Diamond Multimedia Systems, Inc. v. Superior Court

BROWN, J., Dissenting.—

I

Plaintiffs contend that both the language and legislative history of California’s Corporate Securities Law of 1968 (Corp. Code, § 25000 et seq.) 1 demonstrate “a clear . . . intent” that the Act apply “to interstate as well as intrastate transactions.” But that construction is belied by the text of the Act itself, by statements of its principal drafter, by commentators and securities litigation practice, and by court decisions. According to these interpretations, spanning more than 30 years, the Act was never intended to have an extraterritorial effect. Instead, it was drafted and enacted in the expectation that it would supplement the federal securities acts, statutes that apply to and regulate a truly nationwide securities market. That was the view of the Act and its role from the outset. In a letter dated April 19, 1968, to Senator Randolph Collier, a member of the California Senate Committee on Finance, Harold Marsh, Jr., a corporate law professor and the reporter for the committee of experts appointed to draft what became the Act, wrote that in drafting the legislation, the committee “tried to reach a balanced judgment as to how far it was possible for California to go in asserting jurisdiction over . . . predominately foreign transactions and, as a matter of policy, how far it should attempt to go.” (Harold Marsh, Jr., Letter to Sen. Randolph Collier re Assem. Bill No. 1 (1968 Reg. Sess.) Apr. 19, 1968, p. 5.) The committee *1066 sought “to give the greatest possible protection to California investors and at the same time to recognize that California cannot rule the United States.” (Ibid., italics added.)

Professor Marsh’s view of the Act’s strictly intrastate application has been the almost unanimous consensus for more than a quarter-century. Because of the widely shared assumption that California’s Blue Sky statute did not apply to out-of-state transactions, there simply was no litigation seeking to apply it extratenitorially. It was not until after Congress passed the Private Securities Litigation Reform Act of 1995, Public Law No. 104-67 (Dec. 22, 1995) 109 Statutes 737 (1995 U.S. Code Cong. & Admin. News, No. 1) (the Reform Act), legislation intended by its sponsors to put a stop to what the Senate report called “frivolous ‘strike’ suits alleging violations of the Federal securities laws in the hope that defendants will quickly settle to avoid the expense of litigation” (1995 U.S. Code Cong. & Admin. News, No. 2, at pp. 679, 683, reproducing Sen.Rep. No. 104-98 on Pub.L. No. 104-67 (June 19, 1995) (the Reform Act Report)) that serious, concerted efforts were mounted by the securities plaintiffs class action bar to widen the territorial scope of the California Blue Sky statute.

Before this litigation—founded on a revisionist history of the Act’s purpose and scope—efforts were concentrated on enlarging the California statute by amendment. The ill-fated Proposition 211, rejected by California voters at the November 1996 election by a 3-to-l margin, would have added Corporations Code section 25400.1 to the Act, containing almost identical language to existing section 25400, subdivision (d), but removing the limiting words “in this state.” (See Ballot Pamp., Prop. 211: Text of Proposed Law, Gen. Elec. (Nov. 5, 1996) § 3, p. 95.) If, as the majority now assumes, existing Corporations Code section 25400 et seq. 2 has always authorized nationwide blue sky suits, why was the initiative provision needed? Of course, today’s decision makes the defeat at the polls inconsequential. The court now magnanimously flings open the doors the voters emphatically closed. Indeed, the court insists on welcoming these actions despite Congress’s repeated attempts to curtail them.

II

On November 3, 1998, the President signed into law the Securities Litigation Uniform Standards Act of 1998 (Sen. No. 1260, 105th Cong., 2d Sess. (1998) (the Uniform Standards Act)). Among other effects, the Uniform Standards Act expressly preempts state blue sky laws, like California’s *1067 Act, and “makes Federal court the exclusive venue for most securities class action lawsuits.” (Joint Explanatory Statement of the Com. of Conf., Uniform Standards Act of 1998, 144 Cong. Rec. H10/774 (daily ed. Oct. 13, 1998).) The joint statement goes on to describe the Uniform Standards Act as intended “to prevent plaintiffs from seeking to evade the protections that Federal law provides against abusive [securities class action] litigation by filing suit in State, rather than in Federal, court” and to “protect the interests of shareholders and employees of public companies that are the target of meritless ‘strike’ suits.” (Ibid.)

As the majority points out, the Uniform Standards Act does not apply retroactively. (See maj. opn., ante, at p. 1046, fn. 12.) That does not end the preemption inquiry, however. Given the several actual, irresolvable conflicts between the Reform Act and California’s Blue Sky Law, the federal statute itself impliedly preempts the state law on which this suit rests. The reason is as well established as it is simple—California’s Act, as the court now interprets it, “ ‘[stands] as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.’ ” (Barnett Bank of Marion Cty., N.A. v. Nelson (1996) 517 U.S. 25, 31 [ 116 S.Ct. 1103, 1108 , 134 L.Ed.2d 237 ] (Barnett Bank), quoting Hines v. Davidowitz (1941) 312 U.S. 52, 67 [ 61 S.Ct. 399, 404 , 85 L.Ed. 581 ]; see also Freightliner Corp. v. Myrick (1995) 514 U.S. 280, 287 [ 115 S.Ct. 1483, 1487 , 131 L.Ed.2d 385 ] [“a federal statute implicitly overrides state law . . . when state law is in actual conflict with federal law”]; Florida Avocado Growers v. Paul (1963) 373 U.S. 132, 141 [ 83 S.Ct. 1210, 1216-1217 , 10 L.Ed.2d 248 ].)

It is a bedrock proposition of supremacy clause jurisprudence that where federal and state laws are in “irreconcilable conflict,” state law must give way. (Rice v. Norman Williams Co. (1982) 458 U.S. 654, 659 [ 102 S.Ct. 3294, 3298-3299 , 73 L.Ed.2d 1042 ].) That much was established early on by Chief Justice Marshall’s opinion in Gibbons v. Ogden (1824) 22 U.S. (9 Wheat.) 1, 210-211 [ 6 L.Ed. 23, 73 ] (The supremacy clause applies “to such acts of the state legislatures as . . . interfere with, or are contrary to, the laws of congress .... [I]n every such case, the act of congress ... is supreme; and the law of the state . . . must yield to it.” [Italics added.]). That is plainly the case here.

Recent decisions by several state appellate courts applying these established “implied conflict preemption” principles in analogous securities fraud class action cases strongly suggest (if they do not establish unequivocally) that this suit, too, is in “direct and irreconcilable conflict” with the federal Reform Act. It is thus preempted. In Guice v. Charles Schwab & Co., Inc. *1068 (1996) 89 N.Y.2d 31 [ 651 N.Y.S.2d 352 , 674 N.E.2d 282 ], certiorari denied 117 S.Ct. 1250 [ 137 L.Ed.2d 331 ] (Guice), retail securities customers of two nationwide discount stock brokerage firms sought national class action monetary and injunctive relief, claiming that the failure of defendant brokers to disclose the acceptance of “payments for order flow” from wholesale securities dealers for routing customer orders to them breached defendants’ fiduciary obligation under New York’s common law of agency of “full and frank disclosure” to plaintiffs. ( 89 N.Y.2d at p. 38 [ 674 N.E.2d at p. 285 ].)

Relying on Barnett Bank, supra, 517 U.S. 25 [ 116 S.Ct. 1103 ], the latest in a long line of Supreme Court implied preemption decisions, the New York Court of Appeals held the claims of the plaintiff class were preempted by the 1975 amendments to the Securities Exchange Act and the implementing Securities Exchange Commission (SEC) regulations. (Guice, supra, 89 N.Y.2d at p. 39 [ 674 N.E.2d at p. 285 ].) The amendments, the New York high court reasoned, “were intended to give the SEC the power administratively to develop a ‘coherent and rational regulatory structure to correspond to and to police effectively the new national [securities] market system [citation].’ ” (Id. at pp. 45-46 [ 674 N.E.2d at p. 289 ].) If the courts of each of the 50 states were permitted “to impose civil liability on national securities brokerage firms ... for failure to meet more stringent common-law agency standards of disclosure of receipt of order flow payments (rather than the Federally mandated uniform specific disclosure . . .)[,] the congressional purpose of enabling the SEC to develop and police [a] ‘coherent regulatory structure’ for a national market system” would be defeated. (Id. at p. 46 [ 674 N.E.2d at p. 289 ].)

The Guice decision does not stand alone. Fully a half-dozen opinions by appellate courts across the country have reached the identical conclusion. (See Dahl v. Charles Schwab & Co., Inc. (Minn. 1996) 545 N.W.2d 918, 925 (Dahl), cert. den. 519 U.S. 866 [ 117 S.Ct. 176 , 136 L.Ed.2d 116 ] [reasoning that compliance with state laws might lead to an end to the practice of order flow payments, thus conflicting with federal law permitting it; state law preempted]; Eirman v. Olde Discount Corp. (Fla.Dist.Ct.App. 1997) 697 So.2d 865 [adopting rationale of Guice and Dahl]; Orman v. Charles Schwab & Co., Inc. (1997) 179 Ill.2d 282 [ 227 Ill.Dec. 927 , 688 N.E.2d 620 ], cert. den. __ U.S. __ [ 118 S.Ct. 1518 , 140 L.Ed.2d 670 ] [maintenance of state claims by plaintiff class would obstruct the national market system Congress intended to foster; state law preempted]; McKey v. Charles Schwab & Co. (1998) 67 Cal.App.4th 731 [ 79 Cal.Rptr.2d 213 ] (McKey) [collecting the cases nationally and adopting the rationale of Guice and Dahl].) To our knowledge, the only contrary authority consists of two federal district court decisions, one of which is unreported. (See Gilman v. Wheat, First Securities, *1069 Inc. (D.Md. 1995) 896 F.Supp. 507 ; Thomas v. Charles Schwab & Co., Inc. (W.D.La., July 12, 1995, No. 95-0307) 1995 WL 626522 ; cf. McKey, supra, at pp. 740-741 .)

Many of the factors that determined the result in the Guice and Dahl cases are present in this case. It is clear from the legislative history of the Reform Act (see Reform Act Report, supra, at pp. 683-703) that Congress was motivated by what the Senate report called “frivolous ‘strike’ suits alleging violations of the Federal securities laws in the hope that defendants will quickly settle to avoid the expense of litigation. These suits, which unnecessarily increase the cost of raising capital and chill corporate disclosure, are often based on nothing more than a company’s announcement of bad news, not evidence of fraud.” (Id. at p. 683.) Virtually the entire thrust of the Reform Act is directed at inhibiting such “strike” shareholder litigation, which typically takes the form of fraud-based class action suits brought under SEC rule 10(b)-5 ( 17 C.F.R. § 240 .10b-5 (1998)).

The Reform Act adopts a number of measures intended by Congress to remove incentives to shareholder participation in what the Reform Act’s managers called class action litigation “abuses.” (Reform Act Report, supra, at p. 683.) These include a “safe harbor” or circumscribed immunity from liability provision for “forward-looking statements” or forecasts by issuers if prescribed conditions are met (Reform Act Report, supra, § 102(a)); a mandatory stay of discovery in federal court litigation while a motion to dismiss is pending; enhanced pleading standards that require fact-specific recitals of allegations supporting fraud claims; a “lead plaintiff’ provision designed to put shareholders, rather than class counsel, in charge of securities class action litigation; and a system of proportionate, rather than joint and several, liability for defendants not shown to have committed fraud knowingly. (Id., § 101(b).)

Consider only one of the several possible conflicts with the California securities statute these provisions might produce: If, on the one hand, the federal Reform Act limits the liability of securities issuers for “forward looking” forecasts when the conditions prescribed by the “safe harbor” requirements (15 U.S.C. § 78u-5 of the Securities Exchange Act of 1934) are present and, on the other hand, California’s Blue Sky Law imposes an unqualified liability on securities issuers for such forecasts, the two provisions cannot be reconciled. Because it is impossible for those subject to the California statute and the Reform Act to comply with both, the state statute must give way.

Indeed, not a single provision of the Reform Act has a counterpart in California’s Act. That fact probably accounts for the “migration,” in the *1070 wake of passage of the Reform Act, of securities fraud class action litigation from the federal courts, historically the overwhelmingly preferred venue, to the suddenly more hospitable state courts and state blue sky statutes. An analysis prepared by Stanford Law School’s Securities Litigation Law Project found that although the aggregate number of securities fraud class action lawsuits remained relatively static following enactment of the Reform Act, that statistic masks an underlying and significant change—a sharp increase in securities fraud class action litigation brought under state blue sky laws, and a corresponding diminution in comparable federal court SEC-based litigation. (Grundfest & Perino, Securities Litigation Reform: The First Year’s Experience (Feb. 27, 1997) <http://securities.stanford.edu/ report/pslra_yrl/index.html> [visited Jan. 5, 1999] (Grundfest & Perino).)

According to the authors of the Stanford study, the migratory trend from federal to state courts is driven by efforts of the plaintiffs’ securities class action bar to evade the litigation hurdles the Reform Act placed in the path of such suits. The evidence presented, the study’s authors concluded, “suggests that the level of class action securities fraud litigation has declined by about a third in federal courts, but that there has been an almost equal increase in the level of state court activity, largely as a result of the ‘substitution effect’ whereby plaintiffs resort to state court to avoid the new, more stringent requirements of federal cases.” (Grundfest & Perino, supra, at pt. XI, Conclusions and Policy Issues.)

Under California law, nothing comparable to the provisions of the Reform Act—intended both to make abusive securities strike litigation more difficult to mount and sustain, and to further the declared congressional policy of a national securities market—would apply to class action securities fraud suits filed in our courts. Blue sky suits can thus continue to be financed and controlled by the same handful of class counsel whose “appearance ratio” has climbed significantly since passage of the Reform Act. (Grundfest & Perino, supra, at pt. VII, Appearance Ratio of Plaintiff Law Firms.) The Reform Act’s mandatory freeze on discovery imposed by the Uniform Standards Act would not apply to state blue sky suits either. Indeed, class counsel’s use of state blue sky statutes as a device to evade the Reform Act’s provisions has already been documented. Observers point to the increasingly common practice of filing parallel securities fraud class action suits—one in state court, another in federal court—as a means of evading the Reform Act’s mandatory discovery stay. (See, e.g., Grundfest & Perino, supra, at pt. XI, Conclusions and Policy Issues [“There has also been an increase in parallel litigation between state and federal courts in an apparent effort to avoid the federal discovery stay or other provisions of the Reform Act.”].) *1071 Just that kind of whipsaw evasion was apparently attempted in this case. (See In re Diamond Multimedia Systems, Inc. Securities Litigation (N.D.Cal., Oct. 14, 1997, No. C-96-2644-SBA) 1997 WL 773733 .) The same conflict would seem to hold true for the Reform Act’s enhanced, fact-specific pleading requirements and proportionate liability standard.

Although inferential, the conclusion is inescapable: if state courts resolutely ignore implied preemption principles, the effect of Congress’s passage of the Reform Act will be to offer securities plaintiffs and their class counsel a “safe harbor” from which to evade the effects of the Reform Act. And that is exactly what has happened. Congress is now aware of the trend toward circumventing the Reform Act’s impediments to securities class action litigation by migrating to state courts as the forum of choice. Indeed, Congress has acted with unusual speed to pass legislation precluding state court forum-shopping by securities class action counsel. The Uniform Standards Act expressly preempts state laws in conflict with the standards prescribed by the Reform Act.

The effect of the uniform standards legislation, however, is itself “forward looking.” The question thus becomes whether a small population of securities issuers, cut off from the express effects of the Uniform Standards Act, has been marooned: deprived of the benefits of Congress’s dual policy of furthering a national securities market while deterring abusive securities class action litigation. In other words, the relevant inquiry now is not, as plaintiffs argue, whether California’s Act applies to extrastate transactions. Congress has expressly preempted state securities laws as of November 1998 with the enactment of the Uniform Standards Act. Before that date, however, Congress had impliedly preempted state blue sky provisions, including California’s, that are in “irreconcilable conflict” with the provisions of the Reform Act itself.

The similarities between the case before the New York Court of Appeals in Guice, supra, 89 N.Y.2d 31 [ 674 N.E.2d 282 ], and this case are not only compelling, they point to the same conclusion. Just as the 1975 amendments to the Securities Exchange Act “were intended to give the SEC the power administratively to develop a ‘coherent and rational regulatory structure to correspond to and to police effectively the new national [securities] market system’ [citation],” so, 20 years later, the provisions of the Reform Act were intended by Congress to continue the development of that same national securities market. (89 N.Y.2d at pp. 45-46 [ 674 N.E.2d at p. 289 ].) And just as the New York Court of Appeals reasoned that permitting the courts of each of the 50 states “to impose civil liability on national securities brokerage firms ... for failure to meet more stringent [state] . . . standards” (id. *1072 at p. 46 [ 674 N.E.2d at p. 289 ]) would defeat Congress’s “purpose of enabling the SEC to develop and police [a] ‘coherent regulatory structure’ for a national market system,” (ibid.) so fragmentation of the Reform Acts’ express national standard into as many as 50 different state standards would wreak havoc on federal efforts to protect that market from abusive litigation practices.

As the United States Supreme Court said in rejecting a comparable scenario involving nuisance abatement suits under state law and the federal Clean Water Act, “It is unlikely—to say the least—that Congress intended to establish such a chaotic regulatory structure.” (International Paper Co. v. Ouellette (1987) 479 U.S. 481, 497 [ 107 S.Ct. 805, 814 , 93 L.Ed.2d 883 ].) The prospect of regulatory chaos raised by the Ouellette case, a prospect that would result from the efforts of one state to “do indirectly what [it] could not do directly—regulate the conduct of out-of-state [pollution] sources” (id. at p. 495 [ 107 S.Ct. at p. 813 ])—suggests that application of California’s Blue Sky statutes in this case would also violate the commierce clause of the federal Constitution. (U.S. Const., art. I, § 8.)

The court’s reasoning in Edgar v. MITE Corp. (1982) 457 U.S. 624 [ 102 S.Ct. 2629 , 73 L.Ed.2d 269 ] (Edgar) explains why. A newly enacted Illinois antitakeover statute imposed a 20-day freeze on tender offers for shares of certain target companies (defined in terms of the target’s contacts with Illinois residents). Because it favored target defenses, the 20-day freeze conflicted with the federal Williams Act (amending the Securities Exchange Act of 1934), which had no freeze period, and with Congress’s declared policy of neutrality in takeover battles. In addition, provisions of the Williams Act laid down detailed rules intended to protect the interests of shareholders without “tipping the scales” in favor of the takeover company or its target. (Edgar, supra, 457 U.S. at p. 633 [ 102 S.Ct. at p. 2636 ].)

The court found that three provisions of the state antitakeover statute “upset the careful balance struck by Congress [in the Williams Act] and [that] therefore stand as obstacles to the accomplishment ... of the full purposes and objectives of Congress.” (Edgar, supra, 457 U.S. at p. 634 [ 102 S.Ct. at p. 2636 ].) Although states are free to regulate intrastate securities transactions, blue sky statutes that have “a direct restraint on interstate commerce and ... a sweeping extraterritorial effect” are void under the commerce clause. (Id. at p. 642 [102 S.Ct. at p. 2640].) The court in Edgar went on to say that “the State has no legitimate interest in protecting nonresident shareholders” (id. at p. 644 [102 S.Ct. at p. 2641]) and that provisions of the Williams Act also duplicated substantive protection for shareholders provided in the state statute. (Ibid.) Because the Illinois statute *1073 “imposes a substantial burden on interstate commerce which outweighs its putative local benefits,” it was invalid under the commerce clause. (Id. at p. 646 [102 S.Ct. at p. 2642].)

The same considerations that led the court to declare the Illinois statute at issue in Edgar, supra, 457 U.S. 624 , unconstitutional under the commerce clause apply here. And they point to the same result. As the opinion in Edgar observed, “[t]he Court’s rationale for upholding blue-sky laws was that they only regulated transactions occurring within the regulating States.” (Id. at p. 641 [102 S.Ct. at p. 2640].) The commerce clause, however, “precludes the application of a state statute to commerce that takes place wholly outside of the State’s borders, whether or not the commerce has effects within the State.” (Id. at pp. 642-643 [102 S.Ct. at p. 2641], italics added.) Like the constitutional limitations on a state’s assertion of extraterritorial jurisdiction, “[i]n either case, ‘any attempt “directly” to assert extraterritorial jurisdiction over persons or property would offend sister States and exceed the inherent limits of the State’s power.’ ” (Id. at p. 643 [102 S.Ct. at p. 2641], quoting Shaffer v. Heitner (1977) 433 U.S. 186, 197 [ 97 S.Ct. 2569, 2576 , 53 L.Ed.2d 683 ].)

Conclusion

The majority’s decision is at odds with the text and structure of the Act and a quarter-century’s understanding that it does not extend beyond California’s borders. Fearful, perhaps, that state courts would not give effect to an implicit intent by applying established preemption rules, less than two months ago Congress acted to expressly rule out application of conflicting state blue sky laws. For these defendants, congressional action comes too late. Cut off from the Uniform Standards Act, stranded by today’s ruling, these unlucky few are left to fend for themselves. The concrete unfairness of that result is palpable enough; it is only heightened by this court’s determination to ignore well-established principles governing implied preemption even in the face of the near unanimity among courts across the country in holding that similar 1975 amendments to the Securities Exchange Act preempted state laws in conflict with Congress’s intent.

I dissent.

Chin, J., concurred.

References to the Act are to the Corporate Securities Law of 1968.

All statutory references are to the Corporations Code unless otherwise stated.