2013 Mid-Year Securities Litigation Update

July 16, 2013

We are pleased to share with you our mid-year update on significant developments in securities litigation. Filing and settlement trends continue to show a steady state of new cases and increasingly more expensive settlements. Several developments at the Supreme Court suggest a changing landscape for federal securities cases and class actions. We highlight the more notable opinions from the first half of 2013 relating to a variety of federal securities law matters, including fraud-on-the-market, the on-going impact of Janus, Item 303 disclosures, foreign transactions, and scienter. As in the 2012 year-end update, we also discuss notable trends in the ever-growing area of merger & acquisition litigation, including single-bidder transactions, increasing scrutiny of disclosure-only settlements, the effects of competing forums, challenges related to going-private transactions, and the application of fiduciary challenges to companies operating outside the United States. New to our Securities Litigation Update is a summary of notable trends in proxy disclosure litigation, particularly with regard to "say-on-pay" shareholder votes.

For developments related to SEC Enforcement, including what the changing of the guard means for the coming year, please see our Mid-Year Securities Enforcement Update. We also invite you to read Gibson Dunn’s Mid-Year report on trends in Foreign Corrupt Practices Act litigation.




Class Action Filings

Dismissals of Class Actions

Class Action Settlements


A Shot Across the Basic Bow:  Amgen Inc. v. Connecticut Retirement Plans & Trust Funds

Renewed Focus on Rule 23(b)(3) Predominance:  Comcast Corp. v. Behrend

Certiorari Granted to Resolve Split Over Standard of Review in Demand Futility Appeals:  Union de Empleados v. UBS Financial Services Inc. of Puerto Rico

The Supreme Court Denies Defendants’ Petition for Certiorari Second Circuit’s Controversial "Same Set of Concerns" Standard for Determining Standing to Sue:  Goldman v. NECA



Fraud-on-the-Market at the Class Certification Stage

Rebutting Fraud-on-the-Market on the Merits: Gamco Investors, Inc. v. Vivendi



Who "Made" the Allegedly False Statement?

The Impact of Janus Beyond Rule 10b-5(b) Actions




Delaware Court of Chancery Guidance Regarding Single-Bidder Transactions

Chancery Court Carefully Scrutinizes Disclosure-Only Settlement and Adequacy of Plaintiff in Rejecting Settlement of M&A Litigation

Delaware Court Of Chancery Provides Roadmap for Business Judgment Review of Going-Private Merger Transactions



The Preclusive Effect of Dismissal of a Shareholder Derivative Claim

The Delaware Court of Chancery Affirms the Right of Boards of Directors to Centralize Internal Affairs Litigation in Delaware

Demand Futility:  An Upcoming Supreme Court Resolution and Other Updates

Fiduciary Duties Owed to Companies Operating Solely Outside the United States



Filing and settlement trends continue to reflect "business as usual" for the plaintiffs’ bar–hundreds of suits and significant settlement values can be expected for the rest of 2013, based on results from the early half of the year. According to a recent study by NERA Economic Consulting, the annualized rate of new class action filings based on results in the first half of 2013 is expected to be slightly up from the prior six-year averages. Through June 2013, new securities class action filings were annualizing at 222 cases for the full year, representing an uptick from the six-year average of 219 suits. On the other hand, median settlement amounts were somewhat lower that the six-year average:  $8.8 million in the first quarter of 2013, versus the six-year average of $9.3 million, but higher than four out of those six years. The average settlement value in the first quarter of 2013 was more than double the six-year average:  $78 million, versus the six-year average of $35 million. Finally, median settlement amounts as a percentage of investor losses in the first half of 2013 were 2.0%, up from 1.8% for the full year 2012, but slightly lower than the six-year average of 2.15%.

            Class Action Filings

Overall filing rates are reflected in Figure 1 below (all charts courtesy of NERA Economic Consulting). NERA reports an average of 219 new cases filed in the period 2007 to 2012. Annualized filings in the first half 2013 are projected to be higher than the prior six-year average, at 222 cases. Notably, these figures do not include the many such class suits filed in state courts, including the Delaware Court of Chancery Court.

Figure 1

Federal Filings 1996-2013
NERA Economic Consulting

Credit Crisis Cases.  The total number of new cases filed against financial institutions in the first half of 2013 reflects the dramatic decline of "credit crisis" class action cases filed in federal court. These cases were at their zenith in 2008 (with more than one hundred new cases) but were virtually zero in the first half of 2013. Despite this enormous decline in new case filings, a number of major credit crisis cases are still pending, and are expected to result in large settlement amounts in some cases. In addition, while credit crisis class actions may be on the decline, a new generation of cases have replaced them:  single-plaintiff suits by government agencies (such as the Federal Housing Finance Agency on behalf of Fannie Mae and Freddie Mac), monoline insurers (such as MBIA), and institutional and pension fund investors who purchased a wide variety of mortgage-backed securities. A number of these have been filed in state court and involve state law claims for misrepresentation and/or breach of contract. The stakes in these cases are high; a few have already resulted in settlements in excess of $100 million.

Chinese Reverse Merger Cases.  The once highly publicized Chinese "reverse merger" cases, which represented a significant portion of new case filings in 2011, have steeply declined, although the Securities and Exchange Commission continues to actively pursue a number of such cases separate and apart from any private securities class actions. New case filings involving Chinese-based companies declined from 37 in 2011 to only 16 in 2012 and were virtually non-existent in the first half of 2013.

Merger Cases.  Merger-related litigation continues to represent a significant portion of new federal court securities class action filings. Today over 80% of all M&A transactions are challenged by investors, either in federal court class actions, state court class actions, or shareholder derivative actions. This is so even where the proposed transaction provides shareholders of the acquired corporation with substantial premiums. As discussed below in our "Trends in M&A/Delaware Litigation" section, the quantitative trends are frightening, particularly as eight-figure plaintiffs’ counsel fee awards in several high profile M&A cases have provided new economic incentives for the plaintiffs’ bar to file more and more such cases. "Ready, shoot, aim" is an apt metaphor for the growing phenomenon of M&A suits filed within days of the announcement of a significant transaction. NERA reports that in the first half of this year, merger class actions represented roughly 25% of new federal court securities class action filings (28 out of 111 cases).

Filing By Industry Sector.   The trends in new case filings against particular industry sectors reflect the decline in "credit crisis" cases, as new suits against financial institutions have dropped from record-shattering levels in 2009 to second place in the first half of 2013 (17% of all new case filings), behind the technology and technology services sector (19% of new case filings). Health technology and services sector ranked third (15%, down from 21% in 2012), while the energy sector ranked fourth (9%). The biggest jump in new case filings compared to 2012 was in the commercial and industrial sector, where new filings leapt from 4% in 2012 to 9% in the first half of 2013. See Figure 2 below.

Figure 2

Percentage of Filings by Sector and Year
NERA Economic Consulting

            Dismissals of Class Actions

Almost all securities class actions follow one of two paths: dismissal or settlement. When the PSLRA was enacted in 1995, issuers and their directors and officers had high hopes that the new pleading standards in the PSLRA would put a stop to the kinds of meritless cases brought by "pet plaintiffs"–popular sport for many years following the Supreme Court’s adoption of the "fraud-on-the-market" presumption of reliance in cases brought under Section 10(b) of the Securities Exchange Act of 1934. Alas, over the last 17 years since the PSLRA became law, the annual rate of dismissals has never exceeded the rate of settlements. In 2012, defendants settled 92 cases while achieving a dismissal of 79 cases.

The dismissal rates discussed above do not speak to another important trend that makes the modern securities class action so frustrating to the clients who are sued and the lawyers who must defend them:  in general, the average disposition time of PSLRA class actions has lengthened considerably, to the point that in many cases the threshold motions to dismiss can take years, as courts now routinely grant leave to amend even when the case clearly lacks merit. As a result, the "inventory" of cases still pending 3 to 4 years after filing remains high:  NERA reports that as of March 2013, between 30-44% of cases filed in 2009 and 2010 were still pending. Clearly, these cases are moving slowly and rarely are fully resolved within 2 years of filing.

            Class Action Settlements

As Figure 3 shows, median settlements–generally a better barometer of settlement trends–were down in the first half of Q1 2013 over the full year 2012 from $12.3 million to $8.8 million. Still, the Q1 2013 figure is higher than four of six years in the period 2007 to 2012.

Figure 3

Median Settlement Value
NERA Economic Consulting

One can speculate about what may account for the up-and-down fluctuation in median settlements over the last six years. In any given year the statistics can mask a number of important factors that contribute to settlement value, such as (i) the amount of D&O insurance; (ii) the presence of parallel proceedings, including government investigations and enforcement actions; (iii) the nature of the events that triggered the suit, such as the announcement of a major restatement; (iv) the range of provable damages in the case; and (v) whether the suit is brought under Section 10(b) of the ’34 Act or Section 11 of the ’33 Act. The last two and a half years also included the resolution of several of the major credit crisis cases that reached the settlement stage (with more such cases to come), including Bear Stearns, Washington Mutual, Wachovia, Citigroup, Lehman Brothers and Bank of America, which alone totaled several billion dollars. Whatever the variables, the median settlements over the last six years, averaging over $9 million, should be of interest to issuers with cases still in "inventory"; plaintiffs’ counsel and mediators often look to prior settlement "benchmarks" when assigning settlement values to cases.

A final note on attorneys’ fees in securities class action settlements:  they continue to be in the hundreds of millions of dollars per year. Indeed, according to NERA, plaintiffs’ lawyers’ "take" in the last five years has averaged $850 million per year. In 2012, the haul totaled over $600 million. While many courts have grown skeptical about fee awards, and many plaintiffs’ firms have voluntarily reduced their fee petitions seeking a percentage of the aggregate settlement recovery, courts continue to award eye-popping amounts in some of the larger class actions. As one example, the fee award in the Lehman Brothers class action in the Southern District of New York, which settled in 2012, was over $56 million. On a percentage basis, the Lehman Brothers fee award worked out to "only" 10.99% of the settlement, with a multiplier of "only" 1.5, which the court said was appropriate because "we live in hard times." Nevertheless, the fee award represented a huge recovery for plaintiffs’ counsel in absolute terms. With these kinds of paydays, the economic incentives for plaintiffs’ lawyers to continue bringing cases seem irresistible.


The Supreme Court issued several opinions of note to securities litigators this term. While some of the outcomes were not surprising (for example, as in Gabelli v. SEC, where the Court found that the five-year statute of limitations on penalties accrues at the time of the alleged fraud, discussed further in our Mid-Year Securities Enforcement Update), opinions in several other cases portend a coming sea change in securities class actions.

            A Shot Across the Basic BowAmgen Inc. v. Connecticut Retirement Plans & Trust Funds

As discussed previously in our March 1, 2013 alert, the Supreme Court in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds held that, in securities class actions challenging false or misleading statements, the plaintiff need not prove that the alleged misstatements were material in order to obtain class certification using the so-called fraud-on-the-market presumption of reliance. 133 S. Ct. 1184, 1197 (2013). Justice Ginsburg, writing for the majority, explained that because questions of materiality were common to the class, plaintiffs were not required to prove materiality at the class-certification stage. Id.

But the Amgen ruling is far more notable for what it foreshadowed in a footnote and in dissent: a coming challenge to the fraud-on-the-market presumption of reliance established in Basic Inc. v. Levinson. The fraud-on-the-market theory, which "permits certain Rule 10b-5 plaintiffs to invoke a rebuttable presumption of reliance on material misrepresentations aired to the general public," id. at 1192, relies on a "premise that the price of a security traded in an efficient market will reflect all publicly available information about a company." Id. at 1190. Justice Ginsburg explained the economic theory upon which the fraud-on-the-market theory relies as follows:

This presumption springs from the very concept of market efficiency.  If a market is generally efficient in incorporating publicly available information into a security’s market price, it is reasonable to presume that a particular public, material misrepresentation will be reflected in the security’s price.  Furthermore, it is reasonable to presume that most investors–knowing that they have little hope of outperforming the market in the long run based solely on their analysis of publicly available information–will rely on the security’s market price as an unbiased assessment of the security’s value in light of all public information.  Thus, courts may presume that investors trading in efficient markets indirectly rely on public, material misrepresentations through their ‘reliance on the integrity of the price set by the market.’

Id. at 1192 (citations omitted).

But in footnote 6, Justice Ginsburg acknowledged that "modern economic research" tends to demonstrate that "market efficiency is not ‘a binary, yes or no question,’" and thus "differences in efficiency can exist within a single market." Id. at 1198, n.6 (citations omitted). Justice Ginsburg, however, found Amgen "a poor vehicle" for exploring the theories underlying Basic because Amgen had conceded the market for its securities was efficient and reflected current, publicly available information in the stock price.

Four Justices–enough to grant review in a future case–expressed outright skepticism regarding the continuing viability of Basic‘s presumption. Justice Scalia characterized the Basic opinion as "arguably regrettable," id. at 1206; Justice Thomas, joined by Justices Scalia and Kennedy, called it "questionable," id. at 1208, n.4; and Justice Alito joined the majority opinion only after acknowledging that "reconsideration of the Basic presumption may be appropriate," id. at 1204. Amgen may therefore breathe new life into the debate over proof of reliance in securities cases.

            Renewed Focus on Rule 23(b)(3) Predominance:  Comcast Corp. v. Behrend

Though outside the securities context, another recently issued opinion, Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013), highlights the growing focus in class certification battles on the predominance requirement. In Comcast, plaintiffs sought certification of a class of cable service consumers for alleged antitrust violations. Defendants argued that variations within the proposed class made certification inappropriate as plaintiffs could not offer a damages model that satisfied the predominance requirement. The Court made clear that its holding in Wal-Mart Stores, Inc. v. Dukes applied equally to the predominance requirement of Rule 23(b)(3); that plaintiffs must affirmatively demonstrate that common questions of law or fact "in fact" predominate the dispute.

In the context of a securities class action, the Supreme Court has ruled that plaintiffs need not prove certain elements of their claims in connection with a Rule 23 class certification motion. In Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. __ (2011), the Supreme Court ruled that proof of loss causation was not required under Rule 23 at all. And, as noted, the Court ruled in Amgen that securities plaintiffs need not prove materiality in order to invoke the fraud-on-the-market presumption of reliance. Comcast, however, ultimately rests on the predominance requirement of Rule 23(b)(3), a prerequisite not at issue in either Halliburton or Amgen. Thus, after Comcast, an open question remains as to whether, in an appropriate case, a securities class action may fail because the proponents have not put forward a damages model that satisfies the predominance prerequisite.

The decisions in Amgen and Comcast also present intriguing opportunities for case-specific challenges to reliance in securities class actions. While plaintiffs need not show loss causation or even materiality at the certification stage, all other predicates to the fraud-on-the-market theory are fair game to challenge under Rule 23, and if challenged, must be proven by plaintiffs by a preponderance of the evidence. And market efficiency as a predicate to the fraud-on-the-market presumption of reliance seems fertile ground for future challenges. The Amgen ruling appeared to leave open the argument that plaintiffs must show more than market efficiency on a macro basis (e.g., that the stock trades on the NYSE); the plaintiff arguably must also show that it is sufficiently efficient to process the information that is the subject of the lawsuit. This presents defendants with an opportunity to argue that the market price did not process or reflect the particular alleged misstatements at issue. Comcast makes clear that because such inquiries must be addressed and resolved on the basis of the legal theories that survive a motion to dismiss, which may well (as in Comcast itself) require a disaggregated analysis, securities plaintiffs may be required in appropriate cases to show whether and how specific groups of investors can be deemed to have relied on an efficient market as a substitute for proof of actual reliance.

            Certiorari Granted to Resolve Split Over Standard of Review in Demand Futility Appeals:  Union de Empleados v. UBS Financial Services Inc. of Puerto Rico

As noted in more detail below, the Supreme Court granted a petition for writ of certiorari in a case from the U.S. Court of Appeals for the First Circuit regarding the appropriate standard of appellate review in questions of demand futility. Historically, appellate courts gave substantial discretion to district courts’ decisions resolving the question of demand futility. But a more recent trend, developed substantially over the last decade, reflected preference for a de novo standard of review. E.g., Brehm v. Eisner, 746 A.2d 244, 253-54 (Del. 2000). What standard of review applied to questions of demand futility was placed squarely at issue in Union de Empleados v. UBS Financial Services Inc. of Puerto Rico. Siding with courts adopting the de novo standard, the First Circuit reversed a district court dismissal of derivative claims on its own review of the relevant futility allegations. 704 F.3d 155, 161-63 (1st Cir. 2013).

The U.S. Supreme Court granted UBS’s petition for a writ of certiorari to resolve the division of authority on the appropriate appellate standard of review. __ S. Ct. __, 2013 WL 1402320 (2013). The Supreme Court’s decision is not expected before 2014.

            The Supreme Court Denies Defendants’ Petition for Certiorari Second Circuit’s Controversial "Same Set of Concerns" Standard for Determining Standing to Sue: Goldman v. NECA

On March 18, 2013, the Supreme Court denied a petition for certiorari in Goldman, Sachs & Co. v. NECA-IBEW Health & Welfare Fund, 133 S. Ct. 1624 (2013) (No. 12-528). The petition sought review of a well-publicized decision in which the Second Circuit held that a named plaintiff may assert claims on behalf of a putative class that the named plaintiff would not have standing to raise itself. See NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145 (2d Cir. 2012) ("NECA"). As discussed previously in our 2012 Year-End Securities Litigation Update, the Second Circuit’s decision in NECA generated significant controversy and directly conflicts with the First Circuit’s ruling in Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762, 769-71 (1st Cir. 2011).

The Supreme Court’s decision to deny the petition for certiorari will likely only heighten such controversy and the related confusion in the district courts applying the "same set of" or "sufficiently similar" concerns standard. Not surprisingly, several district courts in the Second Circuit have granted motions for class certification in the months since the Supreme Court denied certiorari. In In re Winstar Communications Securities Litigation, No. 01 Civ. 3014 (GBD), 2013 WL 1700993, at *11-12 (S.D.N.Y. Apr. 17, 2013), the United States District Court for the Southern District of New York relied on NECA in certifying a class of stockholders and bondholders even though none of the lead plaintiffs had purchased any bonds. The district court reasoned that the alleged misstatements at issue were "not security-specific" and therefore would relate to both bond and stockholders. Similarly, in Oklahoma Police Pension and Retirement System v. U.S. Bank National Association, No. 11 Civ. 8066(JGK), 2013 WL 2369674, at *9 (S.D.N.Y. May 31, 2013), the court again relied on NECA in holding that a fund had standing to assert claims on behalf of a putative class of purchasers of interest in fourteen covered trusts, even though the fund had purchased interests in only two. Continuing the fallout from NECA, several other district courts are poised to revisit prior orders dismissing claims for lack of standing. See New Jersey Carpenters Health Fund v. Residential Capital, LLC, Nos. 08 CV 8781(HB), 08 CV 5093(HB), 2013 WL 1809767, at *1 (S.D.N.Y. Apr. 30, 2013); In re Lehman Bros. Sec. and ERISA Litig., No. 09 MD 2017(LAK), 2013 WL 440622, at *2 n.6 (S.D.N.Y. Jan. 23, 2013); In re Lehman Bros. Securities and ERISA Litigation, 799 F. Supp. 2d 258 (S.D.N.Y. 2011); Motion for Reconsideration, In re Lehman Bros. Securities and ERISA Litigation, No. 09-md-02017-LAK (S.D.N.Y. Apr. 23, 2013), ECF No. 1184. And in one case, where defendants had successfully moved to dismiss more than 90 offerings of RMBS, the parties stipulated to adding back 36 of those offerings as a result of NECA, which allowed plaintiffs to assert standing over the previously-dismissed offerings. In re IndyMac Mortgage-Backed Sec. Litig., No. 09 Civ. 4583, 2012 WL 3553083 (S.D.N.Y. Aug. 17, 2012); Stipulation and Order Regarding Lead Plaintiffs’ Anticipated Renewal of their Motion for Reconsideration, In re IndyMac Mortgage-Backed Sec. Litig., No. 09 Civ. 4583 (S.D.N.Y., May 9, 2013), ECF No. 431.


On June 27, 2013, the U.S. Court of Appeals for the Second Circuit issued an opinion addressing the "unsettled question" of whether the tolling principles of American Pipe & Construction Co. v. Utah, 414 U.S. 538, 554 (1974), extend to the three-year statute of repose for claims under the Securities Act of 1933. See Police & Fire Ret. Sys. of City of Detroit v. IndyMac MBS, Inc., __ F.3d __, 2013 WL 3214588 (2d Cir. 2013). 

In American Pipe, the Supreme Court held that that "the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action."  414 U.S. at 554. The Supreme Court explained that a contrary holding would "frustrate the principal function of a class action" and create a "multiplicity of activity which Rule 23 was designed to avoid."  Id. at 551. The Court also noted that, "[i]n recognizing judicial power to toll statutes of limitation in federal courts, we are not breaking new ground."  Id. at 558. Since the Supreme Court’s decision in 1974, most lower courts to have considered the question have extended the tolling principles of American Pipe, which involved a statute of limitations, to statutes of repose on the ground that American Pipe tolling is a form of "legal tolling," rather than equitable tolling. 

In IndyMac, the lead plaintiffs had asserted putative class claims relating to 106 offerings of residential mortgage-backed securities. Following the district court’s dismissal of claims relating to over 90 offerings in which the lead plaintiffs did not invest for lack of standing, six different pension funds filed motions to intervene as named plaintiffs to assert class claims relating to eight of the offerings that had been dismissed. The district court rejected myriad prior decisions holding that American Pipe tolling extends to the three-year statute of repose for Securities Act claims, and denied the intervention motions to the extent they were filed more than three years after the offerings occurred. 

On the denied intervenors’ appeal, the Second Circuit concluded that it did not matter whether American Pipe tolling was viewed as a form of equitable or legal tolling as neither form of tolling could stop the running of the statute of repose:  "If [the American Pipe] tolling rule is properly classified as ‘equitable,’ then application of the rule to Section 13’s three-year repose period is barred by [Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 363 (1991)], which states that equitable tolling principles do not apply to that period. Even assuming, arguendo, that the American Pipe tolling rule is ‘legal’ — based upon Rule 23, which governs class actions — we nonetheless hold that its extension to the statute of repose in Section 13 would be barred by the Rules Enabling Act, 28 U.S.C. § 2072(b)." 

The Second Circuit’s decision curbs the ability of absent class members to wait indefinitely for developments in the class action to unfold before deciding whether to participate or file their own action, as Section 13’s three-year statute of repose will bar absent class members from opting-out or otherwise independently asserting their Securities Act claims after the statute of repose has run. Moreover, while the IndyMac decision focuses on the three-year statute of repose in Section 13, its reasoning would apply to other statutes of repose as well. Thus, absent class members must decide, within the applicable repose periods, whether to pursue individual claims or risk losing the right ever to pursue such claims.


The Supreme Court’s decision in Amgen has had ripple effects in class certification battles and even challenges to the fraud-on-the-market presumption. In the few months since the Amgen decision was issued, lower courts have wrestled with Amgen and the Court’s signals regarding the viability of Basic‘s fraud-on-the-market presumption.

            Fraud-on-the-Market at the Class Certification Stage

In Erica P. John Fund, Inc. v. Halliburton Co. (Halliburton II), the U.S. Court of Appeals for the Fifth Circuit revisited the fraud-on-the-market presumption after the Amgen decision. No. 12-10544, 2013 WL 1809760 (5th Cir. Apr. 30, 2013). As previously discussed in our 2011 Mid-Year Securities Litigation Update, the Supreme Court held in Erica P. John Fund, Inc. v. Halliburton Co. (Halliburton I), 131 S. Ct. 2179 (2011), that plaintiffs in a private securities fraud action are not required to prove the element of loss causation for purposes of class certification under Federal Rule of Civil Procedure 23(b)(3). The Court then remanded the case to the Fifth Circuit, instructing the appellate court to determine whether defendant Halliburton had preserved any other arguments against class certification. See Halliburton II, 2013 WL 1809760, at *1 (citing Halliburton I, 131 S. Ct. at 2187).

On remand, Halliburton argued that class certification was improper because its evidence demonstrated that the alleged misrepresentations did not impact the price of Halliburton stock. [1]  Id. at *2. Following the "analytical framework" set forth in Amgen, the Fifth Circuit focused on the "’pivotal inquiry,’" namely, whether resolution of the price impact question was necessary to ensure common questions predominate. Id. at *6-7 (quoting Amgen, 133 S. Ct. at 1195). The Fifth Circuit first weighed whether price impact evidence was common to the class. The court determined that price impact evidence is generally established by an expert evaluation of market price that "inherently applies to everyone in the class." Id. The court then evaluated the "risk that a later failure of proof on the common question of price impact [would] result in individual questions predominating." Id. (citations omitted). The court rejected Halliburton’s argument that any such failure would disparately impact individual claims, noting that "if Halliburton were to successfully rebut the fraud-on-the-market presumption by proving no price impact, the claims of all individual plaintiffs would fail." Id. Therefore, the court concluded that price impact evidence for purposes of rebutting the fraud-on-the-market presumption was ineffective in defeating class certification, leaving for another day whether the evidence would ultimately defeat the claim. Id. at *8.

While a majority of Justices in Amgen signaled misgivings over the market efficiency element of the fraud-on-the-market presumption, 133 S. Ct. at 1198 n.6, district courts continued to apply the Basic premise that the market for a stock is presumed efficient if publicly available information is rapidly incorporated into the market price. In the past six months, courts continued to apply the traditional factors in the market efficiency analysis. See, e.g., KB Partners I, L.P. v. Barbier, No. A-11-CA-1034-SS, 2013 WL 2443217 (W.D. Tex. June 4, 2013) (applying Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989)); In re Winstar Commc’n Sec. Litig., No. 01-3014, 2013 WL 1700993 (S.D.N.Y. Apr. 17, 2013); In re Sanofi-Aventis Sec. Litig., No. 07-10279, 2013 WL 1149672 (S.D.N.Y. Mar. 20, 2013).

The decision in In re Winstar Communication Securities Litigation is particularly illustrative. There, the defendant argued that class treatment would be inappropriate because the fraud-on-the-market presumption did not apply. Specifically, the defendant argued that plaintiffs could not prove that the market for Winstar’s bonds was efficient throughout the entire class period. 2013 WL 1700993, at *6. The court, applying the Cammer factors to the market efficiency analysis, adjusted "for the realities of the over the counter bond market" and found that two factors, relating to the bonds’ average weekly trading volume and the causal relationship between unexpected corporate events and the security’s price, warranted a finding that the bond market was only efficient for a limited period. Id. at *8-9.

An opinion issued just over a week ago out of the Southern District of New York further illustrates the emerging trend. In George v. China Auto. Sys., Inc., No. 11 Civ. 7533, 2013 WL 3357170 (July 3, 2013), Judge Katherine Forrest explored the effect of the Amgen ruling on a plaintiff’s burden to satisfy the requirements of Rule 23, and Rule 23(b)(3) in particular. The court rejected class certification in part due to plaintiffs’ failure to show by a preponderance of the evidence that the subject securities traded in an efficient market. While noting the plaintiffs failed to meet other prerequisites of Rule 23, the opinion is most notable for its analysis of the predominance requirement as applied to the reliance element of plaintiffs’ Section 10(b) claims. The court found class treatment warranted only where a plaintiff establishes by a preponderance of the evidence that reliance may be presumed class-wide by virtue of the existence of an efficient market, a critical requirement to invoking the fraud-on-the-market presumption of reliance. Id. at *22-23. "In the absence of this presumption of reliance on a market that absorbs the alleged material misstatements and omissions, questions as to whether any particular investor in fact relied on any particular misstatement or omission come to the fore and may overwhelm the common questions." Id. at *22. Defendants, the court found, adequately demonstrated that plaintiffs’ purported proof of market efficiency fell "short of the mark," and that class treatment was therefore unwarranted.

Courts also continued to uphold the presumption that major stock exchanges such as the New York Stock Exchange operate as efficient markets for purposes of the fraud-on-the-market presumption. See, e.g., In re Heckmann Corp. Sec. Litig., No. 10-378-LPS-MPT, 2013 WL 2456104, at *7 (D. Del. June 6, 2013) (citing Basic for the presumption that market prices of stocks traded on "well-developed markets" reflects all publicly available information, including any potential material misrepresentations) (citation omitted); Sanofi-Aventis, 2013 WL 1149672, at *6 (stating that Sanofi stock traded on the NYSE, "an efficient market"); In re Merck & Co., Inc. Sec. Litig., Nos. 05-1151, 05-2367, 2013 WL 396117, at *11 (D.N.J. Jan. 30, 2013) (recognizing the NYSE as "open and developed" and "well suited for application of the fraud on the market theory") (citations omitted). In one opinion, the court even found that application of the Cammer factors was unnecessary to determine efficiency simply because the company’s stock traded on the NYSE. 2013 WL 396117, at *11.

            Rebutting Fraud-on-the-Market on the Merits: Gamco Investors, Inc. v. Vivendi

In an unusual case before the Southern District of New York, defendant company Vivendi, S.A. successfully rebutted the fraud-on-the-market presumption. Gamco Investors, Inc. v. Vivendi, S.A., Nos. 03-5911, 09-7962, 2013 WL 765122, at *1 (S.D.N.Y. Feb. 28, 2013). Plaintiffs alleged that Vivendi made material misstatements and omissions that artificially inflated the company’s American Depositary Shares and that they relied on this inflated price during the relevant time period. Id. The procedural posture was such that the entire case hinged on one element:  reliance. Plaintiffs claimed that reliance could be presumed under Basic, and the district court held a two-day bench trial as to Vivendi’s rebuttal to the presumption of reliance. Id. at *1.

The court found that while attempts to rebut the fraud-on-the-market presumption are "futile in the vast number of cases," findings of fact demonstrated that plaintiffs did not rely on the market price of Vivendi’s stock as an "unbiased assessment of [their] value[.]" Id. at *8 (citations omitted). The evidence before the court showed that plaintiffs had developed a strategy to track Vivendi’s "intrinsic Private Market Value[]" and purchase Vivendi securities when the share price was at a substantial discount to the private market value. Id. at *4. The court found that the plaintiffs’ reliance on private market value, rather than market price, rebutted the fraud-on-the-market presumption. Id. at *9.

While the court cautioned that its holding was "sharply limited to its unusual facts," id., Gamco does demonstrate that the fraud-on-the-market presumption is not completely ironclad, particularly when considered alongside the concerns raised in Amgen regarding the continued viability of the presumption in general.


A little more than a year ago, the Second Circuit issued its decision in Panther Partners, Inc. v. Ikanos Communications, Inc., applying a more qualitative approach to Item 303 of SEC Regulation S-K, which "requires registrants to ‘[d]escribe any known trends or uncertainties . . . that the registrant reasonably expects will have a material . . . unfavorable impact on . . . revenues or income from continuing operations.’" 681 F.3d 114, 120 (2d Cir. 2012) (quoting 17 C.F.R. § 229.303(a)(3)(ii)). We discussed the Panther Partners opinion in the 2012 Year-End Securities Litigation Update, and in the first half of 2013, the Second Circuit’s controversial opinion has met with mixed results.

So far this year, decisions applying Panther Partners have generally split somewhat evenly between plaintiff and defense verdicts. For example, in Silverstrand Investments v. AMAG Pharmaceuticals, Inc., the First Circuit relied on Panther Partners in holding that plaintiffs plausibly pled an Item 303 omission based on defendants’ failure to disclose 23 reports of serious adverse effects ("SAEs") linked to Feraheme, a make-or-break drug for the company. 707 F.3d 95, 103-106 (1st Cir. 2013). The court rejected the defendants’ argument that 23 SAEs was actually less than the SAE rate previously observed during clinical trials and disclosed to the public. Id. at 104. The court quoted Panther Partners‘ reasoning that "Item 303’s disclosure obligations . . . do not turn on restrictive mechanical or quantitative inquiries." Id. at 106. Thus, the court held that it was less concerned with defendants’ statistical comparison and more concerned with plaintiffs’ allegation that "the news that Feraheme had possibly caused a death, as well as the other serious side effects reported in the 23 SAEs, was already circulating within the medical community [the company] needed to win over to remain as a going concern." Id.

In another favorable decision for plaintiffs, the Southern District of New York in Stratte-McClure v. Morgan Stanley reversed its earlier decision that defendants had no duty under Item 303 to disclose Morgan Stanley’s subprime assets during the real-estate downturn. No. 09 Civ. 2017 (DAB), 2013 WL 297954, at *5 (S.D.N.Y. Jan. 18, 2013). The court explained that Panther Partners had since held that Item 303 may provide a basis for a disclosure obligation:  the Court held that plaintiffs sufficiently alleged that defendants "were aware of factually-based uncertainties, stemming from subprime and real estate trends," and that plaintiffs could not have known the extent of the risk without knowing the existence of the company’s subprime assets. Id. at *4-7. 

Other courts, however, have continued to express a critical view of plaintiffs’ Item 303 allegations, distinguishing Panther Partners on various grounds. For example, in Mallen v. Alphatec Holdings, Inc., the Southern District of California dismissed an Item 303 claim based on defendants’ failure to disclose inventory problems. No. 10–cv–1673–BEN (MDD), 2013 WL 1294640, at *12-13 (S.D. Cal. Mar. 28, 2013). The court noted that two things were designated "critical" in Panther Partners: (1) the complaints about defective products came from two of the company’s largest customers, which together accounted for 72% of the company’s revenues; and (2) the company knew at the time that it might have to accept returns on all products sold to those customers. Id. at *13. The complaint in Mallen "describe[d] a variety of inventory problems in broad terms" but lacked equivalent "critical allegations" found in Panther Partners. Id.

As another example, in Johnson v. Sequans Communications S.A., the Southern District of New York dismissed plaintiffs’ Item 303 claims based on defendants’ failure to disclose the decline in the market for WiMAX (a type of wireless 4G protocol) relative to a different protocol called LTE. No. 11 Civ. 6341 (PAC), 2013 WL 214297, at *12-13 (S.D.N.Y. Jan. 17, 2013). The court found that the allegations differed from those in Panther Partners in at least two respects: the complaint contained only conclusory allegations that defendants knew of the alleged trend; and unlike the "generic cautionary language" in Panther Panthers, the disclosures specifically warned that "the WiMAX market may decline significantly in anticipation of LTE deployments." Id.

The Northern District of California, while not citing Panther Partners explicitly, took a similar view of Item 303 allegations in In re Netflix, Inc. Securities Litigation, No. 12–00225 SC, 2013 WL 542637, at *3, *5 (N.D. Cal. Feb. 13, 2013). The court found "not plausible" plaintiffs’ allegations that defendants failed to disclose a known trend or uncertainty regarding the prospects of the streaming market for movies and television shows. Id. at *5. The court found defendants’ disclosure sufficient where it warned that "success in the streaming market depended on multiple factors, especially Netflix’s ability to keep its subscriber base large and happy." Id.

A final example is the U.S. Court of Appeals for the Tenth Circuit’s decision in Slater v. A.G. Edwards & Sons, Inc.. The Tenth Circuit declined to cite Panther Partner, but affirmed the district court’s dismissal of plaintiffs’ Item 303 claims based on the defendants’ failure to disclose exposure to subprime mortgage-backed securities. Slater, No. 07-CV-00815-JB-WDS, 2013 WL 3390038 (10th Cir. July 9, 2013). The defendants had disclosed in an 8-K that the company "benefitted from wider spreads on new prime quality mortgage assets caused by credit concerns in the subprime and Alt-A segments of the mortgage market." Id. at *6. The court found defendant’s disclosure sufficient, in that "[w]ithout a contemporaneous collapse in the value of its MBSs, or at least some sign that their value would collapse shortly after the statement was made, [the defendant’s] portfolio of MBS holdings does not darken the marginally optimistic picture painted by the 8-K."  Id. at *7.


As discussed in both our 2012 Mid-Year Securities Litigation Update and the 2012 Year-End Securities Litigation Update, the Supreme Court, in Janus Capital Group Inc. v. First Derivative Traders, held that an individual or corporation cannot be held primarily liable in a Rule 10b-5(b) private securities action for "making" a misleading statement or omission unless the person or corporation had "ultimately authority" over the statement’s "content" and "whether and how to communicate it." 131 S. Ct. at 2307. Our recent updates have highlighted subsequent decisions applying the holding in Janus in cases concerning, among other issues, who is the actual "maker" of the allegedly misleading statement and what constitutes the "making" of a statement. We have also reviewed cases considering whether Janus should be applied beyond private actions under Rule 10b-5(b). As explained below, in the first half of 2013, courts have continued to interpret Janus in connection with these and other issues.

            Who "Made" the Allegedly False Statement?

Over the past six months, a number of courts applying the Janus decision have declined to impose liability on third parties who did not actually make the allegedly misleading statements. For example, several courts have held that attorneys responsible for drafting corporate documents that contained alleged misrepresentations were not liable for the misleading statements. In In re DVI Inc. Sec. Litig., No. 03-5336, 2013 WL 56073, at *7-8 (E.D. Pa. Jan. 4, 2013), the court held that, under Janus, Clifford Chance was not responsible for material misstatements made in DVI’s public filings even if it participated in the drafting of those documents where none of the statements were publicly attributed to Clifford Chance. Similarly, in ESG Capital Partners, LP & Limited Partners v. Troy Stratos, No. 13 Civ. 01639 (C.D. Cal. June 26, 2013), the court held that a law firm and its attorneys could not be held liable for "unknowingly conveying their client’s allegedly false representations to a third party when their clients so direct." Id., slip op. at 7-8. See also Derby City Capital, LLC v. Trinity HR Services, No. 3:12 Civ. 850, 2013 WL 2470900, at *27 (W.D. Ky. June 7, 2013) (holding that, under Janus, an attorney who may have drafted Schedule 13D filings that contained material misrepresentations was not responsible as he was not the filer of record). But see SEC v. Garber, No. 12 Civ. 9339 (SAS), 2013 WL 1732571, at *5 (S.D.N.Y. Apr. 22, 2013) (holding that alleged misrepresentations made in attorney opinion letters could be attributed to defendants as defendants "solicited the advisory opinion and had ‘ultimate authority . . . over whether and how to communicate it.’") (internal citations omitted)).

The reluctance to hold third parties responsible for misstatements has not been limited to corporate attorneys. In a different circumstance, the Second Circuit held that an investor was not liable for a Rule 10b(5) private claim even though he had facilitated the alleged fraud because plaintiff did not allege that the defendant investor "communicated the artificial price information to the would-be buyers." Fezzani v. Bear, Stearns & Co. Inc., No. 09-4414, 2013 WL 1876534, at *4 (2d Cir. May 7, 2013). Courts have also distinguished between related corporate entities, limiting liability to the actual maker of the misleading statement. See, e.g.,  McIntire v. China MediaExpress Holdings, Inc., No. 11 Civ. 0804, 2013 WL 752954, at *25 (S.D.N.Y. Feb. 28, 2013) (holding that an umbrella international auditing firm and U.S. member firm were not liable for alleged misstatements by Hong Kong member firm where plaintiff had failed to allege that these other entities had "ultimate authority" over the alleged misstatements); North Port Firefighters’ Pension-Local Option Plan v. Temple-Inland, Inc., No. 11 Civ. 3119, 2013 WL 1263161, at *9 (N.D. Tex. Mar. 28, 2013) (holding that a corporation was not liable for misstatements describing spin-off of bank included in bank’s Form 8-K prior to the spin off as plaintiff failed to allege corporation had "ultimate authority" over the alleged misstatement).

Courts appear to be split as to whether corporate insiders can be held liable for corporate statements under Section 10(b). For example, in City of Austin Police Retirement System v. Kinross Gold Corp., No. 12 Civ. 1203 (PAE), 2013 WL 2449188, at *5, n.1 (S.D.N.Y. June 6, 2013), the court noted that courts in the Southern District of New York are unsettled as to whether, under Janus, corporate officers working together in the same entity could be jointly liable for a misstatement even where the officers did not sign the filings containing the misstatement. Id. at *5 n.1. See also In re Pfizer Inc. Sec. Litig., No. 04 Civ. 9866, 2013 WL 1285173, at *11 (S.D.N.Y. Mar. 28, 2013) (holding that individual officers can be held liable for allegedly misleading statements not expressly attributed to them because the individual defendants had ultimate authority over those statements ); In re Satyam Comp. Servs. Ltd. Sec. Litig., No. 09 MD 2027, 2013 WL 28053, at *20, n.16 (S.D.N.Y. Jan. 2, 2013) (holding that the group pleading doctrine survived Janus).

            The Impact of Janus Beyond Rule 10b-5(b) Actions

As noted in our 2013 Mid-Year Securities Enforcement Update, the SEC continues to challenge Janus‘ effect on enforcement actions, with some success.  But as one court noted, "there have been at least several cases where the SEC has simply conceded that Janus applies to its enforcement actions."  SEC v. Benger, No. 09 Civ. 676, 2013 WL 1150578, at *4 (N.D. Ill. Mar. 21, 2013).

Courts have continued to resist broader application of Janus, including to actions brought under Rule 10b-5(a) and (c), Section 17(a) of the Securities Act of 1933, and state securities actions. Garber, 2013 WL 1732571 at *4; In re Allstate Life Ins. Co. Litig., No. 09 Civ. 8162, 2013 WL 2474508, at *3 (D. Ariz. June 10, 2013) (finding that Janus "did not hold that the substantial participation test is inapplicable to state securities law claims" and that "Arizona has defined its state securities action more broadly than the federal action."); Prousalis v. Moore, No. 12 Civ. 134, 2013 WL 1165249, at *6 (E.D. Va. Mar. 20, 2013) (holding that Janus did not apply as that decision "stemmed from a line of decisions limiting judicially created private causes of action" and does not apply to issues of criminal liability).


Courts continue to define the extra-territorial securities litigation landscape following the Morrison v. National Australia Bank opinion. Even in SEC enforcement proceedings, where Morrison’s reach is curtailed by Dodd-Frank, the international reach of federal securities laws remains a focus of proceedings. Those decisions are discussed in our Securities Enforcement Mid-Year Update. Here we explore post-Morrison decisions from the first half of 2013 in other contexts and a pending appeal that promises to resolve one significant outstanding question.

Federal courts applying Morrison continue to grapple with what constitutes a "domestic transaction" in securities not listed on a U.S. stock exchange. In our 2012 Year-End Securities Litigation Update, we discussed the Second Circuit’s resolution of this question in Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012). There, the Second Circuit held that "to sufficiently allege a domestic securities transaction in securities not listed on a domestic exchange," a plaintiff must "allege facts suggesting that irrevocable liability was incurred or title transferred within the United States." Id. at 68. The court noted that its test combines the "title transfer" test adopted by the U.S. Court of Appeals for the Eleventh Circuit in Quail Cruises and the "irrevocable liability" test employed by district courts within the Second Circuit. Id. During the first half of 2013, district courts within and outside the Second Circuit have applied the Absolute Activist test.

Most recently, a Section 10(b) claim survived in the Southern District of New York under Morrison and Absolute Activist because it "alleged facts leading to the plausible inference that irrevocable liability was incurred when the funds were delivered to HSBC in New York," as the agreement at issue provided that such delivery made the contract "irrevocably binding." Arco Capital Corp. Ltd. v. Deutsche Bank AG, No. 12 CIV. 7270, 2013 WL 2467986, at *9, 10 (S.D.N.Y. June 6, 2013); see also In Absolute Activist Master Value Fund, Ltd. v. Ficeto, No. 09 CIV. 8862 GBD, 2013 WL 1286170 (S.D.N.Y. Mar. 28, 2013) (denying defendants’ motion to dismiss where, among other things, offering memoranda explicitly provided irrevocable liability upon delivery, which occurred in the United States). But several opinions earlier this year went the other way. In re Sanofi-Aventis Securities Litigation, No. 07 CIV. 10279 GBD FM, 2013 WL 1149672 (S.D.N.Y. Mar. 20, 2013) (finding securities purchases did not constitute domestic transactions because point of irrevocable liability occurred when the parties entered into contract and plaintiff conceded purchases were made abroad); SEC v. Amerindo Inv. Advisors, Inc., No. 05 CIV. 5231 RJS, 2013 WL 1385013 (S.D.N.Y. Mar. 11, 2013) (dismissing claims and denying summary judgment on one where questions existed as to location of parties at point of irrevocable liability); In re Satyam, 2013 WL 28053 (dismissing claims and noting that "[a]n investor’s location in the United States does not transform an otherwise foreign transaction into a domestic one"). And in one class certification opinion, the court excluded putative class members who were foreign purchasers. In re Smart Tech. Inc. Shareholder Litig., No. 11 Civ. 7673, 2013 WL 139559 (S.D.N.Y. Jan. 11, 2013).

Additionally, courts have continued to dismiss claims where plaintiffs provided insufficient context for the court to determine where the transactions occurred. See Mori v. Saito, No. 10 CIV. 6465 KBF, 2013 WL 1736527, at *7 (S.D.N.Y. Apr. 19, 2013) (granting defendants’ motion to dismiss and noting that "Morrison and Absolute Activist make perfectly clear that the conduct and effects test, which previously governed in this Circuit, is no longer valid"); MVP Asset Mgmt. (USA) LLC v. Vestbirk, No. 2:10-CV-02483-GEB, 2013 WL 1726359, at *5 (E.D. Cal. Mar. 22, 2013) (dismissing Section 10(b) claim where plaintiffs failed to allege where defendants were located when they accepted the agreement at issue.").

District courts have continued to find that Morrison‘s transactional test applies equally to claims under securities and other laws. For example, courts applied Morrison‘s transactional test to claims under Section 15(a) of the Securities Exchange Act of 1934 and Section 11 of the Securities Act of 1933. See Benger, 2013 WL 1277872, at *4 (granting defendant brokers’ motion to dismiss claims under Section 15(a) of the Securities Exchange Act of 1934 for failure to register before engaging in sale of securities in foreign exchanges; the transaction was not domestic under Morrison because "the ultimate and intended purchase and sale was foreign and thus, itself, outside the scope of the Act"); In re Smart Technologies, 2013 WL 139559, at *4, 6 (excluding  putative class members who acquired a corporation’s stock outside of the United States from a class in suit brought under Section 11 of the Securities Act of 1933 because "[c]ourts in this District uniformly concur" that Morrison‘s prohibition on extraterritoriality applies to Securities Act [of 1933] claims"). Two decisions also found that Morrison‘s presumption against the extraterritoriality "applies with equal force" to claims under the Commodity Exchange Act ("CEA"), which prohibits fraud in connection with the trading of commodity futures. Starshinova v. Batratchenko, No. 11-CV-9498 KMW, 2013 WL 1104288, at *6 (S.D.N.Y. Mar. 15, 2013); see also Loginovskaya v. Batratchenko, No. 12 CIV. 336 JPO, 2013 WL 1285421, at *13 (S.D.N.Y. Mar. 29, 2013).

Finally, securities litigators eagerly await the Second Circuit’s decision in In re UBS Securities Litigation, now on appeal. A successful appeal for plaintiffs in that action could dramatically undercut Morrison‘s force for securities defendants. In September 2011, U.S. District Judge Richard Sullivan ruled that, under Morrison, the plaintiffs in a consolidated securities class action lawsuit tied to UBS’s $100 billion stock drop during the financial crisis could not pursue claims on behalf of United States and foreign UBS shareholders that purchased their securities abroad. Under plaintiffs’ theory, any non-U.S. issuer that "cross-lists" any of its shares for trading on U.S. and foreign exchanges could be sued for securities fraud on behalf of a worldwide class of investors. In dismissing the claims, Judge Sullivan held that the plaintiffs’ "listing" theory turned on a "strained interpretation" and "hyper-technical parsing" of Morrison that "is in stark tension with the language of the opinion as a whole." No. 07 Civ. 11225, 2011 WL 4059356, at *4 (S.D.N.Y. Sept. 13, 2011). Judge Sullivan dismissed what little remained of the case with prejudice in September 2012, and the plaintiffs filed an appeal on February 8, 2013.

Plaintiffs’ arguments on appeal in UBS are expansive but turn largely on persuading the Second Circuit to accept their "cross-listing" theory. UBS filed a response on May 10, 2013, and several powerful groups have filed amicus briefs in support of UBS, including the government of the United Kingdom, Securities Industry and Financial Markets Association, the U.S. Chamber of Commerce and several of its foreign counterparts, the NYSE Euronext, the Swiss government, and the Swiss Bankers Association. Plaintiffs filed their reply brief on June 14, and oral argument will be set in the coming months.  


New cases concerning plaintiffs’ burden to plead scienter have been consistently beneficial to defendants. Reflecting a trend we previously reported in our 2012 Year-End Securities Litigation Update, federal circuit courts have overwhelmingly continued to affirm trial court orders dismissing securities fraud cases for failure to plead sufficient facts to give "rise to a strong inference" that the defendant acted with intent to deceive, manipulate, or defraud. Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1324 (2011) (citing 15 U.S.C. § 78u-4(b)(2)(A)).

For example, in Belmont v. MB Investment Partners, Inc., the U.S. Court of Appeals for the Third Circuit affirmed the dismissal of a federal securities law claim brought against a managing director of an investment advisory firm who allegedly encouraged plaintiffs to invest in a Ponzi scheme-hedge fund. 708 F.3d 470, 494 (3d Cir. 2013). The court held that plaintiffs failed to allege that the managing director knew that the hedge fund was in fact a fraudulent Ponzi scheme. Id. at 493. Moreover, the court found that the allegations did not demonstrate that the nature of the fraud was "so obvious that it should have been known" to the managing director, especially because the Ponzi-scheme-hedge fund’s sole principal and managing member had an "apparently successful investment track record." Id. at 493-94 (emphasis added).

Likewise, the U.S. Court of Appeals for the Seventh Circuit affirmed an order dismissing a complaint alleging federal securities law violations against the Boeing Company ("Boeing") and its executive officers. City of Livonia Emps.’ Ret. Sys. & Local 295/Local 851 IBT v. Boeing Co., 711 F.3d 754, 762 (7th Cir. 2013). Plaintiffs alleged that Boeing executives had made fraudulent statements regarding the date on which the Boeing 787-8 Dreamliner would make its "First Flight," notwithstanding the fact that defendants allegedly knew that the Dreamliner had failed certain testing procedures and the "First Flight" would be delayed. Id. at 757. Plaintiffs initially survived a motion to dismiss in the district court based on allegations from a confidential source, who was said to have seen communications to Boeing’s executive officers that established that they knew the Dreamliner could not fly as scheduled.  After Boeing proved, and the Plaintiffs eventually conceded, that the source was not who Plaintiffs claimed he was and could not have had access to such communications, Boeing renewed its motion to dismiss, which the district court granted. On appeal, the Seventh Circuit held that the Plaintiffs’ "abandonment of their sole confidential source" was "fatal." With the confidential source allegations stripped from the complaint, the court found the remaining allegations insufficient, noting that defendants had no motive to delay an announcement that the ‘First Flight’ would be delayed because ‘[t]he buyer of a $200 million dollar airplane … will not overlook bad news about the plane merely because the news emerged a few days after the industry trade show rather than before or during it." Id. at 758. According to the court, "[a] more plausible inference than that of fraud is that the defendants, unsure whether they could fix the problem by the end of June, were reluctant to tell the world ‘we have a problem and maybe it will cause us to delay the First Flight and maybe not, but we’re working on the problem and we hope we can fix it in time to prevent any significant delay, but we can’t be sure, so stay tuned.’" Id. at 758-59. Therefore, the court affirmed the order dismissing plaintiffs’ complaint. Id. at 762. The court remanded the case for a determination of whether Plaintiffs’ counsel violated Rule 11 for misrepresenting key facts about their confidential source and, if so, what an appropriate sanction award would be.

In Hemmer Group v. Southwest Water Company, the U.S. Court of Appeals for the Ninth Circuit also affirmed an order dismissing Section 10(b) claims related to misstatements of revenue and income in the financial statements of a water production, treatment, and collection company. No. 11-56154, 2013 WL 2460197, at *3 (9th Cir. June 7, 2013). The court, while noting that most of plaintiffs’ allegations were consistent with both fraudulent and non-fraudulent intent, found it more likely that the company was merely negligent–and therefore not liable–because the company disclosed potential problems in its accounting system during the class period, the company made efforts to improve its accounting system, and the accounting errors at issue originated from distinct geographic regions. Id.

Over the first half of 2013, several courts–particularly courts in the Second Circuit–also grappled with the question of whether the "core operations" inference remains a viable vehicle for pleading scienter. Under the "core operations" inference, "knowledge of the falsity of [a] company’s . . . statements can be imputed to key officers who should have known of facts relating to the core operations of [the] company that would have led them to the realization that the company’s . . . statements were false when issued." Shemain v. Research In Motion Ltd., No. 11 Civ. 4068(RJS), 2013 WL 1285779, at *17 (S.D.N.Y. Mar. 29, 2013) (quotation marks omitted). In a continuation of a trend from previous years, courts in the first half of 2013 have noted that the passage of the PSLRA has left the survival of the "core operations" inference in doubt. See id. at *18 ("As an initial matter, this Court has carefully considered the continued viability of the ‘core operations’ inference in light of the PSLRA’s heightened pleading requirements and found it lacking. The Second Circuit declined to reach [this] question in affirming the ruling.") (citations omitted); Wallace v. Intralinks, No. CV 8861(TPG), 2013 WL 1907685, at *8 (S.D.N.Y. May 8, 2013) ("The passage of the PSLRA has threatened the validity of this doctrine."); Horowitz v. Green Mountain Coffee Roasters, Inc., No. 10-CV-227, 2013 WL 1149670, at *7 n.7 (D. Vt. Mar. 20, 2013) ("This April, the Second Circuit left open the question of whether the core operations doctrine remains valid.") (citation omitted). However, these courts generally have accepted "that although the doctrine cannot provide the sole basis for inferring scienter, it can provide additional evidence" to support a finding of scienter. Wallace, 2013 WL 1907685, at *8.

For example, in Wallace, plaintiffs brought federal securities law claims against a "cloud-based" virtual data room provider and its executive officers for allegedly making optimistic statements related to the strength of the company’s business and its customer satisfaction without disclosing the impending departure of the company’s largest client. 2013 WL 1907685, at *1. The court held that plaintiffs had adequately pleaded scienter, where plaintiffs alleged that the executives in question participated in the decision not to re-negotiate a new contract with the company’s largest client and in fact executed the "final 6 month extension" of that customer’s pre-existing contract. Id. at *8. Moreover, the court held that the "fact that the FDIC was [the company’s] largest customer . . . provide[d] a basis for the core operations doctrine," but noted that the core operations doctrine was "not the sole basis for [the] court finding scienter[.]" Id. at *9. Instead, the court found that the "core operations" inference supported the finding of scienter only when "added with the previously mentioned allegations . . . ." Id.

In Shemain, putative class action plaintiffs sued Research in Motion Limited ("RIM"), the mobile technology manufacturer and producer of the Blackberry smartphone, and executive officers of RIM for making allegedly false and misleading statements related to the Blackberry product pipeline and the prospective financial performance of the company. Shemain, 2013 WL 1285779, at *1. The court considered the "centrality of Blackberry devices to RIM’s operations" as part of its holistic analysis on the issue of scienter. Id. at *18. However, despite the vital importance of the Blackberry to RIM, plaintiffs failed to tie RIM’s executive officers to the information that allegedly would have demonstrated the falsity of their statements, and thus failed to plead a strong inference of scienter. Id.


Through the first half of the year, there have been no significant judgments or fee awards in M&A litigation like we saw in 2012, but that has not slowed the pace of deal litigation. Cornerstone Research released a report in February 2013 showing that, as was the case in 2011, virtually every deal over $500 million resulted in litigation.

Percentage Subject to Litigation

Cornerstone Research, Shareholder Litigation Involving Mergers and Acquisitions (Feb. 2013). And with plaintiff fees averaging $725,000 per settlement in 2012, the pace of deal litigation is unlikely to slow considerably in 2013, despite what appears to be an increased skepticism of these cases by at least one Delaware judge.

Rather than noteworthy judgments and outsized fee awards, the major developments in Delaware litigation in the first half of 2013 were doctrinal in nature, with the Delaware courts offering guidance to M&A participants, advisors and litigants on a number of issues that had gone unresolved for years. For example, Delaware courts handed down decisions offering guidance regarding the duties of boards in negotiating and approving single-bidder transactions; the application of the business judgment rule in going-private transactions; challenges involving disclosure-only settlements of M&A litigation; the duties of directors who sit on the boards of companies with foreign operations; and the collateral estoppel effect of decisions in substantially similar shareholder actions filed in separate jurisdictions. We discuss below these important developments from the first half of 2013.

            Delaware Court Of Chancery Guidance Regarding Single-Bidder Transactions

In two Delaware Court of Chancery decisions–In re Plains Exploration & Production Company Shareholder Litigation, C.A. No. 8090-VCN, 2013 WL 1909124 (May 9, 2013) and Koehler v. NetSpend Holdings Inc., C.A. No. 8373-VCG, 2013 WL 2181518 (May 21, 2013)–the court provided a useful reminder that while a target’s board of directors may reasonably conclude that negotiating a sale of the company with a single bidder is consistent with the board’s Revlon duties, the board must ensure that, at every step in the transaction, it has followed a process reasonably designed to achieve the best possible price under the circumstances, including through the implementation and monitoring of deal protection measures.

In Plains Exploration, the stockholder plaintiffs sought a preliminary injunction in connection with the combination of mining and natural resources companies Freeport and Plains Exploration. 2013 WL 1909124, at *1. The plaintiffs alleged that they were likely to succeed on their claim that the Plains Board breached its fiduciary duties by negotiating a sale of the company with Freeport, and by not seeking out alternative bidders. Id. at *3. In rejecting plaintiffs’ argument, Vice Chancellor Noble found that the expertise of the Plains directors–most of whom had extensive experience in the oil and gas industry–supported a reasonable inference that they were capable of determining whether the transaction price was a fair one to the Plains stockholders, notwithstanding the absence of a market check or go-shop process. Id. at *5-6. The court went on to conclude that the deal protections in place–a no-solicitation clause coupled with a fiduciary out, a three-percent termination fee, and matching rights–were not so onerous that they would have precluded a competing bidder from making an offer or the Board from accepting a superior proposal. Id. at *6. Moreover, given that more than five months had passed since the deal had been announced, the court credited the Plains Board with allowing "sufficient time for competing acquirers to emerge," which, according to the court, was further evidence that the Board had acted reasonably under the circumstances. Id. Accordingly, the court denied plaintiffs’ request for a preliminary injunction. Id. at *11.

In NetSpend, stockholder plaintiffs sought to preliminarily enjoin the sale of NetSpend to Total System Services, Inc. in an all-cash $1.4 billion transaction. 2013 WL 2181518, at *1, *9. Plaintiffs attacked the merger on several grounds, including that the NetSpend Board breached its Revlon duties by failing to conduct a sales process designed to lead to the best value reasonably available for NetSpend’s stockholders. Id. at *11.

With respect to the Revlon claim, Vice Chancellor Glasscock concluded that while a single-bidder process is not per se invalid, a board pursuing this strategy is required to be "particularly scrupulous" in its sales process to ensure that it obtains the best value reasonably available. Id. at *13. The court identified two factors that, together, according to the court’s decision, impaired the Board process. First, the court found that the fairness opinion delivered to the Board was, in the court’s view, "weak" and a "poor substitute for a market check." Id. at *16.

Second, the court addressed so-called "Don’t Ask, Don’t Waive" provisions (discussed in Gibson Dunn’s 2012 year-end update), which prohibit bidders from requesting that a target company waive the terms of a standstill entered into between a bidder and target. Id. at *18-19. The court concluded that, because the NetSpend Board was prohibited under the terms of the merger agreement from waiving (without the buyer’s consent) "Don’t Ask, Don’t Waive" provisions that NetSpend had entered into with two private equity companies that had previously expressed an interest in purchasing a minority stake in the Company, the Board had approved the merger without adequately informing itself that the consideration was the best value reasonably available to NetSpend stockholders. Id. After oral argument, but before the court handed down the decision, the buyer consented to NetSpend waiving the "Don’t Ask, Don’t Waive" provisions to allow the private equity buyers to submit competing bids, but NetSpend still received no competing offers. Id. at *19. Thus, the court declined to enter the preliminary injunction because, in its view, the risk to NetSpend of losing what appeared to be the only available deal outweighed any harm to stockholders resulting from the sales process. Id. at *24. 

These recent decisions should remind boards considering a sales process that: (1) under Delaware law, single-bidder sales are not per se invalid under Revlon and there is no single way for a board to conduct an appropriate sales process; (2) "Don’t Ask Don’t Waive" provisions can be appropriate and effective tools in maximizing shareholder value in the bidding process, but such provisions require close attention where they survive announcement of a sale transaction; and (3) in an environment where deals over a certain size are all but guaranteed to be challenged in litigation, boards in a single-bidder process must diligently develop a record of careful and deliberate action designed to deliver the best value reasonably available to stockholders.

            Chancery Court Carefully Scrutinizes Disclosure-Only Settlement and Adequacy of Plaintiff in Rejecting Settlement of M&A Litigation

In March 2013, Chancellor Strine of the Delaware Chancery Court issued a bench ruling rejecting a disclosure-only, negotiated settlement of an M&A stockholder lawsuit. The decision, In re Transatlantic Holdings Inc. Shareholders Litigation, No. 6574-CS, 2013 WL 1191738 (Del. Ch. Mar. 8, 2013), signals that the Chancery Court will carefully scrutinize the terms of negotiated settlements to ensure that named stockholder plaintiffs are adequate class representatives and that the additional disclosures provided to voting stockholders in connection with the settlement offer some benefit to the purported stockholder class.

The litigation arose out of the sale of the reinsurance organization Transatlantic Holdings Inc. to Alleghany Corporation.[2] The stockholder plaintiffs alleged that defendant directors breached their fiduciary duties in connection with merger approval and that the preliminary proxy statement failed to provide stockholders with sufficient information to consider the adequacy of the proposed transaction. The parties reached a preliminary agreement to resolve the litigation, with Transatlantic agreeing to make additional disclosures to its stockholders in advance of the vote, and with no monetary consideration paid to the purported class. These additional disclosures included:  (i) disclosure of Alleghany’s projected expense ratio (a measure of operating expenses to premium income); (ii) disclosure of the total amount of premium value that Transatlantic might lose if all of its policyholders terminated their insurance contracts after the merger; (iii) disclosures concerning the financial advisors’ compensation and relationships with Alleghany and Transatlantic; and (iv) additional disclosures concerning the background to the merger.

At a hearing held to consider the settlement, Chancellor Strine noted that the plaintiffs had failed to show why the additional disclosures "would have been meaningful, would have been interesting, in any real way to someone voting on this transaction," and that the disclosures did not in any way "contradict or meaningfully affect the flow of information in a way that’s different from what the board is suggesting" about the transaction. In re Transatlantic Holdings, 2013 WL 1191738, at *1-2. Turning to the named plaintiffs, Chancellor Strine noted that it was the court’s obligation to "have some confidence that the class is actually represented in the right way." Id. at *2. The Chancellor found it "very telling" that the two named stockholders who brought the litigation were small stockholders (in one case, holding only two shares of Transatlantic stock); that one of the stockholders acknowledged that it did not vote on the transaction; and that the other stockholder could not remember whether he voted. Id. at *1-2. Because plaintiffs had failed to show that the disclosures were material to Transatlantic stockholders, and in light of the inadequacy of the named plaintiffs, the court rejected the settlement, noting that plaintiffs’ counsel had failed to provide the court with any "examination of the grounds for liability, which also suggests that there probably wasn’t any, really, grounds to bring this suit to begin with." Id. at *3.

Months after Chancellor Strine’s decision in Transatlantic, the court in In re Gen-Probe Inc. Shareholders Litigation reduced attorney fees from a "terribly thin" disclosure-only settlement from $450,000 to $100,000.  No. 7495-VCL, 2013 WL 3246605, at 16 (Del. Ch. Apr. 10, 2013). In consideration for the proposed fee, defendants had agreed to disclose information regarding (1) prospective employment for the CEO after the transaction; (2) how the financial advisor adjusted cash flow data; and (3) the timing of the disclosure of quarterly results. Id. at 9-11. Vice Chancellor Laster opined that he could not see how the disclosures were "terribly distinct from what the Chancellor decided were insufficient to support the settlement in Tranatlantic." Id. at 14. But the court chose not to reject the settlement outright because defendants had already disclosed the information at issue, and plaintiffs could likely recover a fee under the Delaware mootness doctrine. Id. at 13.

In support of the negotiated fee, plaintiffs’ counsel argued that Vice Chancellor Laster had approved fees in similar cases ranging from $400,000 to $500,000.  Id. at 12.  The Vice Chancellor admitted his preference "to stick to the ranges," but stated that he was "starting to think of that range as too high" for disclosure-only settlements. Id. at 16. In comparison to the effort exerted and fees recovered by plaintiff firms who "fought hard" and obtained million dollar judgments, Vice Chancellor Laster argued that $400,000 to $500,000 for "thin" disclosures seemed "excessive." Id. Laster reasoned that in a world where 95% of deals are challenged by plaintiffs, "there may need to be a recalibrating of the market" with regard to attorney’s fees for disclosure-only settlements.  Id.

While it is too early to tell whether plaintiff firms will heed Chancellor Strine and Vice Chancellor Laster’s admonitions to refrain from bringing meritless M&A lawsuits on behalf of absentee plaintiffs, the decision represents an unmistakable warning to those firms. They cannot continue to count on paydays by merely filing suit in the wake of announced deals. The underlying merits and the existence of an actual, involved plaintiff in the litigation will be carefully evaluated by the Chancery Court, where more M&A lawsuits are filed than anywhere else. 

            Delaware Court of Chancery Provides Roadmap for Business Judgment Review of Going-Private Merger Transactions

In In re MFW Shareholders Litigation, C.A. No. 6566-CS, 2013 WL 2436341 (Del. Ch. May 29, 2013), Chancellor Strine considered a question of law that had long vexed the deal community: whether a controlling stockholder that expressly conditions a going-private merger transaction on the approval of both a committee of independent directors and a majority-of-the-minority stockholders is entitled to the protections of the business judgment rule, or whether such transactions–because they involve a controlling stockholder–are necessarily evaluated under the more onerous entire fairness standard.

In MFW, a 43% holder of MFW sought to take the company private. 2013 WL 2436341, at *1. At the outset of the proposed transaction, the controlling stockholder made clear to the MFW board that it would only agree to the transaction if it were approved by both an independent committee of MFW’s Board of Directors and by a majority of the non-controlling stockholders of MFW. Id. In response to the acquisition proposal, MFW formed a special committee of independent directors, which hired its own financial and legal advisors and was empowered to negotiate and veto the transaction. Id. After negotiations with the controlling stockholder and due consideration, the special committee voted to recommend the transaction to MFW’s stockholders. Id. at *1, *3. 65% of MFW’s non-controlling stockholders then voted to approve the transaction. Id. at *14. 

Chancellor Strine granted the defendants’ motion for summary judgment, finding no disputed facts as to the independence of the special committee and the approval by a majority of the minority stockholders. Id. at *25. On the critical question of what standard applied for review of the transaction, Chancellor Strine concluded that it was an issue of first impression in Delaware and that the application of the "potent combination of procedural protections" was a "transactional structure that is most likely to protect" the interests of minority stockholders. Id. at *21. Accordingly, the Chancellor concluded that these "fairness enhancing" protections should be encouraged by providing controlling stockholders that utilize both protections the benefit of the deferential business judgment rule, rather than the entire fairness standard of review. Id. at *24-25.

Because of MFW, controlling stockholders in going-private merger transactions should consider implementing the "both" structure, as Chancellor Strine called it–by insisting up front that the transaction will not go forward unless approved by both a truly independent committee of the board that is fully informed and has real negotiating power (including the power to reject a proposed transaction), and by a majority of the minority stockholders that are fully informed as to the deal terms. With these conditions in place, controlling stockholders may proceed with added confidence that going-private transactions will escape the costly and lengthy process of demonstrating, at trial, that the transaction was entirely fair to the minority stockholders. 


Beginning in 2012, a new trend has emerged in securities litigation. Led largely by a single plaintiffs’ law firm, plaintiffs have filed shareholder class actions seeking injunctions to prevent annual shareholder votes from going forward, on the theory that proxy materials published in advance of the annual vote are false or misleading. Plaintiffs have themed these cases on merger-and-acquisition lawsuits that allege insufficient proxy disclosures in advance of a vote on material corporate transactions. See Gibson Dunn Update, "Say on What? Plaintiffs’ Lawyers Target "Say-On-Pay" Disclosures in Annual Proxy Statements," Feb. 26, 2013.

In this new breed of proxy-disclosure litigation, plaintiffs generally move for an injunction to prevent the annual shareholder vote shortly before the vote occurs, claiming that an injunction is necessary to prevent shareholders from voting based on misleading information. Leveraging the threat of disrupting the shareholder meeting, they seek a quick settlement from the company.  If the company issues an amended disclosure that addresses the plaintiffs’ claims, the plaintiffs’ lawyers demand a fee for conferring that purported "benefit" to the company’s shareholders.  These lawsuits put companies in a no-win situation: they either have to settle the lawsuit, moot it by making changes in the proxy disclosure and paying fees to the plaintiffs’ law firm, or fight and risk delaying their annual shareholder vote.

Plaintiffs have asserted a number of legal theories in these cases. Some cases attacked the sufficiency of a proxy statement’s disclosures related to a proposal to amend an equity incentive plan, often to increase the amounts of shares authorized for issuance. Such cases have alleged deficiencies in disclosures about the data considered by boards in formulating the amendments, as well as the dilutive impacts of authorizing additional shares for issuance. Other cases claimed that a proxy statement insufficiently described information required to be disclosed under the Dodd-Frank Wall Street Reform and Consumer Protection Act’s "say-on-pay" proxy disclosure rules. In these cases, plaintiffs generally allege that the proxy statements insufficiently disclose compensation consultants’ reports, the issuers’ analyses of compensation benchmarks, comparisons of specific elements of compensation plans with industry peers, and the rationale for executive severance agreements. Yet other cases have claimed that proxy statements contain inadequate disclosures concerning incentive compensation plans designed to maximize favorable tax treatment under section 162(m) of the Internal Revenue Code, which imposes conditions on when companies can take deductions for compensation paid to their top executives in excess of $1 million per year.

Plaintiffs claimed initial victories in 2012, winning preliminary injunctions against Abaxis and Brocade Communications Systems and obtaining settlements from Martha Stewart Living Omnimedia, WebMD, and H&R Block. In most of these cases, plaintiffs claimed the defendants breached fiduciary duties by failing to make adequate proxy disclosures.

In late 2012, the court decisions began to trend in favor of the defendants, and courts denied motions for preliminary injunctions against Symantec, AAR Corp., Clorox, Globecomm, and Microsoft. The Santa Clara County Superior Court ruling for Symantec was particularly noteworthy in light of the same court’s previous grant of the preliminary injunction against Brocade. Furthermore, when the court sustained Symantec’s demurrer in March 2013, it noted that plaintiff shareholders no longer had a direct claim against Symantec for deficiencies in proxy disclosures. Gordon v. Symantec Corp., No. 1-12-CV-231541 (Super. Ct. Santa Clara County, filed Mar. 4, 2013). The court pointed out that the company’s shareholders had already voted on the proposals at issue; any alleged harm arising from voting without complete and accurate information was irreparable and therefore could no longer be the subject of a direct claim. Id. Instead, plaintiffs were limited to a derivative claim. Id. In the dismissal of the case against AAR Corp., the district court for the Northern District of Illinois also determined that the plaintiffs were limited to a derivative claim. Noble v. AAR Corp., No. 1:12-cv-07973 (N.D. Ill., filed Apr. 3, 2013). In AAR Corp., the proposal at issue involved executive compensation, and the court found that any overpayment would have damaged the company and not individual shareholders. Id. In addition, the court found that the plaintiff failed to raise legal precedent creating disclosure obligations greater than those embodied in federal disclosure requirements under Dodd−Frank. Id.

Most recently, plaintiffs have sued to enjoin the "bundling" of several changes into a single shareholder vote. In February 2013, the district court for the Southern District of New York ruled against plaintiffs in proxy disclosure litigation by declining to enjoin a say-on-pay vote proposed by Apple. Greenlight Capital, L.P. v. Apple, Inc., No. 1:13-cv-00900 (S.D.N.Y., filed Feb. 22, 2013). However, the court granted the injunction with respect to a separate vote, proposed by Apple, to amend the company’s articles of incorporation by making four categories of changes. Id. The court found that the proposal violated SEC Exchange Act Rules 14a-4(a)(3) and 14a-4(b)(1)–the "unbundling" rules–which require that each matter for shareholder consideration must be proposed for a separate vote. Id. In May 2013, Groupon shareholders filed a complaint in Delaware district court claiming the company bundled its proposed amendments to an equity incentive plan in violation of federal securities laws. MacCormack v. Groupon, Inc., No. 13CV00940 (D. Del., filed May 24, 2013).

This wave of proxy-disclosure litigation continues to unfold. Going forward, companies should be aware of this fast-paced litigation and have a plan of action ready in advance of disclosing their proxies for annual shareholder votes.


            The Preclusive Effect of Dismissal of a Shareholder Derivative Claim

In April 2013, the Supreme Court of Delaware issued a decision strongly supporting a corporation’s defensive use of collateral estoppel to avoid duplicative shareholder derivative suits, in Pyott v. Louisiana Municipal Police Employees Retirement System, __ A.3d __, 2013 WL 1364695 (Del. 2013) ("Pyott").

Allergan, Inc. had secured dismissal on the pleadings of a shareholder derivative action in federal court in California, which had been based on a theory that Allergan’s directors had failed to exercise adequate oversight, leading to a government investigation and a multi-million dollar settlement. Following that dismissal, Allergan sought dismissal on collateral estoppel grounds of a parallel action in the Delaware Court of Chancery that made virtually identical allegations. The Delaware Court of Chancery denied the collateral estoppel motion on two independent grounds: (1) in the court’s view, the different shareholder-plaintiffs in the two cases were not "in privity" with each other; and (2) the plaintiff in the California case was an inadequate representative of other shareholders because it had rushed to file suit before conducting a books and records investigation. The court based the latter holding on a "fast-filer" presumption, which we addressed in more detail in our 2012 Year-End Update.

The Supreme Court of Delaware unanimously reversed the Court of Chancery on both grounds. First, under constitutional principles of full faith and credit, the Delaware Court of Chancery was obligated to apply the collateral estoppel law of California, and under clear precedent from the same California federal court, different shareholder-plaintiffs are in privity with each other when they initiate competing shareholder derivative actions based on the same corporate trauma. See LeBoyer v. Greenspan, No. 03-5603, 2007 WL 4287646 (C.D. Cal. June 13, 2007). Second, the Supreme Court rejected the Court of Chancery’s "’fast-filer’ irrebuttable presumption of inadequacy." Although the Court of Chancery had legitimate concerns about shareholder-plaintiffs who "file quickly," there was "no record support" for the court’s assumption that plaintiffs (and plaintiffs’ firms) who file quickly are not acting in the best interests of the corporation.

The Pyott decision is likely to have a significant positive effect for corporate defendants facing shareholder derivative litigation in multiple jurisdictions. Where the company secures dismissal of a derivative complaint in a jurisdiction that recognizes privity among shareholders, that dismissal ordinarily should preclude a successive derivative suit in any other jurisdiction brought on similar theories. Jurisdictions recognizing privity currently include the First Circuit, district courts in California, Nevada, New Jersey, New York, and Texas, as well as New York state court. (We are aware of no jurisdictions that reject privity in these circumstances.) 

            The Delaware Court of Chancery Affirms the Right of Boards of Directors to Centralize Internal Affairs Litigation in Delaware

In 2010, Vice Chancellor Laster of the Delaware Court of Chancery suggested in dicta that "if boards of directors and stockholders believe that a particular forum would prove an efficient and value-promoting locus for dispute litigation, then corporations are free to respond with charter provisions selecting an exclusive forum for intra-party disputes." In re Revlon Inc. Shareholders Litig., 990 A.2d 940, 960 (Del. Ch. 2010).

In late 2010 and early 2011, several companies acted on that suggestion, adopting by bylaws or proposing to their shareholders charter amendments that would make Delaware state court the exclusive forum for shareholders to file derivative actions against the company and other actions generally implicating internal corporate affairs. More than a dozen of those companies were sued by shareholder plaintiffs on the theory that the directors had breached their duties by changing the bylaws or had failed to disclose material information regarding the proposed changes to the corporate charters (among other claims). All but two companies withdrew the bylaw or charter amendment proposals. Chevron Corp. and FedEx Corp., however, elected to defend their exclusive forum clauses, which their boards adopted into their corporate bylaws without seeking shareholder approval. Boilermakers Local 154 Retirement Fund and Key West Police & Fire Pension Fund v. Chevron Corp., No. 7220; IClub Investment Partnership v. Fedex Corp., No. 7238.

These bylaw provisions selected Delaware as the exclusive forum for four categories of cases: (i) derivative actions brought on behalf of the corporation; (ii) claims of fiduciary breach asserted against directors, officers, or employees with respect to their duties to the corporation or its stockholders; (iii) any claim arising pursuant to the Delaware General Corporation Law; and (iv) any claim governed by the internal affairs doctrine. Both corporations’ bylaw provisions permitted the corporation to consent in writing, in a specific case, to a different forum.

In June 2013, Chancellor Strine upheld Chevron’s and FedEx’s exclusive forum bylaws against facial challenges. First, he held that boards possessed the statutory power under 8 Del. C. § 109(b) to adopt such clauses into their bylaws. That statute permits boards to adopt bylaws on subjects "relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees." According to the court, the challenged bylaws, which involve only internal corporate affairs, plainly involved the "rights" of the stockholders, and related to the "conduct" of the corporation’s affairs. Second, Chancellor Strine held that the bylaws were "contractually" valid, meaning that they were enforceable against shareholders, even though shareholders were not permitted to vote on their adoption. That is because the certificates of incorporation for Chevron and FedEx authorized their boards to act unilaterally to adopt bylaws. The court rejected the plaintiffs’ contention that stockholders had a "vested right" in the bylaws that existed before the bylaw amendments. Since Chevron and FedEx "put all on notice that the by-laws may be amended at any time, no vested rights can arise that would contractually prohibit an amendment." As the court explained, "the Chevron and FedEx stockholders have assented to a contractual framework established by the DGCL and the certificates of incorporation that explicitly recognizes that stockholders will be bound by bylaws adopted unilaterally by their boards." The court further explained that if shareholders are unhappy with any bylaw changes, they are empowered to respond in several ways, including repealing the bylaw change or replacing the directors.

Although plaintiffs raised a "parade of horribles" trying to show how such bylaws might be unreasonably applied in specific cases, the court held that those hypothetical problems did not impact the bylaws’ facial validity. Any unreasonable application of such bylaws would have to be adjudicated in the context of a specific case in which a board seeks dismissal pursuant to the bylaw. The court pointed out that plaintiffs have several mechanisms by which to challenge the operation of the bylaws in specific instances: they may ask the board for written authorization to sue elsewhere, as the clauses specifically allow; they may sue in their preferred forum and argue that the enforcement of the clause is unreasonable under The Bremen v. Zapata Offshore Co., 407 U.S. 1 (1972); or they may claim that the board’s attempt to apply the forum selection bylaw in a specific case is itself a breach of fiduciary duty, under Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971).

It is likely that the plaintiffs will seek to appeal Chancellor Strine’s decision to the Supreme Court of Delaware, and therefore the law regarding exclusive forum provisions will remain unsettled until the outcome of any such appeal.

            Demand Futility:  An Upcoming Supreme Court Resolution and Other Updates

In Delaware and most other jurisdictions, plaintiffs are required to make a demand on the board of directors, or adequately plead that doing so would have been futile, before filing a derivative lawsuit. Courts have diverged on what standard of review applies in appeals from rulings on motions to dismiss derivative cases due to a plaintiff’s failure to comply with this requirement. In a surprising and rare order, the United States Supreme Court recently granted review of a case that raises this question.

Historically, shareholder derivative actions were proceedings in courts of equity, and the decision of whether demand would have been futile was an inherently equitable one that required the court to determine whether the board of directors was too conflicted. See, e.g., Dodge v. Woolsey, 59 U.S. (18 How.) 331 (1855). In conjunction with this understanding, many courts and commentators also stated that the appellate court should give the trial court’s equitable decision a substantial amount of deference, and review the court’s decision on demand futility only for abuse of discretion. See, e.g., 3 B.J. Moore & J. Kennedy, Moore’s Federal Practice § 23.19 (2d ed. 1982). But more recently, the Supreme Court of Delaware and other courts have held that because the standards for evaluating demand futility require a purely legal analysis of the pleadings (and do not, e.g., involve the evaluation of any testimony), the trial court’s decision is not entitled to any deference on appeal, and demand futility decisions should be reviewed de novo. E.g., Brehm v. Eisner, 746 A.2d 244, 253-54 (Del. 2000).

In Union de Empleados v. UBS Financial Services Inc. of Puerto Rico, the First Circuit agreed with Brehm and other appellate courts that have adopted a de novo standard, reversing the district court’s dismissal of derivative claims. 704 F.3d at 161-63.

The U.S. Supreme Court recently granted UBS’s petition for a writ of certiorari to resolve the division of authority among the U.S. Courts of Appeals on the appropriate appellate standard of review. __ S. Ct. __, 2013 WL 1402320 (2013). The Supreme Court’s decision, likely in 2014, should resolve whether the federal appellate standard of review is abuse of discretion, de novo, or some other standard (for example, the Court might hold that the federal standard should be borrowed from the law of the state of incorporation).

Many of the demand futility cases that came down in the first half of 2013 focused on the adequacy of plaintiffs’ allegations of board knowledge. Derivative plaintiffs frequently argue that a majority of a board is too self-interested to review a demand because it faces a substantial likelihood of liability for some alleged wrongdoing. To adequately plead demand futility on this theory, plaintiffs typically are required to allege that the directors had knowledge of that wrongdoing. See, e.g., Wood v. Baum, 953 A.2d 136, 141 (Del. 2008). Most courts to address this issue in the first half of the year found plaintiffs had not discharged this pleading obligation.

For example, courts rejected allegations of knowledge based on "the sheer magnitude and duration" of the alleged underlying wrongdoing where plaintiffs failed to allege "particularized facts that allow the Court to draw an inference that any director knew or should have known about the alleged scheme."  Gulbrandsen v. Stumpf, No. C–12–05968 JSC, 2013 WL 1942158, at *5 (N.D. Cal. May 9, 2013) (applying Delaware law); see also In re SAIC Inc. Deriv. Litig., No. 12 Civ. 2437 (JPO), 2013 WL 2466796, at *18 (S.D.N.Y. June 10, 2013) (magnitude and duration of corporate wrongdoing "will rarely suffice in their own right to satisfy Rule 23.1’s requirement in this context that plaintiffs allege with particularity actual or constructive board knowledge") (applying Delaware law). But see In re Abbott Depakote S’holders Deriv. Litig., 2013 WL 2451152, at *9 (N.D. Ill. June 5, 2013) (denying motion to dismiss and holding that "[w]hen a derivative plaintiff alleges a particularized scheme of substantial magnitude and duration that allegedly occurred when a majority of a board served as directors, courts infer that the board had notice of the scheme for purposes of assessing demand futility" even in absence of allegations of direct board knowledge) (applying Illinois law, which follows Delaware law).

Courts also held that particularized allegations of management’s knowledge of, or participation in, wrongdoing do not suffice to plead knowledge on the part of the board. In re SAIC, 2013 WL 2466796, at *14 (rejecting argument that allegations of company’s "admissions" concerning knowledge of SAIC’s management pled knowledge of its directors); Kococinski v. Collins, No. 12–633 (JRT/JJG), 2013 WL 1197676, at *6, *11 (D. Minn. Mar. 25, 2013) ("While these red flags may tend to establish that Medtronic employees were marketing Infuse illegally and that Medtronic’s officers likely knew the details of Infuse’s marketing and sales, they are insufficient, in the absence of more direct evidence, to support an inference that the outside directors actually knew these details.") (emphasis in original; applying Minnesota law, but "look[ing] to the Delaware courts for guidance" on demand futility).

Several other decisions likewise dismissed shareholder derivative complaints for failure to adequately plead directors’ knowledge. See Louisiana Mun. Police Emp. Ret. Sys. v. Wynn, No. 2:12–CV–509 JCM (GWF), 2013 WL 431339, at *6 (D. Nev. Feb. 1, 2013) (demand futility not pled as to board approval of allegedly improper $135 million donation to University of Macau where plaintiffs failed "to sufficiently allege that defendants knew that the Macau donation was improper") (emphasis in original; applying Nevada law, which follows Delaware law); In re Falconstor Software, Inc., Deriv. Litig., 2013 WL 823310, at *11 (N.Y. Sup. Mar. 15, 2013) (demand futility not pled where complaint "never explain[ed] what, if any knowledge, the board members had concerning the misstatements and filings in connection with the unlawful contracts nor what involvement they had with the criminal activity uncovered") (applying Delaware law). In all of these cases, the plaintiffs’ fundamental failing was their inability to "allege any direct path by which information about the [alleged wrongdoing] actually reached the Board." In re SAIC, 2013 WL 2466796, at *21. See also Harold Grill 2 IRA v. Louis R. Chênevert, C.A. No. 7999-CS, Ltr. Op. at 8 (Del. Ch. June 18, 2013) (granting motion to dismiss on demand futility grounds where "the complaint does not even plead any facts in an attempt to support a pleading stage inference that any particular director should have known that the disclosures were false, much less plead facts supporting a pleading stage inference of actual knowledge").

Relatedly, courts in the first half of this year have continued a trend of declining to infer board "knowledge" merely from allegations that a company had adopted corporate governance policies designed to detect wrongdoing. For example, in Kococinski, the court rejected allegations that the outside directors on the audit committee knew of the company’s allegedly false and misleading financial statements based on the duties set forth in the "Audit Committee’s Charter." 2013 WL 1197676, at *11 n.28. The court held that such allegations tended to establish at most that the directors "should have known," not that they "actually knew." Id. at *11. See also Gulbrandsen, 2013 WL 1942158, at *1, *6 (rejecting allegations of board knowledge based on "Wells Fargo’s Corporate Governance Guidelines"). These cases echo decisions from 2012 in which federal courts similarly held that board knowledge cannot be pled based simply on the presumed perfect functioning of corporate governance policies and internal controls. See In re Abbott Depakote S’holders Deriv. Litig., No. 11 C 8114, 2012 WL 5561268, at *9 (rejecting argument that directors "must have learned about [off-label drug marketing] because of [the company’s] compliance mechanisms" and holding that "[p]leading the existence of compliance mechanisms is insufficient to establish knowledge or awareness") (applying Illinois law, which follows Delaware law); In re Google, Inc. S’holder Deriv. Litig., 2012 WL 1611064, at *7 (N.D. Cal. May 8, 2012) (holding that "plaintiffs’ reliance on general code of conduct and/or corporate governance maxims [were not] sufficient for the court to impute notice" of unlawful advertising to directors) (applying Delaware law).

Cases in which courts denied motions to dismiss on demand futility grounds in the first half of 2013 typically involved specific, detailed allegations regarding the conduct of particular directors. For example, in one case the court held demand futility adequately pled where the board’s three independent directors who previously had constituted a majority of the board resigned shortly after the derivative action was filed, leaving the alleged principal wrongdoer as the sole director for the company at the time the court considered the motion to dismiss. In re Puda Coal, Inc. Stockholders Litig., C.A. No. 6476-CS, H’g Tr. at 5-6 (Del. Ch. Feb. 6, 2013). As the court noted, the independent directors’ actions left "the company under the sole dominion of a person they believe has pervasively breached his fiduciary duty of loyalty," and the court opined that finding demand excused in these circumstances would subject Delaware to "totally legitimate ridicule." Id. at 6, 16-17. (This decision was issued in an oral bench ruling, and it appears to be inconsistent with a long line of Delaware cases holding that demand futility is assessed based on the composition of the board at the time suit is filed.)

In another case, the court found demand excused where the board had approved an interested transaction: an $8 million purchase of a subsidiary owned by the company’s two co-founders, both of whom were directors and one of whom was the chairman. The actual value of the acquired interest in the subsidiary was approximately $50,000, and the court held that demand was excused because the "litigation risk that the [directors] would face in an entire fairness challenge to the Yinlong Transaction raises a reasonable doubt about their ability to disinterestedly consider a litigation demand." In re China Agritech, Inc. S’holder Deriv. Litig., 2013 WL 2181514, at *17-18 (Del. Ch. May 21, 2013). Further, the company had successively terminated two sets of outside auditors, one of which it terminated following its identification of potential violations of law and expression of concern about whether the firm could rely on management’s representations. Id. at *28. Finally, the audit committee had failed to meet even once during a two-year period, and large discrepancies between the company’s filings with the SEC and its filings with a Chinese regulatory agency supported an inference that the audit committee "existed in name only." Id. at *19-20. See also Union de Empleados, 704 F.3d at 165-69 (demand futility pled where plaintiffs challenged board’s allegedly improper reliance on investment adviser that invested in certain bonds; court found that majority of board lacked independence because of directors’ extensive ties to investment adviser and company issuing the bonds) (applying Delaware law in absence of any applicable Puerto Rico law).

Finally, in the first half of the year, courts have continued to urge plaintiffs to utilize requests for corporate books and records under Section 220 of the Delaware General Corporation Law to research their claims before filing a complaint. In 2012, Vice Chancellor Laster engaged in a lengthy discussion encouraging derivative plaintiffs to "use Section 220 to investigate their claims" in lieu of "fast-filing." Louisiana Mun. Police Emp. Ret. Sys. v. Pyott, 46 A.3d 313, 342-49 (Del. Ch. 2012), rev’d, 2013 WL 1364695 (Del. Supr. Ct. Apr. 4, 2013). In 2013, courts have echoed Vice Chancellor Laster’s comments. For example, in Kococinski, the court found plaintiffs had not adequately pled demand futility and observed critically that "Kococinski did not inspect Medtronic’s books and records pursuant to Minn. Stat. § 302A .461, subd. 4, and thus cannot allege that the Directors actually discussed these issues at a particular meeting, nor can she allege that the Directors reviewed documents relating to these issues." 2013 WL 1197676, at *8. See also In re Diamond Foods, Inc. Deriv. Litig., 2013 WL 755673, at *2 n.17 (Del. Ch. Feb. 28, 2013) (noting that "Plaintiffs did not use the time between June 2012 and the disclosure of Diamond’s financial irregularities in November 2011 to put together a complaint with a better chance of success, for example by filing a request for books and records under 8 Del. C. § 220"). Vice Chancellor Laster himself has continued to encourage derivative plaintiffs to pursue Section 220 demands prior to filing suit. In finding demand futility adequately pled in In re China Agritech, Vice Chancellor Laster repeatedly and approvingly emphasized that before filing suit the plaintiff there had "used Section 220 . . . to obtain books and records, and his complaint relies both on materials that the Company produced and on the glaring absence from the production of books and records that the Company should have readily possessed and provided." 2013 WL 2181514, at *1; see also id. at *9 ("But heeding the Delaware Supreme Court’s repeated admonitions to use Section 220 to conduct a pre-suit investigation, Rish sought books and records relating to the Yinlong Transaction, the terminations of two outside auditors, the allegations in the McGee Report, the Company’s response, and the nature and degree of oversight provided by the board and its committees.").

            Fiduciary Duties Owed to Companies Operating Solely Outside the United States

In In re Puda Coal, Inc., Chancellor Strine cautioned directors regarding ongoing fiduciary duties where a company’s operations are wholly outside the United States. C.A. No. 6476-CS (Feb. 6, 2013). Plaintiffs brought suit on the behalf of Puda Coal, Inc. against certain of its officers and directors for breaches of their fiduciary duties. Consol. Compl. ¶ 1. Plaintiffs alleged that Puda’s operations were conducted exclusively by Shanxi Puda Coal Group Co., Ltd., a Chinese entity of which Puda purportedly had a 90% interest. Plaintiffs further alleged that the Chairman of Puda’s board illegally transferred Shanxi Coal to himself and then sold Shanxi Coal to a private equity firm for funds that were never returned to Puda. Id. ¶ 3. Shareholders brought suit claiming that certain defendant directors breached their fiduciary duties by: (1) not knowing that the company’s primary asset (Shanxi Coal) had been taken from the company; (2) allowing the company to make false statements regarding revenues as a result of the alleged theft of Shanxi Coal; and (3) permitting the company to maintain inadequate internal controls. Id. ¶¶ 103-104. Certain defendant directors moved to dismiss the complaint for failure to state a claim and for failure to plead that pre-suit demand would have been futile. Br. in Supp. of Mot. to Dismiss at 11-28.

While denying the In re Puda defendants’ motion to dismiss breach of fiduciary duty claims, Chancellor Strine commented on the duties of directors where "a company [is] domiciled for the purposes of its relations with its investors in Delaware and the assets and operations of that company are situated in China." C.A. No. 6476-CS, at 17. Of note, Chancellor Strine indicated that for directors of companies operating solely outside the United States to comply with their fiduciary obligations, such directors must have their "physical bodies" in the relevant country or countries, establish "a system of controls to make sure you know that you actually own the assets," obtain "language skills to navigate the environment in which the company is operating," and retain "accountants and lawyers who are fit to the task of maintaining a system of controls over a public company." Id. at 18. When directors oversee companies with foreign operations, he noted that "you’re not going to be able to sit in your home in the U.S. and do a conference call four times a year and discharge your duty of loyalty. That won’t cut it." Id. at 21. While Puda Coal involved a particularly egregious set of facts, Chancellor Strine’s comments provide important guidance to directors of companies incorporated in the United States, but whose entire operations are abroad.

While the Chancery Court has not had the chance to determine whether the duties described by Chancellor Strine apply to companies with substantial–though not entire–operations outside the United States, directors of companies with substantial foreign operations and their advisors should take heed of Chancellor Strine’s remarks.

  [1]   In Halliburton I, Halliburton argued that it was entitled to rebut the fraud-on-the-market presumption at the class certification stage for other reasons, including evidence of price impact. 131 S. Ct. at 2187. The Court however declined to address these concerns, stating that "the Court of Appeals erred by requiring [plaintiffs] to prove loss causation at the certification stage, . . . and [we] do not, address any other question about [the fraud-on-the-market] presumption, or how and when it may be rebutted."  Id.

  [2]   Gibson Dunn served as counsel to Transatlantic and its Board in the transaction and litigation. 

Gibson, Dunn & Crutcher LLP      

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Wayne Smith – Orange County (949-451-4108, [email protected])
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