Opinion
Civil Action No. 02-220-DLB.
March 29, 2004
OPINION ORDER
INTRODUCTION
This case originated with Plaintiff's Kenton Circuit Court filing of what Plaintiff characterizes as a state law derivative action. The case is presently before the Court on all pending motions, which have been briefed and upon which oral argument was held. These motions include Plaintiff's motion to remand (Doc. #6); motions to dismiss by all Defendants except Ernst Young, LLP (Docs. #9 #24); and motion of Defendant Ernst Young, LLP to extend time to answer (Doc. #25).
FACTUAL PROCEDURAL BACKGROUND
Plaintiff Central Laborers' Pension Fund (Central Laborers) owns shares of stock in Ashland, Inc. (Ashland). Central Laborers filed what is captioned as a shareholder derivative action with the Kenton Circuit Court. Named as Defendants are Ashland's former Chairman and CEO, Paul W. Chellgren; its CFO and Vice President, J. Marvin Quin; its former Vice President and Chief Operating Officer, James R. Boyd; and the members of Ashland's Board of Directors — Samuel C. Butler, Frank C. Cerlucci, Ernest H. Drew, James B. Farley, Roger W. Hale, Bernadine P. Healy, Mannie L. Jackson, Patrick F. Noonan, Jane C. Pfeiffer, William L. Rouse, Jr., Theodore M. Solso, and Michael J. Ward. Also named as Defendants are Edward Lunceford, who is not an officer or director of Ashland, but who formerly served as President of the Manassas Division of one of Ashland's businesses, known as APAC, along with other former officers of APAC identifed as John Doe Defendants 1 and 2. Central Laborers also sues Ernst Young, LLP (Ernst Young), hired by Ashland to perform auditing services. Finally, in light of the fact that Central Laborers filed the action as a purported shareholder derivative suit, Ashland, Inc. is also named as a nominal Defendant.
Factually, Plaintiff's lawsuit can be summarized as alleging that those who were in charge of running Ashland have done so poorly and in a manner evidencing more interest in their own personal gain over what Plaintiff contends would have been in the best interests of the corporation. Plaintiff's complain and allege that not only was the corporation poorly run, but that the effects of the poor management were then effectively hidden through the accounting efforts of Ernest Young, resulting in an alleged overstatement of earnings and understatement of expenses.
Plaintiff's complaint contains general categories of alleged improper activity and mismanagement by the various Defendants, summarized briefly as follows:
Alleged Environmental Crimes
Central Laborers claims that Ashland's Board of Directors has allowed multiple environmental violations to occur unchecked, has subjected Ashland to criminal sanctions due to the Board's dereliction in overseeing these environmental operations, and has then underreported the financial impact of these violations on Ashland's financial documents. Central Laborers asserts that despite these concerns, and in an effort to keep this information from being publicly exposed, the Board released Ashland's insurers from future exposure to environmental liabilities in exchange for what Plaintiff asserts was an inadequate payment of $43 million. Plaintiff claims that the Board, in conjunction with Ernst Young, has consistently and intentionally understated Ashland's environmental liabilities and environmental remediation reserves.
Alleged Accounting Manipulations Intentional Securities Fraud
Plaintiff alleges Ashland's accounting disclosures were manipulated by Defendants in conjunction with Ashland's acquisition of a Danish conglomerate, Superfos, and to facilitate insider trading and excessive executive compensation. Plaintiff claims that by 1999 the value of Ashland's stock had diminished due to its growing reputation as a polluter and so Defendants, concerned with the stock value decline and potential takeover and/or breakup of Ashland's divisions, devised a plan to change the composition of Ashland's balance sheet. Plaintiff claims this plan included doubling the size of Ashland's APAC paving division by a number of costly acquisitions; and acquiring Superfos in 1999 and subsuming it into Ashland's APAC construction subsidiary, in the course of which a price so high was offered it unduly increased Ashland's debt load.
Plaintiff claims that following this acquisition, Ashland reported APAC had increased Ashland's earnings in 2000, when in fact the earnings had been overstated and the costs associated with the acquisition and ongoing operations had been understated. Plaintiff asserts Ernst Young was aware of these misrepresentations on Ashland's financial reports and yet approved them. Plaintiff claims that when this information was subsequently revealed to the public and the operating losses recognized in 2001, the Board of Directors initially sought to portray it as falsified fiscal results by APAC executives. Ashland communicated that a "correction" of improperly recognized construction contract earnings at one of APAC's forty-six divisions would be required and allegedly represented that the local management of that APAC division in Manassas, Virginia, had been replaced. Plaintiff specifically alleges that the fraud in conjunction with the Superfos acquisition was in fact more widespread than represented to the public. Plaintiff asserts that Defendants Chellgren and Boyd headed up efforts to acquire Superfos and then personally oversaw all of the reporting in conjunction therewith, and were aided in this misconduct by Ernst Young, while the Board of Directors intentionally took a "head in the sand" approach at seeking out details.
Plaintiff alleges that some of the Defendants used this inflated value of Ashland's stock to engage in unlawful insider selling in violation of securities laws. Specially, Plaintiff claims that during the time period from 1999 until 2001 the Directors paid themselves millions in deferred compensation benefits based upon the then-inflated stock value, then sold shares just before disclosing that APAC's income had been overstated. Plaintiff further claims the Board, concerned about public exposure of the accounting fraud, entered into substantial financial arrangements with Defendants Chellgren, Boyd, and the Manassas division's controller and division president, in conjunction with their departure from the corporation. Plaintiff asserts the Board has done nothing to recover these improper gains.
Plaintiff argues that all of this conduct by Defendants has resulted in a poor corporate reputation for Ashland Plaintiff has brought what it labels as state law derivative claims against Chellgren, Boyd and the Board members for alleged abuse of control (Count II) over Ashland's operations and finances for their own personal benefit; for alleged waste of corporate assets (Count IV) in complying with environmental and securities laws; and for alleged breach of fiduciary duty (Count I) by allowing Ashland to violate state and federal securities and environmental laws, failing to sue those responsible for violating these laws to recover the resulting damage to the corporation, engaging in insider trading, failing to recover illegally obtained insider trading proceeds, failing to institute policies and procedures to prevent future reoccurrences of insider trading, and failing to institute policies to prevent fraudulent financial reporting. Plaintiff has sued all Defendants for gross mismanagement (Count III) by failing in their duty to "prudently supervise, manage and control Ashland's operations." Plaintiff sues Defendants Boyd and Chellgren for unjust enrichment (Count V) by claiming they obtained millions of dollars in benefits to which they were not entitled, and against Chellgren only for usurping corporate opportunities (Count VI). Plaintiff also claims that Ernst Young committed professional negligence and accounting malpractice (Count VII), and aided and abetted Ashland's executives in violating their fiduciary duties, committing corporate waste, abusing their control, and grossly mismanaging Ashland (Count VIII).
Plaintiff filed its derivative action in the Kenton Circuit Court on August 16, 2002, asserting state law claims under Kentucky law, Ashland's state of incorporation. A Notice of Removal was then filed with this Court on September 9, 2002. The Notice was signed by legal representatives for all Defendants, with the exception of Ernst Young, though the Notice indicated Ernst Young had no objection to removal. (Doc. #1, ¶ 3) Ernst Young filed a separate written consent to removal on September 20, 2002. (Doc. #5)
Defendants' Notice asserts that removal is based upon federal question jurisdiction, 28 U.S.C. § 1331. Defendants' Notice describes Plaintiff's purported derivative action as a securities class action in disguise (Doc. #1, ¶ 10) that therefore is removable pursuant to the Securities Litigation Uniform Standards Act (SLUSA), 15 U.S.C. § 78bb(f)(2). Defendants offer that a proper interpretation of Plaintiff's cause of action is one for federal securities law violations, that such a claim is preempted by SLUSA despite Plaintiff's failure to expressly allege such, and therefore removal upon this federal question is appropriate.
Central Laborers seeks to remand the action to state court, for two reasons. One, it protests that the notice of removal was procedurally deficient because it lacks the required unanimity. Two, it protests that federal jurisdiction is lacking because it did not include in the complaint a class action governed by SLUSA and therefore no federal question is presented.
Although Plaintiff has requested this matter be remanded, the Defendants, with the exception of Ernst Young, have also moved for this Court to dismiss Plaintiff's claims against them. (Docs. #9 #24) Defendants challenge that Plaintiff cannot state federal securities law or state law derivative claims against them; Defendant Lunceford also raises a challenge to personal jurisdiction.
ANALYSIS
Pursuant to 28 U.S.C. § 1441(a), defendants can remove any state court civil action over which a federal court has original jurisdiction, provided it is removed in compliance with the procedures set forth in § 1446. A federal district court's original jurisdiction includes actions presenting a federal question. 28 U.S.C. § 1331, 1441(b).
Plaintiff seeks remand on the bases that the procedure of § 1446 has not been satisfied and because, even if it was satisfied, the cause of action filed by it does not raise a federal question so as to provide original jurisdiction. Before analyzing these issues raised by Plaintiff in its motion to remand, defense counsel at oral argument suggested the Court look first to adjudicating the motions to dismiss filed by Defendants. (Docs. #9 #24) As noted above, filed shortly after Plaintiff's remand motion was a motion to dismiss by all Defendants (Doc. #9) with the exception of Ernst Young, and with the exception of Defendant Lunceford, former President of APAC's Manassas division, who filed a separate motion to dismiss (Doc. #24).
Defendants' motion to dismiss (Doc. #9) points out that the gravamen of Plaintiff's complaint is a securities fraud claim and that, as such, SLUSA applies to preempt it. Defendants then note that this preempted securities fraud claim fails to allege an actionable claim under the Private Litigation Securities Reform Act, 15 U.S.C. § 78u-4 § 77z-1. In its response to the motion to dismiss (Doc. #32), Plaintiff of course disputes that it has asserted any federal securities claim at all, and argues it never intended to assert a separate securities fraud claim.
Defendants' motion to dismiss also alleges that to the extent Plaintiff seeks to assert a viable derivative claim under Kentucky law, this too fails. Defendants protest that pursuant to K.R.S. § 271B.7-400, Plaintiff must first make a presuit demand upon the Board, as the managers of the corporation, to bring suit. Because Plaintiff has not done so, Defendants argue any shareholder derivative claim must be dismissed. In addition to bringing a separate challenge to personal jurisdiction, Defendant Lunceford in his motion to dismiss joins in this presuit demand argument. In response (Doc. #32), Plaintiff does not deny that a presuit demand was not made. Plaintiff argues that no such demand is necessary under Kentucky statutory and common law when demand would be useless and futile, and that this is the case here. Defendants also protest that the derivative claim does not allege an actionable breach of fiduciary duty against them. Defendant Lunceford also adds that the complaint specifically fails to state a claim against him for breach of fiduciary duty because he is not a director or a person with control over Ashland Plaintiff responds that Defendants do not understand its breach of fiduciary claim, and that such a claim is not governed by the pleading requirements of Civil Rule 9(b).
Despite defense counsel's suggestion, the Court does not believe that adjudicating the motions to dismiss prior to reviewing the motion to remand would be reasonable or appropriate. If removal was improvidently sought, the Court would thereby be without authority to adjudicate the motion to dismiss since subject matter jurisdiction would be lacking. Steel Co. v. Citizens for a Better Environment, 523 U.S. 83, 94-99 (1998) (counseling against reaching the merits while an unresolved jurisdiction issue exists). Therefore, the Court first considers the motion to remand The Court understands and notes that many of the substantive challenges to Plaintiff's claims raised by Defendants in their motions to dismiss are also set forth in Defendants' responses to the motion to remand (Docs. #19 #22) Defendants suggest the motion to dismiss evidences the lengths to which Plaintiff has gone in order to plead a state claim for what is more accurately a securities law claim. To the extent Defendants' arguments in this regard in their motions to dismiss overlap and support their arguments in opposition to remand, this information has been considered by the Court in the context of analyzing the motion to remand A. Procedural Challenges to Removal
Plaintiff argues that the Notice of Removal is procedurally deficient because it lacks the requisite unanimity; namely, that Ernst Young did not join in removal nor properly or timely indicate its consent. At oral argument, Plaintiff argued that Ernst Young must either join in or sign off on the removal petition. Defendants' Notice indicated Ernst Young "does not object to the removal of this action" (Doc. #1, ¶ 3), but the Notice was not signed by Ernst Young's legal representative. Ernst Young then subsequently filed a separate written consent. (Doc. #5)
What is considered adequate and timely consent to removal?
The general rule is that all defendants must join in the removal of an action. Chicago, Rock Island, Pacific Railway Co. v. Martin, 178 U.S. 245, 248 (1900). This means that official consent must be provided within the thirty day limit prescribed by 28 U.S.C. § 1446. Mehney-Egan v. Mendoza, 124 F. Supp.2d 467, 471 (E.D. Mich. 2000). The Sixth Circuit has clarified that this general rule applies to all defendants who have been served in the action. That is, the rule of unanimity requires that for a notice of removal to be properly before the court, each served defendant is required to either join in the removal notice or file a written consent thereto within thirty days following service upon that defendant. Brierly v. Alusuisse Flexible Packaging, Inc., 184 F.3d 527, 533 n. 3 (6th Cir. 1999). In cases with multiple defendants served at different times, later-served defendants have thirty days from the date of service to remove a case to federal district court, so long as they have the consent of the remaining defendants. Id. at 532-33.
In this case, Ernst Young was served on August 20, 2002, in the same general time frame as the other Defendants. The notice of removal was signed by all other Defendants and filed on September 19, 2002. Ernst Young did not sign off on the notice, though the notice did state that Ernst Young "did not object" to removal. Pursuant to § 1446 and the above authority, Ernst Young could have joined in the Notice or had until September 19, 2002 (thirty days from the date of service upon it) to file its consent to removal or file its own notice of removal with the other Defendants joining in. However, Ernst Young filed its written consent to removal on September 20, 2002, which was one day past the specified thirty day time period.
Does including in the Notice of Removal that Ernst Young "did not object" constitute valid consent?
Review of applicable case law suggests the preferred method is for the notice of removal to state that those defendants who are not signatories to the notice nevertheless consent to removal or intend to consent to removal. See Brierly, 184 F.3d at 533 n. 3 (all properly served defendants must either join in the removal by either signing the notice or filing a formal written consent to removal). "Passive acquiescence" is generally viewed as insufficient to comply with the technical pleading and procedural requirements for removal. Hicks v. Emery Worldwide, Inc., 254 F. Supp.2d 968, 974 (S.D. Ohio 2003); Patrick v. Joint Construction Code Authority, 2002 WL 31938726, *2 (E.D. Mich. 2002) (remand appropriate where unanimity lacking, and notice of removal did not say nor in fact did two of the defendants consent to removal).
In Knickerbocker v. Chrysler Corp., 728 F. Supp. 460 (E.D. Mich. 1990), the district court rejected as insufficient a statement in the notice of removal that a nonremoving defendant "does not object to the removal," finding this did not satisfy 28 U.S.C. § 1446. Id. at 462. Although strict adherence to Knickerbocker would suggest the attempted removal herein should be rejected as being procedurally defective, there are two distinctions with the Knickerbocker decision worth noting. First, the nonremoving defendant did not file a separate consent in Knickerbocker, as Ernst Young did here. Second, Knickerbocker was decided in 1990, prior to the Sixth Circuit's 1993 decisions in Brierly and in Tech Hills II Assocs. v. Phoeniz Home Life Mut. Ins. Co., 5 F.3d 963 (6th Cir. 1993) (noted in more detail below), wherein both cases the Sixth Circuit concluded there is some leeway in the formal rules of removal. This change in strict adherence to procedure since Knickerbocker, as far as allowing defendants to cure jurisdictional defects in removal petitions, was noted in Jordan v. Murphy, 111 F. Supp.2d 1151, 1152 (N.D. Ohio 2000).
In summary, the case law suggests the Notice's reference to the fact that Ernst Young "does not object" to removal fails to satisfy the joinder or consent pleading requirement for valid removal. Ernst Young did file a written consent on September 20, 2002, but this was thirty-one days after service upon it. Therefore, the consent arguably is untimely under § 1446 and Brierly unless strict compliance with this thirty day requirement is excusable.
Is untimely consent to removal a curable defect?
The Sixth Circuit has permitted defects in removal petitions to be cured after the time for removal has expired. Tech Hills II Assocs. v. Phoenix Home Life Mut. Ins. Co., 5 F.3d 963, 969 (6th Cir. 1993) (leave granted to amend to cure deficiency in allegation of diversity of citizenship); Gafford v. General Elec. Co., 997 F.2d 150, 164 (6th Cir. 1993) (same). Although Gafford involved permission to amend to cure a jurisdictional deficiency of failure to adequately state grounds for diversity jurisdiction, the Sixth Circuit, albeit in an unpublished case, has applied Gafford's reasoning of substance over form and liberalized amendment of removal petitions in the context of alleged procedural deficiencies as well. See Klein v. Manor Healthcare Corp., 1994 WL 91786, **3-4 (6th Cir. 1994) (unpublished) (failure to explain in notice that consent from co-defendant was not required since it was not yet served could be amended, including after the thirty day removal period, without violating the rule of unanimity, where the court otherwise had federal question jurisdiction). See also Callahan v. Callahan, 247 F. Supp.2d 935 (S.D. Ohio 2002) (where notice stated co-defendant has agreed to removal, and amended notice was filed wherein defendant consented in writing to removal, the procedural defect created by the initial lack of unanimity was cured by amendment); Scaccia v. Lemmie, 236 F. Supp.2d 830, 836 (S.D. Ohio 2002) (overruling motion for remand based on lack of unanimity where notice of removal indicated that all defendants consented to the removal and where nonremoving defendants filed formal consent two days after removal).
Where, as here, the Notice of Removal advised Plaintiff and the Court that all Defendants were aware of and acquiesced to removal, the more recent practice of permitting amendment to cure technical deficiencies would seem appropriate. In Jordan v. Murphy, 111 F. Supp.2d 1151 (N.D.Ohio 2000), for example, the notice stated only that certain defendants consent to removal; these defendants had not signed the petition. A joint statement of written consent to removal was filed some thirty-eight days after service of process, and a later unopposed motion to amend the notice of removal was granted. However, in Hicks v. Emery Worldwide, Inc., 254 F. Supp. 968 (S.D. Ohio 2003) the notice had not been signed by all defendants, but the nonsigning defendants did file written consents, though more than thirty days after being served. The court held the timeliness requirement had not been waived and the untimely filing of the consents was more than a technical defect. This was because the notice did not state that the nonsigning defendants nevertheless consented to removal, which would have at least provided timely notice of the fact of consent, despite the written consents being filed late. Id. at 977.
After considering the above authorities, the Court concludes the answer to whether Ernst Young's late consent should be accepted is better left until determination of whether subject matter jurisdiction otherwise exists.
Better if jurisdiction in fact exists, to permit the petition for removal to be amended to reflect it. It appears that the time has come to reexamine this entire matter and expressly adopt the approach . . . that amendments to the jurisdictional allegations of removal petitions should be permitted in the same manner as amendments to any other pleading.". . . . the decision holds only that the time has come to apply the principles of modern pleading relating to amendments to removal petitions, and that amendments should be permitted, to implement the spirit of the statute and rules cited herein, where the jurisdictional facts do indeed exists, and the parties are in law entitled to invoke the jurisdiction of the federal court.Gafford, 997 F.2d at 164. Here, "does not object" is questionable as constituting effective consent. But arguably it does give at least some notice to Plaintiff, which is corroborated by the written consent, though untimely. The Court gleans from these cases that allowing this amendment is less of a concern where substantive jurisdiction is clear, and it would be unfair to unduly deprive of jurisdiction based on procedural deficiencies, the Court next turns to measure of whether substantive federal question jurisdiction exists.
B. Federal Question Jurisdiction Based Upon Application of SLUSA
Turning then to federal question jurisdictional considerations, Defendants propose in their Notice of Removal that federal question subject matter jurisdiction exists under 15 U.S.C. § 78bb(f)(1) (2), the Securities Litigation Uniform Standards Act (SLUSA). Plaintiff counters that it has brought a shareholder derivative suit and that such suits are excluded from the provisions of SLUSA under § 78bb(f)(5)(C).
SLUSA, enacted in 1998, was intended to remedy increased state court filings that occurred after the 1995 passage of the Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. § 78u-4 § 77z-1. The legislative history of SLUSA reflects that one of its purposes was to prevent class action plaintiffs from bypassing PSLRA by filing cases in state court that are in the nature of class action securities fraud cases, but are disguised to avoid jurisdiction in federal court and PSLRA's more stringent requirements governing class action securities cases. See Pub.L. No. 105-353, § 2, 112 Stat. 3227, 3227 (1998) (codified throughout Title 15 of the United States Code); see also Lander v. Hartford Life Annuity Ins. Co., 251 F.3d 101, 108 (2d Cir. 2001) ("SLUSA was passed in 1998 primarily to close this loophole in the PSLRA[,]" by making federal courts "the exclusive venue for class actions alleging fraud in the sale of certain covered securities" and that "such class actions be governed exclusively by federal law.").
The Securities Litigation Uniform Standards Act provides that
No covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging —
(A) a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security; or
(B) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.15 U.S.C. § 78bb(f)(1). If a "covered class action" as so defined by the Act is brought in state court, SLUSA provides that it shall be removable pursuant to § 78bb(f)(2). Defendants assert the action filed by Central Laborers contains this type of "covered class action" SLUSA is intended to encompass. Plaintiff claims no such claim was either intended or stated, disguised or otherwise.
In order to establish that a federal district court has jurisdiction based upon SLUSA, the statute dictates Defendants must show Plaintiff's cause of action includes: (a) a covered class action, (b) that is based upon state law claims, (c) arising from a misrepresentation or omission of a material fact, (d) in connection with the purchase or sale, (e) of a covered security. 15 U.S.C. § 78bb(f)(1). Not in dispute is that the face of Plaintiff's complaint asserts only state law claims, element (b); that at least part of the conduct challenged by Plaintiff herein involves the alleged failure of the individual Defendants to disclose certain financial information about Ashland, element (c); and that Ashland stock is a covered security, element (e). What is at the heart of the dispute is whether Defendants can demonstrate requirements (a), that Plaintiff's cause of action is a "covered class action," and (d), that the misrepresentation or omission occurred "in connection with" the purchase or sale of Ashland stock.
SLUSA defines a "covered class action" as "any single lawsuit in which damages are sought on behalf of more than 50 persons or prospective class members." 15 U.S.C. § 78bb(f)(5)(B)(i). The face of Plaintiff's complaint states in the caption that Plaintiff is suing derivatively on behalf of Ashland, Inc. It does not state Plaintiff is suing as a class representative for a class consisting of Ashland's shareholders or some other class. The Court notes that many of the cases Defendants rely upon to support removal as a covered class action under SLUSA involved circumstances where the face of the state court complaint identified the action as a class action suit and that the plaintiff intended to pursue the case expressly as a class action. See, e.g., Dudek v. Prudential Securities, Inc., 295 F.3d 875 (8th Cir. 2002); Araujo v. John Hancock Life Ins. Co., 206 F. Supp.2d 377 (E.D.N.Y. 2002); Hardy v. Merrill Lynch, Pierce, Fenner Smith, 189 F. Supp.2d 14 (S.D.N.Y. 2001).
Defendants point out that Plaintiff's Complaint contains many references to "and its shareholders," arguing such language is suggestive of a securities fraud action, not a derivative claim. Defendants argue, for example, that Plaintiff alleges damages to Ashland shareholders throughout the complaint, that Defendants' conduct continues to injure Ashland and its shareholders, and that Plaintiff will adequately and fairly represent the interests of Ashland and its shareholders. Plaintiff responds by noting that to pursue a derivative action under Kentucky law, allegation of harm to the corporate shareholders is required and that this was the purpose for those references. "The derivative proceedings shall not be maintained if it appears that the person commencing the proceeding does not fairly and adequately represent the interests of the shareholders in enforcing the right of the corporation." K.R.S. § 271B.7-400(1).
Defendants also argue that the manner in which Plaintiff has described the damages it seeks is also indicative of a securities fraud class action. They point out that the complaint says Plaintiff seeks restitution, compensatory and punitive damages in favor of Plaintiff. An examination of the complaint language confirms Defendants' point; however, Defendants neglected to note the complaint also prays for those damages in favor of Plaintiff, on behalf of Ashland And at oral argument Plaintiff confirmed that any monies due from a favorable judgment of this litigation would be payable to the corporation and paid into the corporation, not recouped as damages by individual shareholders.
Plaintiff points to and relies upon that portion of SLUSA that exempts derivative actions. Plaintiff poses that Defendants cannot fit its lawsuit into the box of a covered class action because they simply have not asserted one. This portion of the Act states that "`covered class action' does not include an exclusively derivative action brought by one or more shareholders on behalf of a corporation." 15 U.S.C. § 78bb(f)(5)(C). According to Defendants, however, Plaintiff cannot avail itself of this subsection because Plaintiff's case is not an exclusively derivative action given that it contains within it a carefully worded federal securities claim.
Plaintiff contends that it has properly asserted only state law claims; that the reference to violation of "federal securities laws" relates to the underlying mismanagement by Defendants and is not a suit against Defendants for federal securities law violations; and that the damages sought are consistent with those pursued in a derivative suit. Plaintiff concludes that the definitional requirements of SLUSA have therefore not been met, and so the action is not removable thereunder. The Court does not interpret the term "exclusively" in this context to mean that if the derivative complaint could have alleged a SLUSA action, then SLUSA must apply, even if the complaint was limited on its face to derivative claims only. See Coykendall v. Kaplan, 2002 WL 31962137, at *2 (N.D. Cal.). Rather, "exclusively derivative" commonly means that it asserts only derivative claims, not that derivative claims are the only claims that can be asserted.
The Court is not persuaded Plaintiff has stated a "covered class action" as that phrase is defined in the Act. Though the Act is fairly new, there have been a few other cases involving challenges to state court claims as being covered class actions subject to preemption and adjudication by federal courts. The Courts' research and authorities relied upon by Plaintiff suggest that pursuit of a derivative claim such as here is still an accepted carve out from SLUSA. The most analogous reported case is Arlia v. Blankenship, 234 F. Supp.2d 606 (S.D.W.Va. 2002). In Arlia a shareholder derivative action was filed against the board and officers for profits obtained by inside trading. Id. at 609. The action was removed by defendants in reliance upon SLUSA by asserting the shareholder derivative claim was in actuality an insider trading securities fraud class action. Id. The court concluded that plaintiff's misappropriation of information claim, if viable, is an exclusively derivative action brought by a shareholder on behalf of the corporation, id. at 612, and so is not a covered class action removable by 15 U.S.C. § 78bb. Id. at 613. The federal district court rejected defendant's argument that because West Virginia had not yet determined whether a derivative shareholder tort of misappropriation of information would be recognized under state law, the plaintiff's insider trading claims "are `really' federal securities claims, as federal law provides the only basis for those claims." Id. at 611. The Court, in rejecting this argument noted that
Since conducting the oral argument, Plaintiff has filed various notices containing recent decisions in support of its position for remand The Court's review of these supplemental filings reflects they consist of unreported opinions from various other federal district courts which therefore, although informative, have not been relied upon by this Court.
If the West Virginia courts decline to recognize this tort, then the plaintiff in this action would simply suffer dismissal of his insider trading claims. The plaintiff could then of course replead his claim as a direct class action, not a shareholder derivative claim, in which case the suit would be removable under the plain terms of 15 U.S.C. § 78bb. As currently plead, however, Mr. Arlia's claims are state, not federal, in nature, and thus removal is improper.Id. at 611. Similarly, in Coykendall v. Kaplan, 2002 WL 31962137 (N.D. Cal.) plaintiff filed a shareholder derivative action in state court alleging breach of fiduciary duties, abuse of control, waste of corporate assets and unjust enrichment by corporate officers and directors. Id. at *1. Defendants removed as a covered class action under SLUSA. Id. The court held that plaintiff was the master of his complaint and could plead a derivative action against board members and officers for harm done to the corporation without necessarily being forced to plead or having the complaint converted into a federal securities class action seeking recovery on behalf of a class of purchasers of the corporation's stock that were defrauded. Id. at *3. SLUSA does not preempt all state law claims involving corporate securities, but rather preempts only those state law claims that constitute "covered class actions." Id. at *3 n. 1.
Defendants vehemently protest viewing the lawsuit as only a derivative suit. Defendants pose the claims, when reviewed carefully, are federal in nature and give rise to a federal question, but Plaintiff has cleverly worded its complaint so as to avoid federal jurisdiction. Defendants argue the true nature of Plaintiff's suit is federal, regardless of how it is characterized by Plaintiff.
Where diversity of citizenship is lacking, federal courts only hear cases arising under federal law, as determined by the well-pleaded complaint, and disregarding anticipated federal defenses. See generally 14B Charles A. Wright, Arthur R. Miller Edward H. Cooper, Federal Practice Procedure § 3722 (3d ed. 1998) [hereafter "Wright Miller"]; Greaves, 264 F. Supp.2d at 1086-87. Federal question jurisdiction cannot be based on a defense, even if the defense alleges ordinary preemption of state law. Wright Miller § 3721. "The well-pleaded complaint rule generally provides that the plaintiff is the master of his complaint, and the fact that the wrong asserted could be addressed under either state or federal law does not ordinarily diminish the plaintiff's right to choose a state law cause of action." Loftis v. UPS, Inc., 342 F.3d 509, 515 (6th Cir. 2003) (quoting Alexander v. Elec. Data Sys. Corp., 13 F.3d 940, 943 (6th Cir. 1994)). Ordinary preemption will not permit removal jurisdiction if plaintiff chooses to frame his claim based solely on state law, and preemption is raised only as a defense by the defendant. Loftis, 342 F.3d at 515; see also Wright Miller § 3722.1. Complete preemption applies to a narrow class of claims that are so "necessarily federal" that they always will permit removal to federal court even if only raised by way of defense. Warner v. Ford Motor Co., 46 F.3d 531, 534 (6th Cir. 1995). With complete preemption the court substitutes a federal cause of action for the state cause of action. Metropolitan Life Ins. Co. v. Taylor, 481 U.S. 58, 65 (1987). "[T]he complete preemption doctrine overrides such fundamental cornerstones of federal subject matter jurisdiction as the well-pleaded complaint rule and the principle that the plaintiff is master of the complaint." Wright Miller § 3722.1.
Defendants try to argue, relying upon Ontario v. Detroit, 874 F.2d 332, 339 (6th Cir. 1989) and Franchise Tax Board v. Laborers Vacation Trust, 463 U.S. 1 (1983) that if "some substantial, disputed question of federal law is a necessary element of one of the well-pleaded state claims" or if plaintiff's claim is "really one of federal law" then the matter should be in federal court. While Ontario may stand for this general principle, in the actual decision the Sixth Circuit held defendants could not remove plaintiff's separate and independent state environmental law claim, nor was that claim removable as one more properly characterized as a federal Clean Air Act claim just because it arose out of a transaction that could also give rise to a federal claim. And in Franchise Board the Supreme Court also held that a California suit for failure to comply with tax levies was not subject to removal just because federal law became relevant by way of defense to an obligation created entirely by state law.
Defendants suggest Plaintiff has "clothed a federal claim in state garb," citing Travelers Insurance Co. v. Sarkisian, 794 F.2d 754, 758 (2d Cir.), cert. denied, 479 U.S. 885 (1986). Sarkisian says that cases arise under federal law where federal law "creates" the cause of action, and that federal jurisdiction is allowed for state-created claims that involve construction of federal law, but only if the federal element is substantial. In Sarkisian the court held that state claims of unlawful salary payments and payment of dividends, et cetera, filed for the same transaction for which a RICO action was filed were not removable, as the state claims were viable and required separate elements than those for the RICO claim.
Defendants also rely upon Wright v. GM, 262 F.3d 610, 615 (6th Cir. 2001), a wrongful termination case, to support this point. However, in Wright the court actually rejected the argument that plaintiff's claims were preempted by ERISA, and noted the claim was one for state law discrimination only. Although one aspect of damages resulting from the discrimination was that the employer refused to issue conversion authorization for plaintiff's life insurance provided by an ERISA plan, this did not mean plaintiff's state law claims were preempted by ERISA.
While Defendants acknowledge the complaint "does not necessarily plead all the elements of a securities class action," they argue that it nevertheless still falls within SLUSA if the "gravamen" of the complaint is a securities fraud claim. Defendants rely heavily upon Dudek v. Prudential Securities, Inc., 295 F.3d 875 (8th Cir. 2002) in support of their position. In Dudek the Eighth Circuit held that the state law claim by purchasers of tax-deferred annuities against investors was essentially one for misstatement or omitted facts in connection with the purchase and sale of tax-deferred annuities, despite plaintiff's characterization of the claim as one for state law "improper marketing." It is noteworthy that the case was filed as a class action in state court for plaintiffs' direct purchase of annuities because or based upon the misrepresentation or improper marketing of the annuity by the defendant seller as being tax-deferred, thereby causing damage to each plaintiff. Defendants also cite to Hardy v. Merrill Lynch, Pierce, Fenner Smith, 189 F. Supp.2d 14 (S.D.N.Y. 2001) as an example of a case where the claim was that of a traditional securities claim and therefore removable. The court agreed and permitted removal of the case under SLUSA. However, the suit was filed by shareholders in state court as a class action. It was also brought against the brokerage firm for poor and misleading recommendations on stock, with shareholders who bought or sold securities (stock) based upon the recommendations, seeking to recoup their individual losses from the brokerage firm. Central Laborers has not sued on behalf of a class because of how Defendants marketed Ashland shares to it, or recommendations about the shares, but for the underlying conduct that gave rise to a decline or misrepresentation of the share value, seeking to recover from those who engaged in the underlying conduct, so as to restore those damages to the corporation's value.
Defendants argue substance should win out over form, citing Araujo v. John Hancock Life Ins. Co., 206 F. Supp.2d 377 (E.D.N.Y. 2002), wherein the federal district court for the Eastern District of New York held that a state law claim for breach of contract and unjust enrichment for premiums charged for the interim time period when a new policy was not yet effective was preempted by SLUSA. Worth noting in Araujo is that the case was brought by purchasers, in state court, specifically as a class action, unlike what Central Laborers has done here. The claim in Araujo was for the policy purchasers to recover their damages after relying upon the misstatements made to them by the seller about the actual price of the variable insurance product. In contrast, Central Laborers does not seek damages for itself for monies lost in its purchase or sale of Ashland stock. It seeks to have paid to the corporation the allegedly improper gains by Defendants based upon alleged manipulations of Ashland's stock value.
The Court finds helpful on this point the Seinfeld v. Austen decision cited by Plaintiff. Although the decision predates SLUSA, in it defendant sought to remove a state court shareholder derivative action. Plaintiff had sued the board of directors for alleged breach of fiduciary duty to the corporation by failing to keep executives from engaging in violations of antitrust laws, causing the corporation to incur damages to settle those antitrust claims. Seinfeld v. Austen, 39 F.3d 761, 762-63 (7th Cir. 1994), cert. denied, 514 U.S. 1126 (1995). Although the case was filed as a state law derivative suit, defendant argued the assertion of antitrust violations presented a claim "arising under" federal law and therefore removable. Id. at 763. But the Seventh Circuit noted that the "mere presence of a federal issue in a state cause of action does not automatically confer federal-question jurisdiction." Id. at 764. Here, similar to the circumstances of Seinfeld, the "practice under scrutiny" was the alleged failure to monitor and supervise officers and directors to prevent them from exercising poor business judgment and engage in insider trading, though this failure to do so does not itself constitute a breach of federal securities laws. Id. at 765; (see also cases cited in Doc. #28, Plaintiff's Reply, at pp. 3-4 for further examples of state claims premised upon alleged violations of federal regulations or statutes, but which do not give rise to a separate substantial federal question). In other words, a claim for breach of fiduciary duty by corporate directors predicated on violations by the directors of other federal statutes does not automatically create federal question jurisdiction. Greaves v. McAuley, 264 F. Supp.2d 1078, 1087 (N.D. Ga. 2003) ("In the securities context, various courts have . . . found that reference to federal securities regulations in a complaint does not create federal question jurisdiction."). Thus, the well-pleaded complaint rule still applies with SLUSA. SLUSA does not completely preempt state law claims, but only those state law claims constituting "covered class actions." The well-pleaded complaint rule applies to determine if the claims at issue are "covered class actions" as defined in the statute. Coykendall, 2002 WL 31962137, at *3.
Moreover, Defendants essentially acknowledge that they cannot, based upon the language of the complaint and conduct complained of by Plaintiff, point to specific allegations or circumstances that would satisfy the "in connection with purchase or sale" requirement (d) above, as applied to Plaintiff. At oral argument Defendants pointed to Zoren v. Genesis Energy, L.P., 195 F. Supp.2d 598 (D. Del. 2002) to support the "in connection with" requirement and also more generally the idea of Plaintiff's complaint being a "covered class action." But Zoren is distinguishable from the circumstances here. Zoren was specifically filed and pursued as a class action securities case for claims of fraud in connection with the purchase or sale of a covered security. The case is simply inapposite here as Central Laborers' action primarily concerns shareholder derivative claims.
The other case Defendants relied upon heavily at oral argument in this regard was Professional Management Assocs., Inc. Employees' Profit Sharing Plan v. KPMG LLP, 335 F.3d 800 (8th Cir. 2003), cert. denied, 124 S.Ct. 1176 (2004). But relying upon this case is also misplaced. Again, plaintiff in PMA specifically asserted a class action on behalf of itself and other investors for their damages after buying and holding stock, id. at 802-03, not a shareholder derivative action to effectuate a recovery on behalf of the corporation, as here. The PMA court concluded the class action complaint implicitly alleged what plaintiff refused to concede — that plaintiff and the class members bought and held stock during the relevant period when financial misrepresentations were alleged to have been made, thereby incurring damages. Id. at 802. Central Laborers is not claiming here that it and other purchasers of Ashland stock sustained damages because they bought stock after relying upon misrepresentations by Ashland officers, board members and Ernst Young. Central Laborers instead alleges insider trading by certain Defendants as one of various breaches of fiduciary duties, which damaged the corporation and must be recovered for the corporation.
The Court is not persuaded by Defendants' arguments on the "in connection with purchase or sale" requirements. In this derivative action, Central Laborers simply has not asserted that it or a class of stockholders purchased or sold stock in connection with Defendants' alleged breaches of fiduciary duties. See Shen v. Bohan, 2002 WL 31962136 (C.D. Cal.) (rejected "look to complaint as a whole" argument; shareholder class action for equitable relief related to voting rights, which was combined with shareholder derivative action for damages, did not satisfy the "purchase or sale in connection with securities" requirement of SLUSA); see also Shaw v. Charles Schwab Co., Inc., 128 F. Supp.2d 1270, 1274 (C.D. Cal. 2001), appeal dismissed, 2002 WL 1929469 (9th Cir., unpublished) ("in connection with" for SLUSA not satisfied because claim related to vehicle used to deliver securities and not securities themselves). Likewise, Plaintiff challenges specific conduct of Defendants in operating and managing the corporation and its effects upon the public representations of Ashland's corporate status, not the purchase and sale of Ashland stock by Plaintiff or a class of investors.
When pressed at oral argument, Defendants could not present case law or other authority wherein a shareholder derivative action, specifically filed as a shareholder derivative action, was held to be removable under SLUSA. Defendants acknowledge that a shareholder derivative suit is a viable claim under Kentucky law. If and when Plaintiff brings the type of lawsuit that the authorities Defendants rely upon involved — class action federal securities lawsuits alleging a direct injury and seeking direct damages therefrom, a different situation will exist. But until then, this Court is bound to defer to the framing of the viable cause of action that was chosen by Plaintiff.
In summary, federal courts are courts of limited jurisdiction. Any doubts about the existence of subject matter jurisdiction should be resolved in favor of remand All things considered, this Court finds application of this general rule appropriate in this case; SLUSA presents no exception to this general rule. The Court's review of the propriety of Defendants' removal is based upon the Plaintiff's complaint, see Pullman Co. v. Jenkins, 305 U.S. 534, 537 (1939), not Defendants' rewriting of the complaint. The well-pleaded complaint in this case fails to present a federal question for which removal is authorized. Caterpillar, Inc. v. Williams, 482 U.S. 386, 392 (1987). While Defendants may not like the way Plaintiff has framed its case, Plaintiff is the master of its cause of action, and the Court will not re-write Plaintiff's complaint. Should Plaintiff's pursuit of its claim ultimately be something other than that which it has represented to this Court — that of a derivative action, with any recovery therefrom to be paid to the corporation — such a situation can be addressed at any subsequent removal proceeding. However, because the Court concludes that Defendants' removal at this juncture has been based upon a federal claim which Plaintiff has not been pled, subject matter jurisdiction is lacking and remand is the appropriate course of action.
C. Plaintiff's Request for Costs and Fees
Plaintiff also seeks attorneys' fees connected with the motion to remand pursuant to 28 U.S.C. § 1447(c). That subsection provides that "[a]n order remanding the case may require payment of just costs and any actual expenses, including attorney fees, incurred as a result of the removal." In the Sixth Circuit, such an award is discretionary with the Court and often turns upon whether the removal lacked merit. Morris v. Bridgestone/Firestone, Inc., 985 F.2d 238, 240 (6th Cir. 1993). The Court declines to grant costs and fees under the circumstances of the removal in this case. SLUSA is fairly new legislation, the application of which is still being determined by the Courts. Interpreting and applying its provisions is still unfolding, and so the Court cannot conclude that the removal in this situation was frivolous or lacked merit.
CONCLUSION
Accordingly, IT IS ORDERED that:
(1) Plaintiff's motion to remand (Doc. #6) is hereby granted and this case is remanded in its entirety to the Kenton Circuit Court from where it was removed.
(2) Plaintiff's motion for attorneys' fees in conjunction with remand is hereby denied.
(3) The motion to dismiss filed by Defendants Chellgren, Quin, Boyd, the members of the Board of Directors, and Ashland (Doc. #9) is hereby denied as moot, as this Court lacks subject matter jurisdiction over these proceedings. The dismissal these Defendants seek of Plaintiff's state law claims can be subsequently renewed by them in the state court post-remand proceedings.
(4) The motion to dismiss filed by Defendant Lunceford (Doc. #24) is also hereby denied as moot, based upon the Court's lack of subject matter jurisdiction. Said Defendant may renew his request for dismissal on the merits and for lack of personal jurisdiction in the state court post-remand proceedings.
(5) In light of paragraph 4's ruling, Plaintiff's motion to strike the declaration of Edward Lunceford (Doc. #30) is hereby denied as moot, and can be renewed with the state court post-remand if Defendant Lunceford's refiles his motion to dismiss.
(6) The motion to extend its time to answer filed by Defendant Ernst Young (Doc. #25) has been de facto granted, at least through the date of this Opinion and Order. Any further need for extension by Ernst Young can be raised with the state court post-remand
(7) All pending matters having been adjudicated, and this Court now lacking subject matter jurisdiction over any further proceedings, this action is hereby dismissed and stricken from the docket of this Court.