United States District Court, Southern District of New York
August 14, 2001
TOBIAS HOLDINGS, INC., PLAINTIFF,
BANK UNITED CORP. AND GOLDMAN SACHS MORTGAGE COMPANY, DEFENDANTS.
The opinion of the court was delivered by: Scheindlin, District Judge.
MEMORANDUM OPINION AND ORDER
Plaintiff has brought a federal securities fraud action
alleging violations of section 10(b) of the Securities and
Exchange Act of 1934, see 15 U.S.C. § 78j(b), and Rule 10b-5
promulgated thereunder, see 17 C.F.R. § 240.10b-5. Plaintiff's
Amended Complaint ("Am.Cmpl.") also asserts state common law
claims for fraud, breach of contract, conspiracy, and tortious
interference with contract. Federal jurisdiction over the state
claims is based on diversity of citizenship.*fn1 Defendants have
moved to dismiss the Amended Complaint. The automatic stay of
discovery provisions of the Private Securities Litigation Reform
Act of 1995 ("PSLRA"), 15 U.S.C. § 77a et seq., require a stay
of discovery in claims arising under that statute until after the
motion to dismiss has been decided.*fn2 Here, despite the stay
of discovery required by the PSLRA, plaintiff seeks discovery on
all state claims except the common law fraud claim.*fn3 The
narrow question presented is whether the PSLRA stays discovery
with respect to plaintiff's non-fraud state law claims where
over such claims is based on diversity of citizenship. For the
following reasons, I conclude that it should not.
A. Statutory Construction
"Where the meaning of a statute is textually ambiguous,
[courts] may consult its legislative history." Washington v.
Schriver, 240 F.3d 101, 108 (2d Cir. 2001) (citing Oklahoma v.
New Mexico, 501 U.S. 221, 235 n. 5, 111 S.Ct. 2281, 115 L.Ed.2d
207 (1991)), superseded on other grounds, 255 F.3d 45 (2d Cir.
2001); see also Lee v. Bankers Trust Co., 166 F.3d 540, 544 (2d
Cir. 1999) ("Legislative history and other tools of
interpretation may be relied upon only if the terms of the
statute are ambiguous.").
[The] first step in interpreting a statute is to
determine whether the language at issue has a plain
and unambiguous meaning with regard to the particular
dispute in the case. Our inquiry must cease if the
statutory language is unambiguous and the statutory
scheme is coherent and consistent.
The plainness or ambiguity of statutory language is
determined by reference to the language itself, the
specific context in which that language is used, and
the broader context of the statute as a whole.
Robinson v. Shell Oil Co., 519 U.S. 337, 340, 117 S.Ct. 843,
136 L.Ed.2d 808 (1997) (quotation marks and citations omitted).
Where there is ambiguity, however, courts may "`focus upon the
broader context and primary purpose of the statute.'" Elliott
Assocs., L.P. v. Banco de la Nacion, 194 F.3d 363, 371 (2d Cir.
1999) (quoting Castellano v. City of New York, 142 F.3d 58, 67
(2d Cir. 1998)).
Here, the ambiguity arises because the automatic stay
provisions apply to "any private action arising under" Chapter 2B
of Title 15 of the United States Code and "any private action
arising under" Subchapter 1 of Chapter 2A of Title 15 of the
United States Code. 15 U.S.C. § 78u-4(b)(3)(B) and § 77z-1(b)(1).
It is not clear from the face of the statute whether Congress
contemplated the situation where both federal question and
diversity jurisdiction are invoked in a single action.
Conceptually, the claims can be split into two groups: the
federal securities fraud claims which are subject to the
automatic stay and the state law claims which are not. Because
the statutory language is silent on this issue, resort to
legislative history is permitted to determine the scope of the
automatic stay provisions.
B. Legislative History
The PSLRA was passed to redress certain perceived abuses in
securities litigation including "the abuse of the discovery
process to coerce settlement." In re Advanta Corp. Secs.
Litig., 180 F.3d 525, 530-31 (3d Cir. 1999).
The purpose of the [PSLRA] was to restrict abuses in
securities class action litigation, including: (1)
the practice of filing lawsuits against issuers of
securities in response to any significant change in
stock price, regardless of defendants' culpability;
(2) the targeting of "deep pocket" defendants: (3)
the abuse of the discovery process to coerce
settlement; and (4) manipulation of clients by class
Id. at 531 (citing H.R. Conf. Rep. No. 104-369, 104th Cong. 1st
Sess. at 31 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 748
To prevent the unnecessary imposition of discovery costs on
defendants, the PSLRA includes provisions for a mandatory stay of
discovery which are found at 15 U.S.C. § 77z-1(b)(1) and §
Under these provisions, "unless exceptional circumstances are
present, discovery in securities actions is permitted only after
the court has sustained the legal sufficiency of the complaint."
Vacold LLC v. Cerami, No. 00 Civ. 4024, 2001 WL 167704, at *6
(S.D.N.Y. Feb. 16, 2001).
The purposes of these provisions were acknowledged to
include the protection of the defendants in
[securities fraud class actions] from being subjected
to extortionate demands for settlement on behalf of
class plaintiffs simply because of the high costs
associated with discovery in these cases; protection
of the corporate defendants from federal judges'
reluctance to impose Rule 11 sanctions in frivolous
lawsuits; and protection of the corporate defendants
from plaintiffs' counsel "discovering" their way into
facts which could allow them to amend an initially
frivolous complaint so as to state a claim.
In re Transcrypt Int'l Sec. Litig., 57 F. Supp.2d 836, 841
(D.Neb. 1999) (citing Conference Report at 32).
None of the perceived abuses addressed by Congress are present
in this case. Plaintiff is not attempting to use discovery as a
"fishing expedition" to find a sustainable claim not alleged in
its Complaint which has already been amended. Furthermore, as
this is not a class action, there is little, if any, coercive
aspect to plaintiff's discovery demands.*fn4 Finally, this is
not a frivolous lawsuit designed to extort money from defendants
who would rather settle than pay exorbitant discovery costs.
C. Diversity Jurisdiction
Although plaintiff's state law claims arise from the same set
of facts as the federal securities claims, they are separate and
distinct claims that cannot be summarily dismissed. Furthermore,
even if the federal securities claims are dismissed, the state
law claims may survive. See Connecticut Nat'l Bank v. Fluor
Corp., 808 F.2d 957, 963 (2d Cir. 1987) (after district court
dismissed federal claims, it should not have also dismissed state
law claims because jurisdiction was based on diversity of
citizenship as well as pendent jurisdiction); see also Jaquith
v. Newhard, No. 91 Civ. 7503, 1993 WL 127212, at *18 (S.D.N Y
Apr. 20, 1993) ("Upon dismissal of the RICO claim and a finding
that the state claims were not pendent to the remaining 10b-5
claim, the Court cannot automatically dismiss the state claims,
but rather must determine if there is an independent basis of
jurisdiction for such claims.").
In In re Trump, Hotel S'holder Derivative Litig., No. 96 Civ.
7820, 1997 WL 442135, at *1 (S.D.N.Y. Aug. 5, 1997), this Court
was confronted with a federal securities fraud shareholder
derivative action that also asserted claims based on diversity of
citizenship. Magistrate Judge Henry B. Pitman applied the PSLRA's
automatic stay provisions and denied plaintiffs' motion to compel
discovery. In so doing, Judge Pitman stated:
Plaintiffs next argue that staying discovery in this
matter operates unfairly because it effectively
penalizes them for alleging a federal securities law
claim in conjunction with their state law claims.
Plaintiffs contend that had they chosen to proceed on
their state law claims alone, the PSLRA [,] by, [sic]
its own terms, would be inapplicable and there would
be no stay. Although plaintiffs appear [to] be
correct that the PSLRA has no application to actions
in which only state law claims are alleged, this is
simply not such an action. Having chosen to invoke
Section 14 of the Exchange Act, plaintiffs are
necessarily subject to the PSLRA. There is simply
nothing in either the text or the legislative history
of the PSLRA that suggests that Congress intended to
except federal securities actions in which there
happens to be both diversity of citizenship and
pendent state law claims.
Id. at *2.*fn5
I respectfully disagree with Judge Pitman's conclusion and
reasoning for a number of reasons. First, the fact that
Congress is silent with respect to a case invoking both federal
question and diversity jurisdiction cannot be taken as evidence
that Congress considered plaintiff's argument but rejected it.
Indeed, Congressional silence more likely means that the issue
was not considered. Second, the discovery stay provisions are
not absolute but allow for particularized discovery when needed
to preserve evidence or prevent undue prejudice to a party. See
In re Grand Casinos, Inc. Sec. Litig., 988 F. Supp. 1270, 1272
(D.Minn. 1997) ("If, . . . Congress had intended an absolute stay
on discovery, then Congress would not have authorized a judicial
reprieve from such a stay, when a reprieve is needed."). Such
statutory flexibility lends further support to the argument that
an exception based on the presence of non-fraud common law claims
brought under diversity jurisdiction would not frustrate the will
of Congress. Finally, permitting discovery to proceed here would
not represent an impermissible "end run" around the PSLRA's
automatic stay provisions. Plaintiff did not simply append state
law securities fraud or common law fraud claims to its Complaint
in order to bypass the stay. Plaintiff's state law claims are
substantive claims which, in addition to fraud claims, include
separate and distinct breach of contract and tortious
The Complaint is quite different from that at issue in In re
Rational Software Sec. Litig., 28 F. Supp.2d 562, (N.D.Cal.
1998), vacated sub nom., SG Cowen Sec. Corp. v. United States
Dist. Court for the Northern Dist. of California, 189 F.3d 909
(9th Cir. 1999). There, plaintiffs filed a consolidated
amended complaint asserting federal and state law insider trading
claims against various defendants. See 28 F. Supp.2d at 564. The
district court held that the PSLRA's discovery stay extends "to
state law securities fraud claims asserted in a federal forum in
conjunction with federal law claims." Id. at 565. The district
court proceeded to allow limited discovery after concluding that
plaintiffs made a threshold showing of prejudice. See id. at
566. On appeal, the Ninth Circuit issued a writ of mandamus
vacating the district court's order. See SG Cowen, 189 F.3d at
913. In so doing, the court also rejected plaintiff's argument
that the district court should have permitted discovery because
of the pendent state claims.*fn6 See id. at 913, n. 1.
Reiterating the words of the district court, the Ninth Circuit
Congress' attempt to address [concerns of discovery
abuse] would be rendered meaningless if securities
plaintiffs could circumvent the stay simply by
asserting pendent state law claims in federal court
in conjunction with their federal law claims.
Id. (alteration in original, emphasis added). Here, plaintiff's
state law claims do not mirror the federal securities claims but
represent legally cognizable, substantive causes of action.
Furthermore, as noted earlier, these claims are not truly pendent
claims as this Court has independent jurisdiction — diversity of
citizenship — requiring it to hear those claims. Accordingly, the
holding in Rational Software is inapplicable.
D. Judicial Efficiency
Plaintiff should not be penalized for bringing both its federal
securities claims and related state common law claims in one
federal action. To prohibit discovery on the state claims would
encourage a duplication of effort and serve as a disincentive for
efficiency. Plaintiff could have brought its state claims in
state court in a separate action. Such an action would not be
precluded by the Securities Litigation Uniform Standards Act of
1998, P.L. 105-353, 112 Stat. 3227 (1998), which effectively
precludes litigation of securities class actions in state courts.
See 15 U.S.C. § 77p. Furthermore, if plaintiff did bring a
separate state court action for the common law non-fraud claims,
it is highly unlikely that discovery in that action would be
halted by a federal court. While a federal court does have the
power to stay discovery in state court proceedings, the grounds
on which it may do so are quite limited: "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. . . ."*fn7 15 U.S.C. § 78u-4(b)(3)(D)
(emphasis added); see also 15 U.S.C. § 77z-1(b)(4). Here, a
federal court hearing only the federal securities claims would
have no basis on
which to stay discovery in a parallel state action involving
non-fraud claims because the non-fraud claims would not interfere
with the jurisdiction of the federal court or threaten its
judgments in any way.
The availability of a single forum to hear both federal and
state claims should not be diminished by an unduly broad
application of a statute which itself is an exception to the
usual practice in federal courts — permitting discovery to
continue during the pendency of a motion to dismiss. Thus, the
automatic stay mandated by the PSLRA cannot prohibit discovery on
non-fraud common law claims arising under the Court's diversity
jurisdiction. To hold otherwise would give the PSLRA too broad a
brush, sweeping into its purview all related but distinct state
law claims brought under diversity jurisdiction. Discovery
relating to plaintiff's non-fraud state law claims shall proceed