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finding no preemption where "purported injury arose from the mere holding of 3Com stock, and not from any trading of 3Com securities"
Summary of this case from Denton v. H R Block Financial Advisors, Inc.Opinion
No: C 01-0009 MJJ
May 16, 2001
ORDER GRANTING PLAINTIFF'S MOTION TO REMAND
Before the Court is Plaintiff David B. Shaev's motion to remand this action to the California Superior Court. For the reasons discussed below, the Court finds that this action was improperly removed to federal court, and therefore GRANTS Plaintiff's motion.
FACTUAL BACKGROUND
Plaintiff's lawsuit arises out of defendant 3Com Corporation's ("3Com") July 2000 spin off of its wholly-owed subsidiary, Palm, Inc. ("Palm"). 3Com is a Delaware corporation with stock that has been publicly traded on NASDAQ, a national securities exchange, since March 21, 1984. Plaintiff is a shareholder of 3Com. In September 1999, 3Com announced plans to spin off Palm as a separate public company and distribute Palm stock to 3Com shareholders. In conjunction with the spin-off and distribution of Palm stock, 3Com decided to adjust the stock options provided under its company stock option plans. Those plans provide for grants of stock options to employees and directors who work for the company. In order to account for the effect that the distribution of Palm stock would have on the value of outstanding 3Com stock options, 3Com determined a stock option adjustment ratio based on the price of 3Com stock before and after the Palm distribution, and then used that ratio to increase the number of 3Com shares subject to options and decrease the option strike price.
According to Plaintiff's complaint, prior to the Palm spin-off, 3Com employees and directors had outstanding options to acquire approximately 35 millions shares of 3Com stock, which constituted approximately ten percent of the company's outstanding stock. After the spin-off and adjustment of the stock option plans, the complaint asserts that 3Com employees and directors possessed outstanding options to acquire approximately 175 million 3Com shares, which amounts to approximately fifty-one percent of the company. Plaintiff alleges that 3Com's adjustment of its stock option plans in connection with the Palm spin-off was "arbitrary and without rational basis and was inappropriate." Complaint, ¶ 10. Paragraph ten of the complaint sets forth the primary factual allegations of Plaintiff's claims in this action:
The adjustment... was made without authority and in breach of the option grants under the Plans and was an unexpected and unintended result of prior stockholder approval of the Plans. The stockholders were never informed that adjustments could be made which would increase the amount of outstanding options by nearly five times the outstanding options given under the Plans and increase the percentage potentially to be owned by outside directors and employees, from 10% to 51% of the Company. The shareholders were never informed that such an adjustment could be made when a wholly owed subsidiary was spun off to [3Com] shareholders.
See id. Furthermore, Plaintiff claims that the adjustment of stock options "produced no benefit to 3Com] and it received no consideration therefor." See id., ¶ 11. Based on these allegations, Plaintiff brings a derivative claim on behalf of 3Com in which he maintains that 3Com's directors breached the duties they owed to the company and its shareholders by participating in and voting for the adjustment of 3Com's stock options. See Id., ¶ 13C. Plaintiff also asserts a class action claim on behalf of all shareholders of the company, alleging that the defendants conduct was wrongful and to the detriment of 3Com shareholders, and that the defendants breached the fiduciary and common law duties which they owed to members of the class. See Id., ¶ 15B.
The defendants — 3Com and various individual directors and officers of the company (collectively referred to as "Defendants") — removed this case pursuant to sections 77p(c) and 78bb(f)(5)(B) of the Securities Litigation Uniform Standards Act (the "Uniform Standards Act"). See 15 U.S.C. § 77p(c); 15 U.S.C. § 78bb(f)(5)(B). Those sections authorize the removal of any covered class action that is based on state law, where the complaint alleges "an untrue statement or omission of material fact in connection with the purchase or sale of a security," or where the complaint alleges that "the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a security." See 15 U.S.C. § 77p(b); 15 U.S.C. § 78bb(f)(1). Plaintiff now challenges removal under the Uniform Standards Act, arguing that (1) the complaint does not allege any purchase or sale of 3Com stock, (2) the complaint does not allege any misrepresentation or omission of material fact, and (3) the claims may proceed in state court pursuant to the Uniform Standards Act's so-called "Delaware carve-out" provisions.
The "Delaware carve-out" provisions create an exception to removal under the Uniform Standards Act which permits plaintiffs to bring certain class action lawsuits based on state law in state court. See 15 U.S.C. § 77p(d)(l), 78bb(f)(3)(A); 15 U.S.C. § 77p(d)(4), 78bb(f)(3)(D).
LEGAL STANDARD
Removal jurisdiction is governed by 28 U.S.C. § 1441 (a). The removal statute is strictly construed, and the court must reject federal jurisdiction if there is any doubt as to whether removal was proper. Duncan v. Stuetzle, 76 F.3d 1480, 1485 (9th Cir. 1996); Gaus v. Miles, Inc., 980 F.2d 564, 565 (9th Cir. 1992). The party seeking removal bears the burden of showing the propriety of removal. Duncan, 76F.3dat 1485.An action is removable to federal court only if it might have been brought there originally. U.S.C. § 1441(a). Federal question jurisdiction exists if an action arises under the laws of the United States. 28 U.S.C. § 1331. Federal jurisdiction exists only if the federal question appears on the face of the plaintiff's "well-pleaded complaint." Caterpillar Inc. v. Williams, 482 U.S. 386, 392 (1987). Thus, under the well-pleaded complaint rule, a defendant cannot remove a state law claim to federal court even if a defense, including the defense of preemption, is based on federal law. See Hunter v. United Van Lines, 746 F.2d 635, 639 (9th Cir. 1984), cert. denied, 474 U.S. 863 (1985). The "complete preemption" doctrine, however, stands as an independent corollary or exception to the well-pleaded complaint rule. See Caterpillar, 482 U.S. at 393. Under this doctrine, once an area of state law has been completely preempted, any claim purportedly based on that preempted state law is considered, from its inception, a federal claim, and therefore arises under federal law.
ANALYSIS
A. The Uniform Standards Act
The Central District's decision in Gibson v. PS Group Holdings, Inc., 2000 WL 777818, *2-3 (S.D. Cal. June 14, 2000) sets forth the background history and preemptive effect of the Uniform Standards Act:
In 1995 Congress determined that meritless and abusive private securities lawsuits were harming the nation's securities markets. H.R. Conf. Rep. No. 104-369, at 31-32 (1995). It responded by passing the Private Securities Litigation Reform Act of 1995, Pub.L. 104-67, 109 Stat 737 (1995) (the "Reform Act"). The Reform Act enacted tougher procedural and substantive standards for private securities suits in federal courts. Among other things, the Reform Act established heightened pleading requirements, an automatic stay of discovery pending motions to dismiss and a safe harbor for certain forward-looking statements. 15 U.S.C. § 78u-4, 77z-1.
Three years later, Congress determined that class action attorneys were attempting to circumvent the Reform Act's requirements by filing frivolous securities lawsuits in state court and under state law, rendering virtually all of the Reform Act's protections inapplicable. Congress responded by enacting the Securities Litigation Uniform Standards Act of 1998, Pub.L. No. 105- 353, 112 Stat. 3227 (1998) (the "Uniform Standards Act" or "Act"). Congress expressly found that "a number of securities class action lawsuits have shifted from Federal to State courts," and that "this shift has prevented [the Reform Act] from fully achieving its objectives." See Uniform Standards Act § 2(1) — (3). Congress concluded that "to prevent [these] State private securities class action lawsuits... from being used to frustrate the objectives of the [Reform Act], it is appropriate to enact national standards for securities class action lawsuits involving nationally traded securities, while.., not changing the current treatment of individual lawsuits." Id. § 2(5).
The Uniform Standards Act resolves these problems by foreclosing the option of filing class actions in state court or under state law. See H.R. Conf. Rep. No. 105-803, at 13-15 (1998).
Specifically, the provisions of the Uniform Standards Act which permit the removal of, and therefore preemption of, certain securities class actions provide:
(b) CLASS ACTION LIMITATIONS — No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State of Federal court by a private party alleging
(1) an untrue statement or omission of a material fact in connection with the purchase or sale of a covered security; or
(2) thsat the defendant used or employed any manipulative or deceptive device or other contrivance in connection with the purchase or sale of a covered security.15 U.S.C. § 77p(b), 78bb(f)(l). Covered class actions which match the above criteria may be removed from state court to federal district court:
Covered class actions are defined as:
(i) any single lawsuit in which (I) damages are sought on behalf of more that 50 persons or prospective class members, and questions of law or fact common to those persons or members of the prospective class, without reference to issues of individual reliance on an alleged misstatement or omission, predominate over any questions affecting only individual person or members; or (II) one or more named parties seek to recover damages on a representative basis on behalf of themselves and other unnamed parties similarly situated, and questions of law or fact common to those persons or members of the prospective class predominate over any questions affecting only individual persons or members; or (ii) any group of lawsuits filed in or pending in the same court and involving common questions of law or fact, in which (I) damages are sought on behalf of more than 50 persons; and (II) the lawsuits are joined, consolidated, or otherwise proceed as a single action for any purpose.15 U.S.C. § 77p(f)(2)(A), 78bb(f)(5)(B).
(c) REMOVAL OF COVERED CLASS ACTIONS. — Any covered class action brought in any State court, involving a covered security, as set forth in subsection (b), shall be removable to the Federal district court for the district in which the action is pending, and shall be subject to subsection (b).15 U.S.C. § 77p(c), 78bb(f)(2). "Broken down into its component parts," the Uniform Standards Act "obligates the removing party to prove that: 1) the class action sought to be removed is a 'covered class action,'2) the class action complaint is based on state law claims, 3) there has been a purchase or sale of a 'covered security,' and 4) in connection with that purchase or sale, plaintiffs allege that defendants either "misrepresented or omitted a material fact' or "used or employed any manipulative or deceptive device or other contrivance."' Burns v. Prudential Securities, 116 F. Supp.2d 917, 921 (N.D. Ohio 2000); see also Gibson, 2000 WL 777818, *3. The parties do not dispute that Plaintiff's suit falls with the Uniform Standards Act's definition of a "covered class action," nor do they dispute that 3Com stock constitutes a "covered security." Instead, the primary areas of debate concern whether or not Plaintiff's claims involve the "purchase or sale" of a security and, if so, whether or not any misrepresentation or deception accompanied such a purchase or sale.
Covered securities are defined by the Uniform Standards Act as:
[A] security that satisfies the standards for a covered security specified in paragraph (1) or (2) of section 77r(b) of this title [§ 18(b) of the Securities Exchange Act of 1933], at the time during which it is alleged that the misrepresentation, omission, or manipulative or deceptive device occurred . .15 U.S.C. § 78bb(f)(5)(E). Section 77r(b), in turn, provides that a covered security is one that either 1) is "listed, or authorized for listing, on... the Nasdaq Stock Market," or 2) "is issued by an investment company that is registered, or that has filed a registration statement under the Investment Company Act of 1940." As mentioned above, 3Com's stock was traded on the NASDAQ exchange at the time when 3Com's stock options were adjusted.
B. Purchase or Sale
Plaintiff's first argument in favor of remand is that his claims are unrelated to the "purchase or sale" of a covered security, and thus, the Uniform Standards Act's "in connection with" requirement for removal cannot be satisfied. See 15 U.S.C. § 77p(b), 78bb(f)(1). In support of this argument, Plaintiff explains that no particular sale or purchase of 3Com stock is alleged in the complaint. Further, Plaintiff characterizes the complaint as being directed at Defendants' adjustment of 3Com's stock options and the resulting dilution of "present shareholder's interests" in 3Com caused by the adjustment. Complaint, ¶ 9. Neither the adjustment nor the dilution, Plaintiff argues, is based on or in any way dependent upon the purchase or sale of 3Com stock.
The Uniform Standards Act itself does not define the meaning of "in connection with the purchase or sale" of a covered security. Nevertheless, given this language's similarity to section 10(b) of the Securities Exchange Act of 1934 and Securities Exchange Commission Rule 10b-5, courts have consistently looked to decisions interpreting those provisions for guidance in construing the Uniform Standards Act. See Green v. Ameritrade, Inc., 120 F. Supp.2d 795, 798 (D. Neb. 2000); Burns, 116 F. Supp.2d 917, 923; Abada v. Charles Schwab Co., Inc., 68 F. Supp.2d 1160, 1166 (S.D. Cal. 1999), vacated on reconsideration, 127 F. Supp.2d 1001, 1003 (S.D. Cal. 2000). In construing the "in connection with" language of section 10(b), the United States Supreme Court has stated that "Section 10(b) must be read flexibly, not technically and restrictively." Superintendent of Ins. v. Bankers Life Cas. Co., 404 U.S. 6, 12 (1971). Thus, both the Supreme Court and the Ninth Circuit have held that section 10(b) provides redress when there is a sale of a security and fraud that simply touches the sale or has some nexus with a securities transaction. See id. at 12-13; Arrington v. Merrill Lynch, Piece, Fenner Smith, Inc., 651 F.2d 615, 619 (9th Cir. 1981); SEC v. Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1992).
Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 prohibit fraudulent acts "in connection with the purchase or sale of any security." 15 U.S.C. § 78j; 17 CER. § 240.10b-5.
At the same time, however, courts will not find the "in connection with" requirement satisfied where no purchase or sale of a security has been transacted by the claimant who seeks damages under section 10(b) or Rule 10b-5. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975); Birnbaum v. Newport Steel Corp., 193 F.2d 461, 464 (2d Cir. 1952). This so-called "purchaser-seller rule excludes both "shareholders.., who allege that they decided not to sell their shares because of... a failure to disclose unfavorable material (and).., shareholders.., who suffered loss in the value of their investments due to corporate or insider activities.., which violate Rule 10b-5."' Shivers v. Amerco, 670 F.2d 826, 829 (9th Cir. 1982) (quoting Blue Chip, 421 U.S. at 737-38) (finding purchaser-seller requirement unsatisfied as to employee-shareholders who continued to hold stock at time when their employer ended its practice of purchasing certain minority shares at above-book value prices); see also Ohashi v. Verit Indus., 536 F.2d 849, 852-53 (9th Cir. 1976) (ruling that the Birnbaum rule foreclosed recovery based on theory that market value of the plaintiff's stock would have been higher if value of all company stock had not been impaired by defendant officers and directors' wrongful conduct). Indeed, a plaintiff may intentionally frame the complaint in a manner that alleges injury resulting only from the holding of securities, and not from the purchase or sale of securities, and by doing so, shield his or her claims from the Uniform Standards Act's removal provisions. See Gordon v. Buntrock, 2000 WL 556763, *3 (N.D. Ill. April 28, 2000).
The complaint in this action does not mention any purchase or sale of stock by either Plaintiff or the purported class he seeks to represent. Nonetheless, Defendants assert that the "in connection with" requirement is satisfied by Plaintiff's allegations that the class includes all 3Com shareholders and that the class was never informed that adjustments under 3Com's stock option plans could reduce their ownership interests. See Complaint, ¶ 10, 14. According to Defendants, since Plaintiff and the purported class members are alleged to be 3Com shareholders, they necessarily purchased 3Com stock at some point in time, and moreover, since 3Com's shareholders were allegedly not informed at the time of their stock purchases of the impact a stock option adjustment might have, their claims allege fraudulent conduct in connection with the purchase or sale of a covered security.
Defendants' attempt to connect the failure to disclose information regarding the stock option plans' adjustment provisions and Plaintiff's (and other class member's) purchase of 3Com stock is unconvincing. A review of the allegations of Plaintiff's complaint reveals that none of Plaintiff's claims rest upon any purchase or sale of 3Com stock. Rather, the claims are based on the dilution of "present shareholder's interests" that was allegedly caused by Defendants' improper adjustment of 3Com's stock options. Complaint, ¶ 9. In other words, the complaint essentially claims that the value of existing shareholder's ownership interests in 3Com were reduced by the stock option adjustment. This purported injury arose from the mere holding of 3Com stock, and not from any trading of 3Com securities. Under such circumstances, Plaintiff and the class he seeks to represent do not constitute purchasers or sellers for purposes of the "in connection with" requirement, and thus, that requirement is not satisfied in this case. See, e.g., Blue Chip, 421 U.S. at 737-38; Shivers, 670 F.2d at 829; Ohashi, 536 F.2d at 852-53; Gordon, 2000 WL 556763 at *3.
Unlike in the cases cited by Defendants' to support a broad reading of the "in connection with" requirement, Plaintiff's complaint does not mention or otherwise rely upon the purchase or sale of 3Com stock. See Arrington, 651 F.2d at 619 (misrepresentation of the risks of buying securities on margin in a declining market as well as misrepresentations regarding analyst recommendations regarding particular stocks found to be fraud "in connection with" the purchase of securities); Rana Research, 8 F.3d at 1362-63 (fraudulent press release calculated to influence investors regarding stock purchase, and which did touch transactions that occurred, satisfied the "in connection with" requirement).
Furthermore, Defendant'' construction of Plaintiff's allegations fails because it sweeps too broadly. Their conclusion that the purported class in this case is made up of purchasers of 3Com stock who were misinformed about 3Com's stock option plans at the time of their purchases is based on two unfounded assumptions. First, a class composed of all 3Com shareholders is not necessarily exclusively composed of purchasers of 3Com stock. Although the number is probably quite small, some shareholders may have acquired their stock by way of gift, inheritance, or some other means not involving a stock purchase. Second, even assuming that most 3Com shareholders purchased 3Com stock at some point in time prior to the adjustment of stock options, this fact does not necessarily connect any alleged misleading conduct with those purchases. The complaint is devoid of any allegations that make such a connection. As mentioned, it does not refer to any particular stock purchases. In addition, the complaint does not indicate that the purported class chose to become 3Com shareholders based on any misrepresentations or omissions regarding 3Com's stock option plans.
Given the particular allegations of Plaintiff's complaint in this case, Defendants' reference to the "unitary scheme of fraud" theory is unavailing. Under that theory, fraud related to the purchase and holding of a security may satisfy the "in connection with" requirement where the plaintiff alleges a "unitary scheme of fraud" which began before a stock purchase and continued afterward. See Rudolph v. Arthur Andersen Co., 800 F.2d 1040, 1046 (11th Cir. 1986); Gordon, 2000 WL 556763 at *4. As explained above, however, Plaintiff has not made allegations which would constitute such a scheme.
In the absence of a plaintiff or class of plaintiffs who purchased or sold a covered security, removal is not authorized by the Uniform Standards Act and this action must therefore be remanded to state court. See 15 U.S.C. § 77p(c); 78bb(f)(2); see also Burns, 116 F. Supp.2d at 924-25 (finding removal under the Uniform Standards Act improper where complaint lacked any allegation of deception in connection with the trading of covered securities).
Given that the "purchase or sale" analysis discussed above compels remand of this action, the Court finds it unnecessary to address Plaintiff's alternative grounds for remand, namely, the purported absence of any misrepresentation or omission of material fact or the applicability of the Uniform Standards Acts' so-called "Delaware carve-out" provisions.