United States: Third Circuit Reverses Dismissal Of State Law Securities Claims Against Pharmaceutical Manufacturer By Investors Who Opted Out Of Settled Federal Class Action, Holding That Securities Litigation Uniform Standards Act Did Not Preclude Opt-Out Claims

Last Updated: September 23 2019
Article by Shearman & Sterling LLP

On September 12, 2019, the United States Court of Appeals for the Third Circuit reversed the dismissal of state law securities actions by individual investors who elected to opt out of a related class action against a pharmaceutical company (the “Company”).  North Sound Capital LLC v. Merck & Co. Inc., Nos. 18-2317 (3d Cir. Sept. 12, 2019).  Opt-out plaintiffs—individual investors who opted out of the class action and who filed separate state law actions against the Company—brought individual actions asserting claims under New Jersey common law, and included allegations that the District Court noted “track, sometimes verbatim, those filed in the class actions.”  The District Court held that such opt-out actions were precluded by the Securities Litigation Uniform Standards Act (“SLUSA”) and dismissed the individual actions.  The Third Circuit reversed, finding that SLUSA does not prohibit investors who opt out of a class action from bringing individual actions under state law.

Class plaintiffs brought suit after the stock of two pharmaceutical companies (which later merged to form the Company) dropped between 2007 and 2008.  Class plaintiffs alleged the companies made material misrepresentations and omissions in violation of federal securities laws in touting the efficacy and commercial viability of these drugs while allegedly seeking to delay the release of damaging information from clinical trials, attempting to alter the findings of the trials, and concealing their role in pushing for different results.  After the companies eventually released the negative results of the clinical trials, the stock price declined significantly.  Four years after the case was filed—after the claims survived a motion to dismiss and a motion for summary judgment—the District Court granted class certification and allowed investors the right to opt out within 45 days, which the individual plaintiffs exercised.  The District Court subsequently approved a settlement between class plaintiffs and the Company and offered the investors who opted out an opportunity to re-join and share in the recovery.  Sixteen opt-out investors declined to do so and brought individual suits against the Company, making similar allegations as those in the class action with an additional state law fraud claim.  After the federal claims were brought in and the opt-out actions were dismissed based on the statute of repose, the Company moved to dismiss the surviving state law claims, arguing that such claims were precluded under SLUSA because they were “joined, consolidated, or otherwise proceed[ing] as a single action for any purpose” with the class action.  The District Court noted this appeared to be an issue of first impression and ultimately dismissed the state law claims.  The District Court noted that Congress did not “explicitly exempt opt-out suits from SLUSA,” which suggests that Congress “envisioned the aggregation of opt-out suits with related class actions,” and the legislative history of SLUSA required the District Court to “construe the definition of a ‘covered class action’ broadly.”  Opt-out plaintiffs appealed.

The Third Circuit first noted that in the wake of class actions shifting to state courts as the result of the Private Securities Litigation Reform Act, Congress enacted SLUSA to preclude “investors from litigating their state-law claims alleging securities fraud through a ‘covered class action.’”  The Court then turned to SLUSA’s definition of a “covered class action.”  The Court noted that all parties agreed that the first part of the definition—“any lawsuit that seeks to recover damages for more than 50 persons or on a representational basis”—was inapplicable because the total number of investors in the opt-out lawsuits was lower than that threshold.  The second part of the definition, which the Court referred to as the “mass-action provision,” covers lawsuits that “1) are ‘filed in or pending in the same court’; (2) involve common legal or factual questions; (3) seek damages for more than 50 persons; and (4) ‘are joined, consolidated, or otherwise proceed as a single action for any purpose.’”  The Court noted that, given that plaintiffs were fewer than 50, the “mass-action provision” would not apply “unless the individual opt-out lawsuits and the settled class actions together satisfy the statutory definition.”  Because there was no dispute that the class actions and the individual lawsuits were both filed in the same court and involved substantially the same facts, the question accordingly turned on the fourth prong:  whether the class actions and these subsequent opt-out suits were “joined, consolidated, or otherwise proceed[ed] as a single action for any purpose.”

Opt-out plaintiffs argued that their individual actions did not satisfy the “single-action” requirement because “they have never proceeded as a single action with the class actions.”  By contrast, the Company argued that the “single-action” requirement merely required a “functional relationship” between the two suits.  The Third Circuit focused on a textual analysis drawing from Black’s Law Dictionary and Supreme Court precedent.  The Court considered the “joined, consolidated” language of the statute and found that the legal definitions of the words as defined by Black’s Law Dictionary most closely capture the intent of Congress (“to combine or unite in time, effort, action,” and “to unite or unify into one mass or body,” respectively).  The Court also noted that the Supreme Court has used versions of the words interchangeably when interpreting other federal rules.  Similarly, the Third Circuit relied on Supreme Court precedent and the Black’s Law Dictionary definition in interpreting the phrase “otherwise proceed” in the mass-action provision.  In rejecting the Company’s argument that “proceed” should be read to mean “to come forth from a source,” the Third Circuit noted that such a reading was unpersuasive as the SLUSA provision did not use “the preposition ‘from’ nor does it identify any source from which the lawsuits must arise.”  Instead, the Court found that “proceed” should be understood as defined in Black’s Law Dictionary (“to carry on a legal action or process”)—and such a definition would be “consistent with the meaning of joinder and consolidation” and other federal rules.  Regarding the reference to “a single action for any purpose,” the Third Circuit concluded that Congress had sought to clarify that matters were not required to proceed together for most or all purposes, and could still meet the statutory definition even if they had separate trials, judgments, or hearings.  The Court noted that for cases to “be at least partially coordinated,” however, the cases must “coincide [and overlap]” for a period of time.  Employing principles of statutory interpretation as further support for its reading of the provision, the Court observed that because “otherwise” follows a synonymous list of words such as “joined” and “consolidated,” the canon of ejusdem generis (“of the same kind”) provides that there is a “commonality between those preceding words and the phrase “proceed as a single action.”  The Court rejected the Company’s argument that “any” would allow for an expansive reading of the provision, emphasizing that they “do not read statutes in little bites.”

The Third Circuit then considered and rejected the Company’s policy argument that SLUSA should be broadly interpreted such that “federal fraud standards [are uniformly applied].”  Noting that Congress has “repeatedly declined” broad preemption of state law securities claims in drafting legislation, the Court found that under the Company’s interpretation, “the mere existence of a class action would preclude individual plaintiffs from bringing state-law claims” even if individual plaintiffs opt out—which the Court concluded would render SLUSA more prohibitive than Congress intended.  Citing the Supreme Court’s decision in Cyan, the Court stated that “courts have ‘no license to disregard clear language based on an intuition that Congress must have intended something broader.’”  The Court further noted that the Company’s reading of the statute implicated constitutional concerns, because barring opt-out plaintiffs’ state law claims merely because “an unaffiliated party” filed a putative class action would raise Fifth and Fourteenth Amendment due process concerns.

Having concluded that actual coordination was necessary for two matters to be considered a “single action” for the purposes of SLUSA’s mass-action provision, and that actions would not meet this requirement unless they were “somehow combined, in whole or in part, for case management or for resolution of at least one common issue,” the Court found no evidence of such coordination here between the class action and the individual lawsuits.  The Court emphasized that the actions did not temporally overlap and that the mere fact that the Company had already engaged in discovery in the class action that would equally apply to the opt-out cases does not establish “coordination” for SLUSA purposes and would allow only “a hermetically sealed opt-out investor” to proceed with their action.

Circuit Judge Shwartz dissented, arguing that opt-out plaintiffs’ participation in the pretrial proceedings was an important element in whether or not they would be precluded from bringing their own individual suits.  Judge Shwartz noted that the opt-out plaintiffs’ complaints were “virtually identical” to the class action complaint and that the opt-out plaintiffs benefitted from the class action’s discovery (which they intended to “heavily” rely on) rendering their “opt-out actions [as] functionally proceed[ing] as a single action with the class actions.”

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