• Delaware Court Ruling Further Erodes PSLRA Discovery Stay
  • November 30, 2004
  • Law Firm: Gibson, Dunn & Crutcher LLP - Los Angeles Office
  • Last week, Chancellor Chandler of the Delaware Chancery Court issued an important decision that further erodes the protections afforded by the discovery stay provision of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). See Cohen v. El Paso Corporation, 2004 WL 2340046 (Del. Ch. Oct. 18, 2004).

    In 2002, a barrage of securities class action lawsuits were filed against El Paso Corporation in federal court in Texas. In May 2004, a lead plaintiff was appointed and the lawsuits were consolidated into Wyatt v. El Paso Corp., C.A. No. H-02-2717 (S.D. Tex.). El Paso then filed a motion to dismiss. With the filing of El Paso's motion, discovery in the federal court action was automatically stayed pursuant to the discovery stay provision of the PSLRA. See 15 U.S.C. §§ 77z-1(b)(1); 78u-4(b)(3)(B).

    In June 2004, Max Cohen, an El Paso shareholder, filed a state court action in Delaware, pursuant to 8 Del. C. § 220, to inspect El Paso's books and records. Mr. Cohen's state court action sought books and records relating to, among other things, "El Paso's accounting for oil gas and reserves," the subject of the federal securities claims asserted against El Paso. Cohen, 2004 WL 2340046, at *1.

    Arguing that Mr. Cohen's state court action was brought for an improper purpose, El Paso filed a motion in the Delaware Chancery Court to dismiss or stay Mr. Cohen's action. According to El Paso, Mr. Cohen's state court action was a transparent attempt to circumvent the stay of discovery imposed by the PSLRA in the federal court action in Texas. To support its motion, El Paso pointed to both the discovery stay provision of the PSLRA and a provision of the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") designed to prevent circumvention of the PSLRA stay of discovery. See 15 U.S.C. §§ 77z-1(b)(1) and (4); 78u-4(b)(3)(B) and (D).

    While acknowledging that "the PSLRA is aimed at reducing abusive litigation practices in federal securities actions" and that the SLUSA provision identified by El Paso was adopted to "prevent[] plaintiffs from avoiding the PSLRA's mandated stay of discovery by fleeing to state court," the Delaware court denied El Paso's motion:

    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. Conflict between the PSLRA with § 220 will potentially arise only when the § 220 action is seeking records that pertain directly to a federal securities law claim asserted in a pending federal action, and that is not the case here. Cohen's complaint, while relying on similar, if not identical facts, as form the basis for the federal securities claims in Wyatt,seeks to investigate state law claims, and are not the subject of the Wyatt litigation. Therefore, neither the PSLRA nor SLUSA operate to preempt or otherwise interrupt Cohen's § 220 action.

    Cohen, 2004 WL 2340046, at *3.

    Though difficult to parse, the reasoning of the Delaware court appears to be that Mr. Cohen's state court case is "unrelated" to the federal case because Mr. Cohen brought his action to investigate state, rather than federal, claims. The Delaware court apparently was not swayed by the fact that Mr. Cohen's complaint relies on "identical facts as form the basis for the federal securities claims."

    Unlike the Delaware court in Cohen, federal courts in Texas and elsewhere have recognized that discovery in a state court action may properly be stayed where the underlying facts for the state law claims and federal securities claims overlap. See, e.g., Newby v. Enron Corp., 338 F.3d 467 (5th Cir. 2003) (affirming stay of discovery in state court actions asserting state law claims). It is unclear whether El Paso also sought a stay of discovery from the federal court in Texas.

    In light of the Delaware court ruling in Cohen, defendants confronted with competing federal and state court actions may want to turn first to federal court for relief under the SLUSA provision that empowers a federal court to "stay discovery proceedings in any private action in a State court as necessary in aid of its jurisdiction."