Stock suit booted from state court

An appeals court says that a group of former Imation workers cannot sue their ex-employer for fraud in California court because of a 1998 federal securities law.

Declan McCullagh
Declan McCullagh Former Senior Writer
Declan McCullagh is the chief political correspondent for CNET. You can e-mail him or follow him on Twitter as declanm. Declan previously was a reporter for Time and the Washington bureau chief for Wired and wrote the Taking Liberties section and Other People's Money column for CBS News' Web site.
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An appeals court said on Tuesday that a lawsuit over stock options must proceed in federal instead of state court.

The Ninth Circuit Court of Appeals said in an 18-page decision that a group of former Imation workers could not sue their ex-employer for fraud in California court because of a 1998 federal securities law. Imation, based in Oakdale, Minn., sells hard drives, DVD and CD-ROM drives, and tape backup devices.

"Representations about the value of the stock and the terms on which the plaintiffs will be able to purchase the stock are properly subject to uniform federal standards," wrote a three-judge panel, saying the Securities Litigation Uniform Standards Act (SLUSA) means only federal courts can hear such claims.

The judges also said that stock options were not wages and therefore were not covered by a California law that makes it unlawful for a corporation not to pay its employees.

The dispute arose after Imation, which is publicly traded, purchased a privately held company called Cemax-Icon. After the purchase, Cemax employees' stock options became options on Imation stock, which is a common practice. Cemax employees also received a secondary grant of additional Imation stock options.

About a year later, Imation sold Cemax to Kodak. Employees of the Cemax subsidiary were told that because of the sale, they had 30 days to exercise their original grant of vested options--and unvested options would be forfeited. Because Imation was in poor financial straits, the options' values had plummeted.

In response, a group of former Cemax employees and contractors filed a suit claiming that Imation misrepresented the value of its stock and fraudulently concealed the company's weak financials at the time Cemax was purchased.

They filed the case in California state court, but Imation managed to move the case to federal court by citing SLUSA. The federal court also dismissed the other claims, saying the contracts that gave the employees stock options in the first place prevented them from filing that lawsuit.

In its decision Tuesday, the Ninth Circuit sided with the district court on most points but said the breach of contract allegations were substantive enough to deserve an airing during a trial.