February 2, 2004

Applying The Discovery Stay To Related Derivative Cases

The PSLRA provides that "all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." Based on the legislative history, Congress was concerned about the high costs associated with discovery and the possibility that defendants would be forced into early settlements to avoid these costs.

An open question, however, is whether the discovery stay should be applied to related federal cases that do not allege securities law claims. In In re AOL Time Warner, Inc. Sec. and "ERISA" Litig., 2003 WL 22227945 (S.D.N.Y. Sept. 26, 2003), the court stayed all non-ERISA specific discovery. The court found: "If plaintiffs in a securities case could, by tacking ERISA claims onto underlying Securities actions, obtain discovery to which they would otherwise not be entitled under the PSLRA, then the PSLRA's mandatory stay provision would, as a practical matter, never apply. Congress could not possibly have intended for the PSLRA to be so easily marginalized." (The 10b-5 Daily has previously posted about the case.)

The court in In re FirstEnergy Shareholder Derivative Lit., 2004 WL 161330 (N.D. Ohio Jan. 26, 2004) has recently disagreed with this approach (the opinion cites the AOL decision, but does not discuss it). Derivative and securities class action cases have been brought against FirstEnergy based on the same course of conduct. The defendants argued that discovery in the derivative case should be stayed pending a decision on the motion to dismiss in the securities class action, noting that the discovery could be used to assist the securities class action plaintiffs. The court found that the PSLRA is silent on the issue of staying discovery in derivative cases and it refused to "read in this silence Congress's intent to prevent discovery in non-securities fraud cases simply because the cases share facts in common with securities fraud cases." The court also declined to grant a protective order under Fed. R. Civ. Proc. 26(c).

Holding: Motion for stay of discovery denied.

Quote of note: The FirstEnergy court also found that permitting discovery to go forward would not frustrate the PSLRA's goals because "an exchange [between the derivative and securities class action plaintiffs] of information, otherwise discoverable in this derivative action, facilitates the purpose of Fed. R. Civ. Proc. 1." This appears difficult to reconcile with the PSLRA's legislative history and the holding in AOL.

Posted by Lyle Roberts at February 2, 2004 3:22 PM | TrackBack
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