducted by the company. First, the court found that there was a need to preserve evidence because Royal Ahold’s corporate reorganization, including the divestiture of subsidiaries relevant to the case, added “urgency to the discovery timetable.” Although there was no risk that the documents requested by the plaintiffs would be destroyed, they “could help the plaintiffs identify other specific materials that may be at risk of loss.”
Second, the court found that the securities plaintiffs might suffer undue prejudice by being denied discovery that was available to other litigants. In particular, the court held that the discovery stay did not apply to the related ERISA litigation and, therefore, “the securities plaintiffs could suffer a severe disadvantage in formulating their litigation and settlement strategy — particularly if [all of] the parties proceed quickly to settlement negotiations, as the court has urged them to do.”
Holding: Partial lifting of discovery stay (although the court, at the request of the government, postponed production of the investigative reports).
According to a Reuters report, plaintiffs’ counsel in the securities class action pending against Parmalat SpA in the S.D.N.Y. has sought a court order preventing the destruction of documents by the company and its advisors. District Judge Lewis Kaplan was apparently unimpressed with the request. Noting that destruction of documents is a criminal offense and any order would be redundant, the judge suggested at a hearing on Friday that the request for an order was done mainly for the benefit of the media. “If anyone wants to file papers on this, God bless them,” Judge Kaplan said. “But don’t waste my time.”
Quote of note: In response to plaintiffs’ counsel’s description of the Parmalat case as “unusually high-profile,” Judge Kaplan responded – “Not by the standards of this district. There is nobody named Martha in this case.”
The PSLRA provides that “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.” Based on the legislative history, Congress was concerned about the high costs associated with discovery and the possibility that defendants would be forced into early settlements to avoid these costs.
An open question, however, is whether the discovery stay should be applied to related federal cases that do not allege securities law claims. In In re AOL Time Warner, Inc. Sec. and “ERISA” Litig., 2003 WL 22227945 (S.D.N.Y. Sept. 26, 2003), the court stayed all non-ERISA specific discovery. The court found: “If plaintiffs in a securities case could, by tacking ERISA claims onto underlying Securities actions, obtain discovery to which they would otherwise not be entitled under the PSLRA, then the PSLRA’s mandatory stay provision would, as a practical matter, never apply. Congress could not possibly have intended for the PSLRA to be so easily marginalized.” (The 10b-5 Daily has previously posted about the case.)
The court in In re FirstEnergy Shareholder Derivative Lit., 2004 WL 161330 (N.D. Ohio Jan. 26, 2004) has recently disagreed with this approach (the opinion cites the AOL decision, but does not discuss it). Derivative and securities class action cases have been brought against FirstEnergy based on the same course of conduct. The defendants argued that discovery in the derivative case should be stayed pending a decision on the motion to dismiss in the securities class action, noting that the discovery could be used to assist the securities class action plaintiffs. The court found that the PSLRA is silent on the issue of staying discovery in derivative cases and it refused to “read in this silence Congress’s intent to prevent discovery in non-securities fraud cases simply because the cases share facts in common with securities fraud cases.” The court also declined to grant a protective order under Fed. R. Civ. Proc. 26(c).
Holding: Motion for stay of discovery denied.
Quote of note: The FirstEnergy court also found that permitting discovery to go forward would not frustrate the PSLRA’s goals because “an exchange [between the derivative and securities class action plaintiffs] of information, otherwise discoverable in this derivative action, facilitates the purpose of Fed. R. Civ. Proc. 1.” This appears difficult to reconcile with the PSLRA’s legislative history and the holding in AOL.
The mandatory discovery stay in the PSLRA is often the subject of contention in securities class actions. The PSLRA provides that “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.”
A minor district court split has developed over whether this provision allows for the discovery, prior to a decision on a motion to dismiss, of documents that have been produced to governmental entities. Compare, e.g., In re Enron Corp. Securities, Derivative & ERISA Litig., 2002 WL 31845114 (S.D. Tex. Aug. 16, 2002) (permitting partial lifting of discovery stay for documents made available to government entities because burden would be slight and the documents had already been made available outside of securities case) with In re Vivendi Universal, S.A. Sec. Litig., 2003 WL 21035383 (S.D.N.Y. May 6, 2003) (statute does not create exception for documents previously produced to governmental agencies and plaintiffs failed to establish the need to preserve evidence or undue prejudice). The 10b-5 Daily has previously posted about the Vivendi decision.
The N.D. of Alabama has now weighed in on the issue. In In re HealthSouth Securities Litigation, CV-03-BE-1500-S (N.D. Ala. Dec. 8, 2003), relevant documents had been produced to Congress and to the parties in a derivative lawsuit filed against HealthSouth in Delaware state court. Plaintiffs argued that “adherence to the two exceptions enumerated in the [PSLRA’s mandatory discovery stay] would create absurd results in a case like this one of admitted securities fraud and where a discovery stay would not effectuate Congress’ goals in enacting the statute.” The court, however, found that allowing plaintiffs to use documents produced to Congress “is not only inconsistent with the statute’s plain language, but creates an absurd result in direct contravention of Congress’ intent to protect defendants from the possibility that documents produced to governmental entities may by used by the plaintiffs in formulating a complaint or in opposing a motion to dismiss.”
Holding: Motion to partially lift discovery stay denied.
Thanks to Matt Herrington for pointing The 10b-5 Daily to this decision.