Federal Forum Provisions: Historical Development and Future Evolution

Abstract

The Securities Act of 1933 provides for concurrent federal and state jurisdiction. In 2015, plaintiffs significantly increased the frequency with which they filed Securities Act claims in state court, where dismissal rates are lower and weaker claims have greater settlement value. The cost of directors and officers insurance for issuers conducting initial public offerings, the form of transaction most sensitive to Securities Act litigation risk, has increased dramatically. This increase is concurrent with plaintiffs’ shift away from federal court. Federal Forum Provisions (FFPs) appear in charters or bylaws. They require that Securities Act claims be litigated in their traditional forum, federal court. FFPs arose as a direct response to plaintiffs’ shift from federal to state court Securities Act litigation. In Sciabacucchi, Delaware Chancery held that FFPs are invalid. That opinion is currently on appeal to Delaware’s Supreme Court. Part I of this note reviews data documenting the migration of Securities Act claims from federal to state court, and shows that approximately 75% of all issuers today facing Securities Act claims face at least one complaint filed in state court. Part II analyses plaintiffs’ incentive to migrate, and focuses on the lower probability of state court dismissal, combined with an array of other procedural advantages that benefit plaintiffs in state court. Part III presents novel data documenting a rapid and significant increase in the cost of directors’ and officers’ insurance. Part IV documents the evolution and propagation of FFPs, and shows that they have been adopted primarily by Delaware-chartered issuers who face a significant risk of Securities Act IPO litigation. Part V summarizes other scholars’ findings that the stock prices of issuers with FFPs declined in a statistically and financially significant manner in response to Chancery’s decision in Sciabacucchi. Part VI concludes with observations regarding the future evolution of FFPs contingent on the pending decision by Delaware’s Supreme Court. If FFPs are upheld as valid, then Delaware will have a further advantage in the market for corporate charters. If FFPs are held invalid, issuers will face incentives to petition other states to adopt legislation affirming the validity of FFPs. If that occurs, insurers will have a rational incentive to impose a “Delaware penalty” on issuers who are likely subject to Securities Act liability and who charter in Delaware rather than in states that enforce FFPs. If this market response emerges, it will be the first instance in which there is an immediate, quantifiable reason not to charter in Delaware. This result cannot be positive for Delaware’s ability to compete in the market for corporate charters.