On July 24, 2015, in In re Facebook, Inc., IPO Derivative Litigation, the US Court of Appeals for the Second Circuit held that in a case that raises complicated issues of subject matter jurisdiction, the court may dismiss the action based on the threshold issue of failure to plead contemporaneous share ownership as required for derivate actions under Federal Rule of Civil Procedure (FRCP) 23.1 without deciding the issue of subject matter jurisdiction. (No. 14-1445, (2d Cir. July 24, 2015)).

This case arose out of the May 18, 2012 initial public offering of Facebook, Inc. (Facebook) and allegation of inadequate disclosure in the associated registration statement. Just prior to the IPO, Facebook lowered its guidance on revenue estimates and disseminated that information to its underwriters. Plaintiffs alleged that the public did not learn of these revised numbers until after the IPO had been priced, and filed several derivative actions on behalf of Facebook in different jurisdictions around the country.

Federal Rule of Civil Procedure 23.1 states that in a derivative action, the complaint must allege that the plaintiff was a shareholder at the time of the transaction complained of (see Practice Note, Shareholder Derivative Litigation: Drafting the Shareholder Derivative Complaint). Two of the three lead plaintiffs owned units in an investment vehicle that held Facebook shares before the IPO. However, the subscription agreement for this vehicle stated that subscribers had no interest in any Facebook securities, which were held solely by the company. A third plaintiff purchased shares on the open market on the day of the IPO.

Facebook removed the state court actions to federal court and then, while plaintiffs' motions to remand were pending, successfully moved the Judicial Panel on Multidistrict Litigation to transfer the removed actions to the US District Court for the Southern District of New York. Facebook then moved to dismiss all of the related derivative actions on grounds of failure to satisfy FRCP 23.1. The district court granted the motion to dismiss, concluding that:

(In re Facebook, Inc., IPO Sec. & Derivative Litig., (S.D.N.Y. Dec. 23, 2013).)

Plaintiffs appealed the dismissal, arguing that the court erred in deciding the motion to dismiss before adjudicating their motions to remand for lack of subject matter jurisdiction.

The Second Circuit affirmed the district court's dismissal of the plaintiffs' actions. It held that a district court has discretion to decide certain threshold bases for dismissal before adjudicating difficult or novel issues of subject matter jurisdiction (see Rurhrgas AG v. Marathon Oil, Co., 526 U.S. 574, 588 (1999)).

As the court explained, the contemporaneous stock ownership rule is a procedural requirement whose absence deprives a plaintiff of standing to sue. Standing is the type of threshold inquiry a court may make before conducting an analysis of difficult and potentially novel questions of subject matter jurisdiction.

Practitioners in the Second Circuit should be aware that a court may avoid reaching a conclusion on subject matter jurisdiction if a plaintiff bringing a derivative action fails to satisfy FRCP 23.1's contemporaneous stock ownership rule or another threshold procedural issue.