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refusing a discovery stay and finding no circumvention of the PSLRA on similar facts
Summary of this case from Primavera Investors v. Liquidmetal Technologies, Inc.Opinion
Case No. 1:04-cv-0380-DFH-TAB.
February 2, 2005
Richard E. Shevitz, COHEN MALAD LLP, for plaintiff City of Austin Police Retirement System.
Robert B. Weiser, Erich L. Zagar, Schiffrin Barroway, Bala Cynwyd, Pennsylvania, for plaintiff Stein in Stein v. ITT Educational Services, Delaware Chancery action.
Robert E. Palmer, GIBSON DUNN CRUTCHER, LLP, Philip A. Whistler, ICE MILLER, for defendants ITT Educational Services, Inc., et al.
ENTRY ON MOTION FOR STAY OF DELAWARE CHANCERY LITIGATION
This federal securities fraud case now presents a narrow question under 15 U.S.C. § 78u-4(b)(3)(D), a provision of the Securities Litigation Uniform Standards Act of 1998, known as "SLUSA." That statute authorizes a federal court hearing a federal securities fraud class action to stay discovery proceedings in a state court: "Upon a proper showing, a court may stay discovery proceedings in any private action in a 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 this paragraph." The specific question is whether this federal district court should exercise its power under Section 78u-4(b)(3)(D) to stay an action filed by a shareholder in the Delaware Court of Chancery pursuant to Section 220 of the Delaware Corporation Code. In that action, the shareholder seeks to obtain the right to inspect corporate books and records, as a possible precursor to filing a shareholder derivative action against directors and officers based on the same circumstances involved in this federal securities fraud action. The legal question is relatively novel, but it is one that may arise with some frequency.
For reasons explained in detail below, the court denies the defendants' motion for stay, though without prejudice to possible renewal if circumstances should change. Several factors weigh together against issuance of a stay. First, there is no indication that the Delaware action is intended to evade this court's stay of discovery; the Delaware plaintiff and his attorneys do not intend to share information they might learn with the plaintiffs and their attorneys in this case, and are willing to enter into a confidentiality order. Second, the Delaware action arises under the law of the state of incorporation and presents issues at the core of state corporation law, matters that Congress has left to the state of incorporation and its courts. Third, this court sees no potential for the Delaware action to interfere with this court's judgments, jurisdiction, or management of this securities fraud litigation.
Factual Background
The consolidated case pending in this court presents claims of federal securities fraud. The claims have been brought on behalf of a putative class of investors against ITT Educational Services, Inc. and several officers. The claims arise from an announcement by ITT Educational Services in February 2004 that the company was the subject of a federal criminal investigation. After the announcement, the price of the company's stock fell. Numerous plaintiffs filed cases alleging violations of federal securities fraud laws. Pursuant to the terms of the Private Securities Litigation Reform Act of 1995 (known as the "PSLRA"), the court has consolidated the parallel suits, designated a lead plaintiff and lead plaintiff's counsel, and stayed discovery pending resolution of the defendants' motion to dismiss. See 15 U.S.C. § 78u-4. Briefing on the motion to dismiss was finished recently, and a hearing will be held in a few weeks.One of the most significant changes enacted by the PSLRA is the combination of heightened pleading standards for plaintiffs with an automatic stay of discovery unless and until the plaintiffs can survive a motion to dismiss under the new, more exacting pleading standards of Section 78u-4(b)(1) (2). The PSLRA provides for the stay of discovery in the federal securities lawsuit: "In any private action arising under this chapter, 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." 15 U.S.C. § 78u-4(b)(3)(B). That statutory provision was the basis for this court's order staying discovery in this consolidated federal action.
The target of defendants' motion to stay is an action now pending in the Court of Chancery in Delaware. The action is Arthur Stein v. ITT Educational Services, Inc., No. 778-N. Plaintiff Stein filed the Delaware action on October 26, 2004. His complaint alleges that he is and was at all relevant times a shareholder of ITT Educational Services and that on July 1, 2004 he formally demanded that the company's board commence litigation against several officers and directors for alleged breaches of their fiduciary duties. Stein also alleges that he is entitled to inspect and copy books and records of the company, pursuant to § 220 of the Delaware Corporation Code, 8 Del. Code § 220. Stein alleges that he submitted in writing to the company on September 20, 2004, a demand to inspect and copy company records relating to alleged falsification of records of student placement, retention, graduation, attendance, academic progress, recruitment, admissions, grades, graduate salaries, and transferability of credits, as well as records relating to the board's consideration of his litigation demand. After an exchange of correspondence, the company rejected Stein's request, except that it agreed to allow him to inspect the board minutes relating to consideration of the litigation demand.
Stein alleges that he seeks to inspect records to investigate possible mismanagement and breaches of fiduciary duties by officers and directors and to help him determine whether the directors are independent and have acted in good faith in considering his litigation demand. Stein's complaint seeks a judgment ordering the company to permit him to inspect and copy the requested records. According to defendants, Stein owns ITT stock worth roughly $3,000. It seems safe to say that his personal economic interests are not driving the Section 220 action. Stein and his attorneys in the Section 220 action have stated that they are willing to enter into a confidentiality agreement that would prevent them from sharing information with the plaintiffs' attorneys in this federal securities action.
Stein's attorneys in the Section 220 action in Delaware include the law firm of Schiffrin Barroway, LLP. That law firm previously filed several of the federal securities fraud actions that have been consolidated in this court and this action. Although Schiffrin Barroway sought appointment as lead plaintiff's counsel under the PSLRA, other firms and their clients were in stronger positions and were selected as lead plaintiffs and lead counsel. After the hearing on the pending motion for a stay of the Delaware action, Schiffrin Barroway sought and was granted leave to withdraw as counsel in this case.
Discussion
Defendants have moved for an injunction from this court to stay the Section 220 action in the Delaware Court of Chancery. Defendants rely primarily on a provision of SLUSA, 15 U.S.C. § 78u-4(b)(3)(D), and also contend that such a stay is warranted here under the All Writs Act, 28 U.S.C. § 1651(a).I. SLUSA
The key statutory provision states: "Upon a proper showing, a court may stay discovery proceedings in any private action in a 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 this paragraph." 15 U.S.C. § 78u-4(b)(3)(D). Several questions leap from the page. What is "a proper showing"? Is a Section 220 action a "discovery proceeding" in a private action? Is a stay of discovery necessary in aid of this court's jurisdiction or to effectuate this court's judgments? These questions cannot be answered by prolonged meditation on the statutory text. The court must rely on the statutory scheme as a whole, the legislative history, and the applicable case law.
A. SLUSA and its Legislative History
The legislative history of SLUSA provides some context and explanation for the specific provision authorizing stays of discovery in state court. The Congress that enacted SLUSA in 1998 perceived that securities fraud plaintiffs and their attorneys were evading the restrictions of the PSLRA of 1995 by filing securities fraud lawsuits in state courts. The legislative findings themselves focused on state law cases alleging securities fraud:
The Congress finds that —
(1) the Private Securities Litigation Reform Act of 1995 sought to prevent abuses in private securities fraud lawsuits;
(2) since enactment of that legislation, considerable evidence has been presented to Congress that a number of securities class action lawsuits have shifted from Federal to State courts;
(3) this shift has prevented that Act from fully achieving its objectives;
(4) State securities regulation is of continuing importance, together with Federal regulation of securities, to protect investors and promote strong financial markets; and
(5) in order to prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives of the Private Securities Litigation Reform Act of 1995, it is appropriate to enact national standards for securities class action lawsuits involving nationally traded securities, while preserving the appropriate enforcement powers of State securities regulators and not changing the current treatment of individual lawsuits.
Pub.L. 105-353 § 2 (emphasis added); see also H.R. Rep. No. 105-640 at 8-9, cited in Newby v. Enron Corp., 338 F.3d 467, 471 (5th Cir. 2003) (affirming federal order staying discovery in state securities fraud action); Kircher v. Putnam Funds Trust, 373 F.3d 847, 848 (7th Cir. 2004). SLUSA therefore preempted most state law class actions based on allegations of securities fraud. 15 U.S.C. § 78bb(f)(1) (5)(B). Congress did not attempt to prohibit individual (non-class) securities fraud cases in state courts, but it enacted the discovery stay provision at issue here in an effort to prevent plaintiffs from using such state court actions to evade the discovery stay pending a decision on a motion to dismiss.
The committee report on the bill explained the discovery stay provision and similarly focused on state law cases alleging securities fraud, stating:
Subsection 101(a)(2) amends Section 27(b) of the Securities Act of 1933 to include a provision to prevent plaintiffs from circumventing the stay of discovery under the Reform Act by using State court discovery, which may not be subject to those limitations, in an action filed in State court. This provision expressly permits a Federal court to stay discovery proceedings in any private action in a State court as necessary in aid of its jurisdiction, or to protect or effectuate its judgments. This provision authorizes a court to stay such proceedings in State court, regardless of whether: (1) there exists a parallel action in Federal court; or (2) the State proceedings were brought prior to, subsequent to, or concurrently with, a Federal filing. Because circumvention of the stay of discovery of the Reform Act is a key abuse that this legislation is designed to prevent, the Committee intends that courts use this provision liberally, so that the preservation of State court jurisdiction of limited individual securities fraud claims does not become a loophole through which the trial bar can engage in discovery not subject to the stay of the reform Act.
H.R. Rep. No. 105-640 at 17-18 (1998). The report then added that essentially the same amendment for the same reasons was being made to Section 28 of the Securities Exchange Act of 1934, 15 U.S.C. § 78u-4, which is the provision directly at issue here. Id. at 18.
SLUSA is one of the more aggressive examples of federal laws regulating litigation in state courts. Despite the focus on securities fraud cases in the legislative history, the language authorizing stays of state court discovery in Section 78u-4(b)(3)(D) is not limited to state securities fraud actions. It may apply to "any private action." Congress nevertheless took deliberate steps to preserve state authority over areas of corporation law traditionally left to the states:
Preservation of certain actions. (A) Actions under State law of State of incorporation. (I) Actions preserved. Notwithstanding paragraph (1) or (2), a covered class action described in clause (ii) of this subparagraph that is based upon the statutory or common law of the State in which the issuer is incorporated (in the case of a corporation) or organized (in the case of any other entity) may be maintained in a State or Federal court by a private party.15 U.S.C. § 78bb(f)(3). Congress also provided expressly that shareholder derivative actions under state law are not covered by the SLUSA prohibition on securities fraud class actions under state law. 15 U.S.C. § 78bb(f)(5)(C).
B. "Discovery Proceedings"
Stein argues, based on Delaware law, that his Section 220 action is not a "discovery proceeding" within the meaning of Section 78u-4(b)(3)(D). Delaware's Section 220 provides in pertinent part:
(b) Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from:
(1) The corporation's stock ledger, a list of its stockholders, and its other books and records; * * *
(c) If the corporation, or an officer or agent thereof, refuses to permit an inspection sought by a stockholder or attorney or other agent acting for the stockholder pursuant to subsection (b) of this section or does not reply to the demand within 5 business days after the demand has been made, the stockholder may apply to the Court of Chancery for an order to compel such inspection. The Court of Chancery is hereby vested with exclusive jurisdiction to determine whether or not the person seeking inspection is entitled to the inspection sought. The Court may summarily order the corporation to permit the stockholder to inspect the corporation's stock ledger, an existing list of stockholders, and its other books and records, and to make copies or extracts therefrom; or the Court may order the corporation to furnish to the stockholder a list of its stockholders as of a specific date on condition that the stockholder first pay to the corporation the reasonable cost of obtaining and furnishing such list and on such other conditions as the Court deems appropriate. Where the stockholder seeks to inspect the corporation's books and records, other than its stock ledger or list of stockholders, such stockholder shall first establish that:
(1) Such stockholder is a stockholder;
(2) Such stockholder has complied with this section respecting the form and manner of making demand for inspection of such documents; and
(3) The inspection such stockholder seeks is for a proper purpose.
Where the stockholder seeks to inspect the corporation's stock ledger or list of stockholders and establishes that such stockholder is a stockholder and has complied with this section respecting the form and manner of making demand for inspection of such documents, the burden of proof shall be upon the corporation to establish that the inspection such stockholder seeks is for an improper purpose. The Court may, in its discretion, prescribe any limitations or conditions with reference to the inspection, or award such other or further relief as the Court may deem just and proper.8 Del. Code § 220 (emphasis added). Section 220 codifies stockholders' common law rights to examine corporate records. Saito v. McKesson HBOC, Inc., 806 A.2d 113, 116 (Del. 2002).
Stein points out that Delaware courts have distinguished between Section 220 actions and standard civil discovery. E.g., Saito, 806 A.2d at 114-15. For example, Delaware law prohibits a plaintiff in a shareholder derivative action from using discovery under civil procedure rules until the case survives a motion to dismiss under the heightened pleading standard of Court of Chancery Rule 23.1. Grimes v. Donald, 673 A.2d 1207, 1218 n. 22 (Del. 1996), overruled in part on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). In fact, because civil discovery is not readily available in derivative actions, the Delaware courts have repeatedly instructed shareholders contemplating a derivative action to use "the tools at hand," including Section 220, to obtain information needed to investigate and prepare a demand and later derivative action. Brehm, 746 A.2d at 266-67; accord, e.g., Saito, 806 A.2d at 115; In re Walt Disney Co. Derivative Lit., 825 A.2d 275, 279 n. 5 (Del.Ch. 2003); Guttman v. Huang, 823 A.2d 492, 504 (Del.Ch. 2003).
Section 220 actions differ from standard civil discovery in at least two important respects. First, § 220 is limited to the right to inspect existing records and documents. It does not provide the tools of depositions, interrogatories, requests for admission, or inspections of places or things. Second, § 220 involves direct court supervision of the disclosure of information, which differs from the standard civil discovery practice of having opposing parties handle their own exchange of information, with court intervention only as needed.
Nevertheless, whether a Section 220 action under Delaware law is a "discovery proceeding" for purposes of SLUSA is a question of federal law, not state law. The state courts' distinction between § 220 and civil discovery is not controlling. As a matter of federal law, the court is convinced that Stein's Section 220 action is a "discovery proceeding" within the meaning of 15 U.S.C. § 78u-4(b)(3)(D). Stein's action seeks not only the corporation's list of stockholders but a broad range of internal documents relevant to alleged or suspected wrongdoing. Delaware's policy choice to require use of Section 220 before full civil discovery is available does not control the question of federal law. In substance, the Section 220 action is a judicially-controlled procedure for forcing a corporation to provide a form of discovery to stockholders, and at least in Stein's case, the Section 220 action is a precursor to a derivative lawsuit. In enacting the discovery stay provision of SLUSA, Congress chose to use broad language that can be adapted to a variety of state law procedures to accomplish the congressional purpose of preventing evasion of the PSLRA discovery stay. For purposes of federal law, the substance controls, and Stein's Section 220 action is a "discovery proceeding" for purposes of Section 78u-4(b)(3)(D).
C. "Upon a Proper Showing"
The next question is whether defendants have made "a proper showing" to support a federal injunction halting the state court action. In enacting SLUSA, Congress did not spell out the requirements for "a proper showing." In the statutory language, the federal court may act as "necessary in aid of its jurisdiction, or to protect or effectuate its judgments." These words echo the Anti-Injunction Act, 28 U.S.C. § 2283, and the All Writs Act, 28 U.S.C. § 1651. The court is not persuaded that an injunction stopping the Section 220 action is needed to aid this court's jurisdiction or to protect or effectuate its judgments.
Under the Anti-Injunction Act, the phrase "necessary in aid of its jurisdiction" means that "federal injunctive relief may be necessary to prevent a state court from so interfering with a federal court's consideration or disposition of a case as to seriously impair the federal court's flexibility and authority to decide that case." Zurich American Ins. Co. v. Superior Court for State of California, 326 F.3d 816, 825 (7th Cir. 2003) (reversing injunction), quoting Atlantic Coast Line R.R. Co. v. Brotherhood of Locomotive Engineers, 398 U.S. 281, 295 (1970). Stein's pursuit of the Section 220 case in Delaware will not interfere at all with this court's consideration or disposition of the consolidated federal securities fraud case, nor will it impair this court's flexibility in managing the case or its authority to decide the case. It is not at all unusual for securities fraud and related shareholder derivative cases to proceed along parallel tracks, without interfering with one another. Stein's case is merely a precursor to such a derivative action.
Under the Anti-Injunction Act, the concept of protecting or effectuating judgments focuses on final judgments. See, e.g., In re BankAmerica Corp. Securities Lit., 263 F.3d 795, 801 (8th Cir. 2001) (affirming injunction against state securities fraud action under "authorized by Congress" exception, but explaining that exception for injunctions necessary to effectuate or protect district court's judgments was inapplicable because district court's lead-plaintiff order was neither a final appealable order nor an order appealable under the collateral order doctrine), citing Z-Seven Fund, Inc. v. Motorcar Parts Accessories, 231 F.3d 1215, 1218-19 (9th Cir. 2000) (PSLRA lead plaintiff order not appealable final order); 17 Charles Alan Wright, Arthur R. Miller Edward H. Cooper, Federal Practice and Procedure § 4226 (2d ed. 1988) (exception for protection of judgments extends, at best, to interlocutory orders appealable under collateral order doctrine). This court has issued no final judgment in this case.
Nevertheless, it is reasonable to conclude that in enacting SLUSA, Congress intended to expand federal courts' existing authority to block state court proceedings, and it expected that there would be some cases where allowing discovery to proceed in state courts would interfere with a federal court's jurisdiction or its judgments. The most obvious candidate, of course, is the federal court's interlocutory order staying discovery, so that state court proceedings involving efforts to evade or interfere with such orders could be enjoined.
Federal courts have used Section 78u-4(b)(3)(D) to issue stays of discovery in a number of state cases alleging securities fraud. E.g., Newby v. Enron Corp., 338 F.3d 467, 473 (5th Cir. 2003) (affirming stay); Schwartz v. TXU Corp., 2004 WL 1732477, at *2, 2004 U.S. Dist. LEXIS 14782, at *6 (N.D. Tex. July 30, 2004); In re Adelphia Communications Corp., 293 B.R. 337, 355 (Bankr. S.D.N.Y. 2003). The risk of evasion of federal restrictions is obvious in parallel state cases alleging securities fraud under state law, and, as noted above, such cases were the principal target of the SLUSA provision.
The parties have identified only one case in which a federal court issued a stay of discovery in a state court action that was not a securities fraud case. The court in In re DPL, Inc. Securities Litigation, 247 F. Supp. 2d 946 (S.D. Ohio 2003), issued a SLUSA stay of discovery in related shareholder derivative actions under state law and pending in state courts. There is one critical difference between this case and DPL. In DPL, the attorney for the plaintiffs in the state court shareholder derivative actions "indicated that he anticipated sharing discovery obtained in that state court proceeding with the other counsel representing Plaintiffs in these consolidated [federal] actions." 247 F. Supp. 2d at 950. In this litigation, by contrast, Stein and Schiffrin Barroway have made it clear that they are willing to enter into a confidentiality agreement and to refrain from sharing with plaintiffs' counsel in this case any information obtained under § 220. That fact, as well as the difference between derivative actions and Section 220 actions, distinguishes this case from DPL. See generally In re First Energy Shareholder Derivative Lit., 219 F.R.D. 584, 586 (N.D. Ohio 2004) (denying stay of discovery in derivative action in federal court where none of the attorneys in the derivative litigation were attorneys in parallel securities fraud litigation and defendants could not demonstrate that derivative plaintiffs were attempting to evade PSLRA stay of discovery); Tobias Holdings, Inc. v. Bank United Corp., 177 F. Supp. 2d 162, 168 (S.D.N.Y. 2001) (declining to apply PSLRA stay to state law claims other than securities fraud claims).
The parties have cited only one case involving SLUSA and Delaware's § 220. In Cohen v. El Paso Corp., 2004 WL 2340046, 2004 Del. Ch. LEXIS 149 (Oct. 18, 2004), Chancellor Chandler declined to stay the Section 220 action while a securities fraud class action was pending in a federal court in Texas. In Cohen, the Delaware Chancellor explained his decision in some detail. He noted that both his court and the Delaware Supreme Court had "repeatedly admonished shareholder plaintiffs to seek books and records before filing class or derivative complaints, so that they may prepare a factually accurate and legally sufficient pleading. Both Courts have also recognized that shareholder plaintiffs who use § 220 often avoid the `expensive and time-consuming procedural machinations that too often occur in derivative litigation.'" 2004 WL 2340046, at *2, citing Guttman v. Huang, 823 A.2d 492, 493-94, 504 (Del.Ch. 2003), and quoting In re Walt Disney Co. Derivative Lit., 825 A.2d 275, 279 n. 5 (Del.Ch. 2003). Under § 220, a plaintiff shareholder must make a credible showing that there are legitimate issues of wrongdoing and must have a proper purpose. Cohen, 2004 WL 2340046, at *2. The Delaware court found that the plaintiff had made such a showing based on a public announcement of a $1 billion write-down resulting from improper accounting for proven reserves and the launch of a formal SEC investigation. Id.
The defendants in Cohen argued that the plaintiff had an improper purpose: the evasion of the federal stay of discovery in a federal securities fraud class action known as Wyatt v. El Paso Corp. The Delaware court rejected the argument, seeing nothing on the face of the pleadings, and nothing in the history of the dispute, suggesting such an improper purpose. The court specifically noted that there was no indication of any intent to share the results from the Section 220 action with the Wyatt plaintiffs, and that the Section 220 plaintiff was willing to enter into a confidentiality agreement, just as plaintiff Stein is willing to do in this case. The Delaware court concluded that Cohen could continue his Section 220 action.
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). Chancellor Chandler has complied with that order.
Defendants in this case argue that the reasoning of the Delaware Chancery Court in Cohen deserves no weight at all because it is a state court. Def. Reply Br. at 10 n. 5. The argument overlooks the fact that both federal and state courts are obliged under the federal Supremacy Clause to apply federal law. A thoughtful and careful explanation of an issue by either type of court may persuade other courts that are not bound to follow its decision. By comparison, the federal court's one-line order effectively nullifying the Delaware Chancellor's thoughtful decision offers no helpful guidance to other courts.
Busy trial courts, including this one, often issue orders without detailed explanation, or with explanations to follow. This court assumes the parties will quickly provide to this court any further explanation that the Wyatt court might provide.
What standard should be applied in determining whether a party has made "a proper showing" for a stay under § 78u-4(b)(3)(D)? State court actions alleging securities fraud were the principal target of the SLUSA stay provision, but they were not necessarily the only target. At the same time, in enacting SLUSA, Congress took care to preserve the authority of state law and state courts over core areas of corporation law, including shareholder derivative actions and the relationship between shareholders and corporate directors and officers. How should the courts give life to the balance Congress attempted to strike?
Defendants contend that a federal court should stay discovery in a state case when a defendant shows that discovery is being conducted or attempted in a state court proceeding any time the facts at issue and the discovery are related to and overlap with the federal securities fraud case. See Hearing Tr. 19. Defendants contend the standard should be objective, so that intent to evade a stay under the PSLRA or intent to share the results of discovery with federal plaintiffs would be irrelevant. As defendants frame the issue, they have "a uniquely federal right" to such a stay of any state court proceedings in which discovery would overlap with discovery in this case, so that a stay is needed to protect or effectuate that order of this court. That assertion of "a uniquely federal right," however, simply begs the question whether they have made "a proper showing."
As discussed in the hearing, defendants' proposed standard would apply far too broadly, reaching state court cases in which the claims would be entirely different, and in which the federal defendants would not even need to be parties. For example, consider the possibility of a dispute between an accounting firm and its own former partner. The former partner sues the accounting firm for some variety of unlawful termination, alleging that he was removed from the partnership for having refused to remain silent about a client corporation's fraudulent accounting. If the client corporation were also a defendant in a federal securities fraud case, it would be entitled under defendant's standard to a stay of non-party discovery conducted in a state court lawsuit between the accounting firm and its former partner.
Defendants are of course willing to narrow their proposed standard, so long as a stay is issued in this case. They suggest that Schiffrin Barroway's earlier involvement in the ITT Educational Services litigation ought to bar that firm, in essence, from representing any other shareholder in a Section 220 action. There is no convincing reason, however, why that earlier activity should exclude them from another case or why this court should issue an injunction against the Delaware case when, if a different set of lawyers were involved, the case should be allowed to go forward. Moreover, Schiffrin Barroway are no longer involved in this federal litigation.
Defendants also imply, at least, that if there is intent to evade the PSLRA stay of discovery, that fact should weigh in favor of a stay. In fact, such an intent 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. The court agrees that an intent to evade the PSLRA stay of discovery would weigh heavily in favor of a stay under SLUSA, at least where the state court proceeding is not a securities fraud claim. That much is explicit in the state court decision in Cohen and the Southern District of Ohio decision in DPL, which appear to be the only reported cases applying SLUSA's discovery stay provision to state court proceedings not involving securities fraud. See Cohen, 2004 WL 2340046, at *2 (lack of evidence of intent to evade PSLRA stay critical to court's conclusion that defendant failed "proper showing" under SLUSA); DPL, 247 F. Supp. 2d at 950 (evidence of such intent was key factor in court's finding that defendant had made "proper showing").
In this case there is no convincing evidence of an intent to evade the PSLRA stay of discovery. As noted, Schiffrin Barroway has no further involvement in this federal litigation, and both the firm and its client are willing to enter into a protective order in the Delaware case that would bar them from sharing information with plaintiffs' counsel in this case. Defendants may not be happy with Stein's and Schiffrin Barroway's intent to pursue derivative claims, but the PSLRA and SLUSA were not intended to protect corporate management from shareholder derivative claims. Those are left to state law.
Throughout their briefs and arguments, defendants have offered unusually aggressive readings of legislative history and case law in their effort to stretch SLUSA so that derivative actions would be presumptively subject to discovery stays. For example, in their reply brief, defendants wrote at pages 3-4:
Initially, Congress considered preempting all actions under state law that the trial bar and professional plaintiffs were using to burden a corporate-issuer with discovery pending a motion to dismiss in federal court and while the corporate-issuer sorted out its legitimate business issues. For instance, plaintiffs who were unsuccessful in the lead plaintiff's race in federal court were using, as strike-suits, either: (i) state securities class actions; or (ii) actions brought derivatively on behalf of the issuer against the issuer's officers and directors for fiduciary liability. See H.R. Rep. No. 105-640, at 9. Congress addressed the first of these two avenues of abuse by choosing to preempt a clearly defined variety of state securities class actions. See 15 U.S.C. § 77p. Out of federalism-related concerns, however, Congress chose not to entirely preempt the second avenue — that is, actions for fiduciary liability; Congress understood that actions for fiduciary liability brought derivatively on behalf of the corporation issuer are firmly grounded in state law. So instead of preempting those actions entirely, Congress enacted a stay on discovery in order to strike a proper balance between federalism concerns and concerns related to preserving a corporate issuer's right to be free from discovery pending a motion to dismiss. H.R. Rep. No. 105-640, at 17-18.
This account of the legislative history amounts to wishful thinking. The first citation to H.R. Rep. No. 105-640 refers to passages that say nothing about derivative actions being strike suits; the only references on page 9 to derivative actions make clear that they are not preempted by SLUSA. The second citation, to the report's discussion of the stay provisions at pages 17-18, addresses only securities fraud claims. That passage says nothing about shareholder derivative actions.
Similarly, defendants assert "courts [note the plural] have already held that discovery is stayed under SLUSA in state derivative actions pending a motion to dismiss in a factually-related federal securities case. See, e.g., In re DPL, Inc. Sec. Litig., 247 F. Supp. 2d 946 (S.D. Ohio 2003) (staying four state derivative actions pending a motion to dismiss)." Def. Reply Br. at 4-5. In fact, DPL is the only case that supports that claim, and it is readily distinguishable based on the derivative plaintiffs' attorney's stated intent to share the results of discovery with the federal plaintiffs and their attorneys.
In supporting their motion for a stay, defendants have raised objections to the scope and expense of the records request in the Delaware Section 220 action, as well as more general objections to whether Stein has a proper purpose and has made a proper request under § 220 of the Delaware corporation code. As a matter of federalism and comity, this federal court believes those objections are better addressed to the Delaware court. If the Delaware court agrees with the defendants, there may be no need for a federal injunction against the state court proceedings. If the Delaware court disagrees and explains why it believes Stein should be allowed to obtain all or only some of the requested records, such an explanation could give the federal courts important guidance in balancing the defendants' interests against those of the other parties to the Delaware action and the interests of the State of Delaware, in which defendants chose to incorporate.
The choice of Delaware as the state of incorporation weighs heavily in this court's decision. In enacting SLUSA, Congress took care to ensure that it was not preempting state court litigation (other than most securities fraud class actions) under the law of the state of incorporation. 15 U.S.C. § 78bb(f)(3). It is "an accepted part of the business landscape in this country for States to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares. A State has an interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs." CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 91 (1987). This tradition of federal deference to state regulation of the relationships between corporate shareholders, officers, and directors has deep roots in American law:
[S]tate regulation of corporate governance is regulation of entities whose very existence and attributes are a product of state law. As Chief Justice Marshall explained: "A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law. Being the mere creature of law, it possesses only those properties which the charter of its creation confers upon it, either expressly, or as incidental to its very existence. These are such as are supposed best calculated to effect the object for which it was created."CTS, 481 U.S. at 89, quoting Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat.) 518, 636 (1819).
The Delaware courts in general, and the Chancery Court in particular, are well respected for their expertise in corporation law, such as the issues presented by defendants' objections to Stein's request for records and documents under § 220. The need for a federal court to step in and save corporate managers from their own shareholders and the state courts in the chosen state of incorporation, seems minimal. See generally Ralph K. Winter, Government and the Corporation (American Enterprise Institute 1978) (arguing that Delaware corporation law reflects not a "race to the bottom" but a market-tested solution that effectively balances interests of shareholders and management); Macey Miller, Toward an Interest-Group Theory of Delaware Corporate Law, 65 Tex. L.Rev. 469, 498-509 (1987); Fischel, The "Race to the Bottom" Revisited: Reflections on Recent Developments in Delaware's Corporation Law, 76 Nw. U. L.Rev. 913, 919-20 (1982).
To sum up, the court finds that the defendants in this case have not made "a proper showing" at this point requiring a stay of Stein's Section 220 action in the Delaware courts. The Section 220 action is not a securities fraud case, nor a precursor to one. It is instead a precursor to a possible shareholder derivative action under the law and in the courts of the state of incorporation. There is no indication that the Section 220 action is intended to circumvent this court's stay of discovery under the PSLRA. The court also sees no threat to this court's jurisdiction, its judgments, or its ability to manage and decide this federal securities fraud case.
II. The All Writs Act
Defendants also contend they are entitled to an injunction under the All Writs Act, 28 U.S.C. § 1651(a). That Act provides: "The Supreme Court and all courts established by Act of Congress may issue all writs necessary or appropriate in aid of their respective jurisdictions and agreeable to the usages and principles of law." The court sees no need to aid its own jurisdiction by ordering a state court not to decide questions properly before it pursuant to that state's corporation law. The pendency of the Section 220 action does not threaten or undermine this court's ability to decide the claims properly before it. Nor have defendants shown how pursuit of the Section 220 action would somehow interfere with the lead federal plaintiff's ability to manage this litigation.
The court recognizes that the Seventh Circuit has acknowledged that, in unusual situations, such as management of multi-district litigation where parties are clearly engaged in forum-shopping, the All Writs Act and the Anti-Injunction Act may permit a district court to issue an injunction to safeguard a pre-trial ruling limiting discovery. Winkler v. Eli Lilly Co., 101 F.3d 1196, 1203 (7th Cir. 1996). After acknowledging this possibility, however, the Winkler court vacated as an abuse of discretion a federal district court's order attempting to block a state court proceeding to obtain discovery of a document the federal district court had refused to compel be produced. As explained above, the court sees no potential for the Delaware Section 220 action to undermine the court's ability to manage this litigation.
Conclusion
For the foregoing reasons, defendants' motion for an injunction staying proceedings in the Delaware Court of Chancery in Stein v. ITT Educational Services, Inc. is hereby denied. This denial is without prejudice to possible renewal of the motion after further action by the Delaware courts.So ordered.