January 21, 2014
2013 proved to be a watershed year for securities litigation, and 2014 is shaping up to be a "career killing" year for plaintiffs’ lawyers specializing in 10b-5 class actions. In what may turn out to be one of the most important cases in the last three decades, the Supreme Court will address the long debated fraud-on-the-market theory in Halliburton II, and address head on whether the Court’s decades-old ruling in Basic v. Levinson establishing that theory should be overruled. The case for overruling Basic is a strong one, with at least four justices having expressed serious concerns about the fraud-on-the-market theory in the Court’s 2013 decision in Amgen. See "A Shot Across the Basic Bow," in our 2013 Mid-Year Securities Litigation Update. If, as many court observers predict, the Court in fact overturns the fraud-on-the-market theory, securities class actions as we know them may be consigned to the dust heap.
In the meantime, filing and settlement trends indicate a return to pre-credit crisis norms, with median settlement values generally declining to levels much lower than the eye-popping amounts seen in the last two years. Nevertheless, the number of new class actions filed in 2013 is consistent with the "steady state" of over 200 cases per year over the last several years, with the technology sector continuing to be one of the leading industry sectors for new class actions, and M&A litigation in particular being a significant focus of these cases.
We highlight these and other notable developments in shareholder litigation in our 2013 Year-End Securities Litigation Update below.
Filing and settlement trends continue to reflect a "steady state" of several hundred cases a year, notwithstanding the steep decline in credit crisis cases in 2013 from their all-time high of over 100 class actions in 2008. According to a recent study by NERA Economic Consulting ("NERA"), the roughly 234 new class actions filed in 2013 are slightly higher than the five-year average of 222 cases, but the mix of those cases has changed. Merger-related cases have held steady in 2013 with the five-year average of 52 cases per year. "Other" cases–the kinds of cases that have historically been brought–have spiked significantly over the last five years, from a low of 97 in 2009 to 178 cases in 2012. These types of cases hit a nine-year low in 2009, perhaps due to the scores of credit crisis cases–but now have returned to their pre-credit crisis levels (187 cases in 2005, and 178 cases in 2013).
In 2013, the number of settlements was flat compared to 2012–96 settlements in 2013 compared to 94 in 2012. But the number of settlements in the last two years represents a general decline in the number of settlements per year, dating back to the high-water mark of 151 settlements in 2007.
Median settlement amounts in 2013 dropped dramatically in 2013 compared to 2012: while 2012 median settlements stood at $12.3 million, the 2013 median amount was $9.1 million. The 2013 median amount is consistent with the five year average of $9.68 million, so perhaps it signals a "return to normal" after several years of outsized credit crisis settlements.
In stark contrast to median settlement amounts, the average settlement for all settled cases in 2013 was $71 million–over double the average amount in 2012 of $36 million. The 2013 average also is dramatically higher than the five-year average of $40 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%.
As discussed in later sections of this Year-End Report, several key cases may significantly alter the securities litigation landscape and may materially impact future levels of new case filings and settlements. The case that could have the greatest dampening effect on new securities class actions will be the Supreme Court’s decision in Halliburton II, in which a ruling is expected by the end of this Term in June 2014. If, as many speculate, the Court overrules the "fraud on the market" theory, shareholder class action litigation may cease to exist as we know it. Plaintiffs’ lawyers might then migrate to state court (as was true after passage of the Private Securities Litigation Reform Act in 1995) or begin filing single-plaintiff suits, at least where the dollar losses of large institutional investors or pension funds are sufficiently large to warrant a stand-alone suit. If, alternatively, the Court does not entirely overrule the "fraud on the market" theory, but raises the bar on the proof required to establish that securities trade in an efficient market, that too is likely to lead to fewer cases being filed and/or more cases that do not survive class certification. The stakes are high, and depending on the outcome in Halliburton, an entirely new approach to shareholder litigation may be required.
Overall filing rates are reflected in Figure 1 below (all charts courtesy of NERA). There were 234 new cases filed in 2013. Notably, this figure does not include the many such class suits filed in state courts or the increasing number of state court derivative suits, including many such suits filed in the Delaware Court of Chancery. These cases, not included in the statistics discussed here, represent a "force multiplier" of sorts in the dynamics of securities litigation in the United States today.
Credit Crisis Cases. There were virtually no new federal court class actions filed against financial institutions in 2013, reflecting the dramatic decline of "credit crisis" class actions since 2008. While a number of major credit crisis cases are still pending, the trend line is expected to continue: like stock option "backdating" cases, credit crisis class actions will soon be consigned to history. That said, while credit crisis class actions are on the wane, 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. A few have already resulted in settlements in excess of $100 million.
Merger Cases. Merger-related litigation continues to represent a significant portion of new federal court securities class action filings. NERA reports that in 2013, merger class actions represented roughly 20% of new federal court securities class action filings (50 out of 234 cases). Today, well 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 discussion of "Merger & Acquisition and Proxy Disclosure Litigation Trends," the exposure of corporations to M&A litigation spans a range of subject matters, with sometimes unpredictable results. Those results may become even less predictable if, as expected, Chancellor Leo Strine is appointed as the new Chief Justice of the Delaware Supreme Court, as Chancellor Strine has shown a willingness to "break new ground" in his rulings in cases before him in the Chancery Court.
Filings 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 third place in 2013 (15% of all new case filings), behind the technology and health sectors (19% and 18%, respectively, of new case filings). The energy sector ranked fourth (11%). The biggest jump in new case filings on a percentage basis compared to 2012 was in the commercial and industrial sector, where new filings grew from 4% in 2012 to 7% in 2013. By contrast, eight out of twelve sectors remained flat to down from the prior year. Sectors that moved up the rankings the most were the retail and transportation sectors. See Figure 3 below.
As Figure 4 shows, the median settlement amount of $9.1 million in 2013–generally a better barometer of settlement trends–was hugely down in 2013 compared to 2012’s median amount of $12.3 million. Still, the Q1 2013 figure is higher than seven of the last ten years–not an occasion to claim victory.
One can speculate about what may account for the up-and-down fluctuation in median and average settlements over the last five years. In any given year, of course, 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 few years also included the settlement of several of the major credit crisis cases totaling several billion dollars. Whatever the variables, median and average settlement amounts over the last decade should not be viewed as a barometer of either a long-term increase or decline in settlement values.
As widely predicted and discussed in our 2013 Mid-Year Securities Litigation Update, the Supreme Court will revisit the viability of the fraud-on-the-market theory presumption of reliance. On November 15, 2013, the Supreme Court granted certiorari to review Erica P. John Fund, Inc. v. Halliburton Co. ("Halliburton II"), 718 F.3d 423 (5th Cir. 2013) and is now poised to decide the continued viability and scope of the fraud-on-the market theory, as well as the more limited question of whether price impact evidence rebutting the presumption is appropriately introduced and weighed at the class certification stage.
Reliance on a misrepresentation in connection with the purchase or sale of a security is an essential element of a Section 10(b) claim. Plaintiff classes generally satisfied this requirement through a presumption of reliance under the "fraud-on-the-market theory." The theory, endorsed by the Supreme Court in Basic v. Levinson, 485 U.S. 224 (1988), allows plaintiffs to forgo the formidable task of proving actual reliance by class members on a specific misrepresentation in purchasing or selling a security. Plaintiffs instead may be presumed to have relied on a misrepresentation "aired to the general public" where the security traded in an efficient market. Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1192 (2013) (discussing Basic). The Supreme Court has stated that "[t]his presumption springs from the very concept of market efficiency," id., and embodies the notion that where a market generally incorporates public information into the security’s price, an investor who purchased stock at a particular price presumptively relied on the alleged public misrepresentation. See Basic, 485 U.S. at 247. Without the fraud-on-the-market presumption, plaintiffs would have a difficult time "meet[ing] the traditional reliance requirement because they [could not] establish that they engaged in a relevant transaction . . . based on [a] specific misrepresentation." Amgen, 133 S. Ct. at 1208 (Thomas, J. dissenting) (internal quotation marks omitted).
As noted in our mid-year review, a majority of the Justices in Amgen acknowledged serious misgivings about the fraud-on-the-market theory and signaled an opening to revisit Basic. See Amgen, 133 S. Ct. at 1197 n.6; id at 1204 (Alito, J., concurring); id at 1206 (Scalia, J., dissenting); id. at 1208 n.4 (Thomas, J., dissenting). And while Amgen may have been "a poor vehicle" for doing so, 133 S. Ct. at 1197 n.6 (majority opinion), the Supreme Court found a suitable vehicle in Halliburton II. The Court’s acceptance of the petition for review suggests an openness to substantially modifying or even overruling Basic. If the Court were to abandon or substantially curtail Basic, it would make securities-fraud class actions much more difficult to maintain, as "securities-fraud class actions [are made] possible" because the fraud-on-the-market presumption "convert[s] the inherently individual reliance inquiry into a question common to the class." Amgen, 133 S. Ct. at 1209 (Thomas, J., dissenting).
Although the matter has not yet been fully briefed, opening briefs have presented the initial assault on Basic. And the significance of the issue has inspired a flurry of amicus briefs, including from former members of Congress, law professors, and industry groups.
In its opening brief, Halliburton contends that Basic was wrong when decided as a matter of statutory interpretation and economic theory. The Section 10(b) cause of action is a "judicial construct," and in defining its contours, the Court has previously looked to other causes of action in the Securities Exchange Act of 1934. Here, the closest textual analogue in the 1934 Act, Section 18(a), expressly requires actual reliance. Br. for Petitioners, No. 13-317, at 12-13; see also Joseph A. Grundfest, Damages and Reliance under Section 10(b) of the Exchange Act (Rock Center for Corporate Governance, Working Paper Series No. 150, 2013).
Twelve former legislators, government lawyers, and SEC officials filed an amicus brief addressing the respondent’s expected argument, namely, that Congress endorsed fraud-on-the-market when it enacted the Private Securities Litigation Reform Act of 1995 ("PSLRA") without addressing the standard for proving reliance. In the Amgen decision, Justice Ginsburg made this precise contention, stating that when Congress enacted the PSLRA, it took "steps to curb abusive securities-fraud lawsuits" but "rejected calls to undo the fraud-on-the-market presumption of class-wide reliance endorsed in Basic." Amgen, 133 S. Ct. at 1201. The former officials’ amicus brief contends that at the time of enacting the PSLRA, Congress was confronted with "competing calls to overturn, modify, or codify the Basic presumption," and that "Congress simply left the fate of that judicially-created presumption to a future Congress or this Court." Br. for Former Members of Congress et al. as Amici Curiae in Supp. of Neither Party, No. 13-317, at 2. The former officials urge that the "Court should not take Congress’s silence as implicit acceptance or rejection of Basic‘s fraud-on-the-market theory." Id. at 3.
In its principal brief, Halliburton also noted that the Court’s recent class action and Section 10(b) cases make Basic‘s presumption of reliance appear even more anomalous. Br. for Petitioners at 25. The rulings in Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013) and Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011), have emphasized that plaintiffs must affirmatively demonstrate compliance with the commonality element of Rule 23 in order to achieve class certification. Halliburton argued that Basic flouts this principle by presuming common reliance in the face of strong evidence to the contrary. Br. for Petitioners at 26.
Appellant’s and amici’s briefs also argue that the reservations of the dissenters in Basic have, over time, proven well founded. As Halliburton pointed out, Justices White and O’Connor argued in dissent in Basic that it was unwise to embrace the nascent economic theory of the "efficient-capital-market hypothesis" when that theory was both unproven and not within the Court’s expertise. Br. for Petitioners at 14 (quoting Basic, 485 U.S. at 253 (White, J., dissenting)). The academic consensus now appears to reject Basic‘s view of market efficiency, in part because investor attempts to identify undervalued stocks demonstrate widespread betting that securities markets are inefficient. Markets move irrespective of public information due to several factors, such as the herd mentality of investors, algorithmic trading programs, and response to media attention to information previously made public, among others. Br. for Petitioners at 16-17, 19-21. As argued in an amicus brief submitted by Vivendi S.A., many investors, including sophisticated institutional investors, volatility arbitragers, and "value" investors, "do not rely on the integrity of market price" but instead rely on their own, private valuation of stock. Br. for Vivendi S.A. as Amicus Curiae in Supp. of Petitions, No. 13-317, at 4-7. It is perhaps unsurprising, therefore, that the theory has led to confusion and inconsistent results. Indeed, the factors repeatedly used by courts in assessing market efficiency and certifying class actions (such as the Cammer factors, see Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989)) have been shown to be largely incapable of differentiating between efficiently and inefficiently priced stocks. Br. for Petitioners at 23.
In urging the Court to overturn Basic, Halliburton and amici have also highlighted the practical arguments as well. While Basic adopted the presumption of reliance because it was necessary for class actions, the briefs question the implicit premise that such class actions are necessary to vindicate securities fraud, and instead suggest that these class actions have become nothing more than a drain on business. And while the presumption of reliance is said to be rebuttable, in all practical terms it is irrebuttable. As a result, actions are settled as "routine tolls that large companies must pay" and the cost of litigation and potential damages make it economically prudent to settle and abandon meritorious defenses. Br. for Petitioners at 40-41. In its amicus brief, the Committee on Capital Markets Regulation has noted that the aggregate value of securities class action settlements was approximately $68.1 billion from 2000 through 2012, suggesting that insurance costs for Fortune 500 companies are six times higher in the United States than in Europe as a result. See Br. for Comm. on Capital Markets Regulation in Supp. of Petitioners, No. 13-317, at 6-7. Settlement payments and litigation defense costs paid by corporations ultimately fall on shareholders, and settlement payments–amounting to only 1.8% of alleged losses in 2012–are merely transferred from one shareholder to another, subject to a 23-32% cut for plaintiffs’ attorney fees. Br. for Petitioners at 43-44. A typical diversified investor is only on the paying or gaining side by happenstance and a "significant portion of actual settlement amounts is never distributed to class members." Br. for Comm. on Capital Markets Regulation at 13.
Of course, the Court may stop short of throwing out the fraud-on-the-market theory altogether. The Court might require a more rigorous or nuanced application of the fraud-on-the-market theory. As has been suggested in academia, an alternative to rejecting the theory in its entirety might be requiring proof of "market efficiency" for each of plaintiffs’ theories of liability. For further discussion, see Joseph A. Grundfest, Damages and Reliance under Section 10(b) of the Exchange Act (Rock Center for Corporate Governance, Working Paper Series No. 150, 2013).
While many have urged the Court to reconsider whether the presumption of reliance should even exist, the Court could resolve only the narrower question presented: whether price impact evidence rebutting the fraud-on-the-market presumption is appropriately introduced and weighed at the class certification stage.
In the Fifth Circuit, Halliburton attempted to defeat class certification by showing that individual issues would predominate if plaintiffs failed to prove that the alleged misstatements affected price. In upholding class certification and refusing to consider Halliburton’s evidence regarding price impact, the Fifth Circuit reasoned that under no circumstance would individual issues predominate because, if no price impact is proved, any individual claims would necessarily fail for no proof of loss causation. Halliburton II, 718 F.3d at 434. In reaching this conclusion, the Fifth Circuit followed Amgen, where the Supreme Court noted that because "materiality is . . . an essential predicate of the fraud-on-the-market theory," 133 S. Ct. at 1195, there was "no risk whatever that a failure of proof on the common question of materiality will result in individual questions predominating," id. at 1196-97.
In its principal brief to the Supreme Court, Halliburton distinguishes Amgen by contending that, unlike materiality, market efficiency is not an element of a Rule 10b–5 claim. Moreover, Halliburton argues that, if it were to rebut the fraud-on-the-market presumption by demonstrating no price impact post-certification, reliance would turn into an individualized question of fact and could not be resolved on a class-wide basis. Br. for Petitioners at 49-52.
Several amicus briefs focus on this narrower question, urging the Court to permit defendants to rebut the presumption of reliance with price impact evidence at the class certification stage. The American Institute of Certified Public Accountants, for example, filed an amicus brief highlighting the practical effect of when price-impact evidence is considered. The costs to defendants of allowing class certification and then later examining materiality or loss causation as a merits issue are simply too high, the AICPA argued, because defendants settle even cases that have no merit once a class is certified. Br. for Am. Inst. of Certified Pub. Accountants as Amicus Curiae in Supp. of Petitioners, No. 13-317, at 23-24 (nothing that the small risk of losing securities class actions later on the merits is overshadowed by the potential for class-wide damages). The Washington Legal Foundation likewise urged that allowing defendants to rebut the presumption of reliance at the class certification stage would harmonize the Court’s affirmative misstatement and omission jurisprudence because the Affiliated Ute presumption, applicable in cases alleging omissions, may be rebutted at the class certification stage with evidence that defendant did not have a class-wide duty to disclose. Br. for Wash. Legal Found. as Amicus Curiae in Supp. of Petitioners, No. 13-317, at 13-23 (discussing Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972).
In sum, regardless of whether the Court decides the ultimate question of the continued viability of fraud-on-the-market theory or settles on the narrower question, the Court is poised to deliver yet another significant decision in the securities context in the coming year.
In the last half of 2013, lower courts wrestled with the Supreme Court’s signals regarding the viability of Basic’s fraud-on-the-market presumption.
In IBEW Local 90 Pension Fund v. Deutsche Bank AG, No. 11 Civ. 4209(KBF), 2013 WL 5815472 (S.D.N.Y. Oct. 29, 2013), Judge Forrest of the Southern District of New York took a hard look at plaintiffs’ evidence and expert testimony supporting the fraud-on-the-market presumption. The court ultimately found that class action plaintiffs failed to meet their burden of establishing market efficiency for the relevant securities. Citing Amgen, the court explained that "[t]he presumption of reliance is, however, just that–a presumption. It is rebuttable." Id. at *20.
The court noted that, "[t]o defeat the presumption of reliance, defendants do not, therefore, have to show an inefficient market. Instead, they must demonstrate that plaintiffs’ proffered proof of market efficiency falls short of the mark." Id. The vast majority of the securities in question were traded outside the United States, primarily in Germany on the Frankfurt Stock Exchange. Id. at *3 n.12. Defendants presented evidence that information tended to be disclosed and incorporated into the securities’ price first in Germany, when the U.S. markets were closed, and that even when both U.S. and German markets were open, the German markets led in incorporating the information. Id. at *9. Plaintiffs’ expert had not analyzed the German market at all, focusing entirely on the U.S. market. Id. at *21. The court concluded that plaintiffs’ expert’s failure to analyze the primary market for the securities was fatal to his analysis. Id. at *21. The court’s denial of class certification provides an example of the searching review in which lower federal courts may increasingly engage post-Amgen.
In another rigorous application of Rule 23, the district court in In re BP P.L.C. Sec. Litig., No. 4:10–md–2185, 2013 WL 6388408, at *1 (S.D. Tex. Dec. 6, 2013), likewise denied a motion for class certification for various reasons. As to the fraud-on-the-market theory, the district court found that the alleged misrepresentations were inadequately publicized to be incorporated into the stock price. In a securities lawsuit arising from the Deepwater Horizon explosion and ensuing oil spill in the Gulf of Mexico, plaintiffs alleged that BP had made fraudulent misstatements in regulatory filings that were later brought to light by the spill. Id. In evaluating the evidence on plaintiffs’ motion for class certification, the court cited Amgen and Halliburton I in noting that the "Supreme Court has clarified that a proposed class representative need not establish materiality or loss causation to invoke the [fraud-on-the-market] presumption." Id. at *13 (citations omitted). Rather, the court explained, "the inquiry at this stage is focused on trade timing, market efficiency, and publicity." Id. (quotation and citations omitted). Because the plaintiffs failed to demonstrate that the particular misrepresentations "were known by the market and incorporated in the [securities’] price prior to the Deepwater Horizon explosion," the court denied class certification. Id. at *15.
Notwithstanding the pro-defense rulings cited above, most lower courts have continued to apply the Basic fraud-on-the-market presumption without critical examination. See, e.g., Harris v. Amgen, Inc., No. 10-56014, 2013 WL 5737307, at *15 (9th Cir. Oct. 23, 2013) (applying fraud-on-the-market theory to ERISA plan participants in the same manner that would apply to any investor); Smilovits v. First Solar, Inc., No. CV12–00555–PHX–DGC, 2013 WL 5551096 (D. Ariz. Oct. 8, 2013) (certifying securities class action on finding of market efficiency based on evaluation of the Cammer factors, but rejecting plaintiffs’ assertion that the predominance requirement was satisfied because plaintiffs conceded they would never seek to individually assert reliance and would instead rely entirely on the fraud-on-the-market theory); In re Puda Coal Sec. Inc. Litig., No. 11 Civ. 2598(KBF), 2013 WL5493007, at *20 (S.D.N.Y. Oct. 1 2013) (citing Basic in certifying a securities class action, but limiting the class to a period when plaintiffs had affirmative evidence of market efficiency because the burden is on plaintiffs to demonstrate an efficient market); Plumbers & Pipefitters, Nat’l Pension Fund v. Burns, No. 3:05CV7393, 2013 WL 4776278 (N.D. Ohio Sept. 4, 2013) (certifying securities class action after evaluating conflicting expert testimony regarding five Cammer factors and concluding that bonds at issue traded on an efficient market); Hawaii Ironworkers Annuity Trust Fund v. Cole, No. 3:10CV371, 2013 WL 4776258 (N.D. Ohio Sept. 4, 2013) (following Amgen in ruling that materiality of alleged misrepresentations did not need to be determined at the class certification stage, but denying class certification because defendants had failed to prove that deception was communicated to the public and accordingly plaintiffs could not rely on the fraud-on-the-market presumption).
If anything, the recent district court opinions perhaps highlight the need for definitive guidance from the Supreme Court on the continuing viability and scope of the fraud-on-the-market theory.
As predicted in our 2013 Mid-Year Securities Litigation Update, the Supreme Court’s decision in Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013) presented other intriguing opportunities for challenges to certification in securities class actions. In Comcast, the Court held that respondents were not entitled to class certification because they failed to satisfy the predominance requirement of Rule 23(b)(3): that "damages are susceptible of measurement across the entire class." Id. Lower courts must therefore consider at the class certification stage whether common damages questions predominate and whether plaintiffs have put forth sufficient–a preponderance of–evidence. Id. at 1432.
In the last half of 2013, several defendants made Comcast-based challenges to securities plaintiffs’ motions for class certification with very limited success so far, and the number of decisions that have even addressed this issue is small. The decision in In re BP p.l.c. Securities Litigation, No. 10 MD 2185, 2013 WL 6388408 (S.D. Tex. Dec. 6, 2013) is notable for several reasons (see discussion above regarding the fraud-on-the-market theory), but it is perhaps most notable for the defendants’ success in persuading the court that certification required more rigorous proof of damages according to the theories of liability. The district court found that Comcast required securities plaintiffs to establish, by a preponderance of the evidence, that damages are "measurable on a class-wide basis" and that the "damages methodology proposed will track Plaintiffs’ theories of liability." Id. at *17.
Defendants in the matter challenged plaintiffs’ motion, arguing, among other things, that plaintiffs failed to meet the Comcast standard as they had not even set forth the event study that they planned to use in the matter. Defendants submitted their own event study to demonstrate the disconnect between plaintiff’s proposed damages model and the theories of liability. For example, where the theory of liability is that defendants understated the risk of a spill, the inflation allegedly inherent in the stock price for understating the risk of a spill cannot be measured by the genuine effects of disclosure of an actual spill. The court agreed, holding that plaintiffs merely invoking the probable use of an event study was insufficient "[w]ithout a more complete explication of how [they] propose to use [the] study to calculate class members’ damages, and how that event study will incorporate–and, if necessary, respond to–the various theories of liability." Id.
Other courts have rejected Comcast-based challenges. In In re Heckmann Corp. Securities Litigation, No. 10-378, 2013 WL 2456103 (D. Del. June 6, 2013), for example, the District Court of Delaware granted plaintiffs’ motion despite defendants’ argument that plaintiffs failed to establish "what the damages to the class are [under Section 14(a) of the Securities Exchange Act of 1934], or how they may be established through a judicially recognized and commonly accepted method." Id. at *14. The court first distinguished Comcast as limited to "antitrust litigation [and] . . . not in regard to a securities fraud litigation." Id. The court then held that "plaintiff’s damage theory is consistent with Section 14(a) precedent because it is based on the diminution in the value of their shares caused by the false and misleading statements in the Proxy." Id. (internal quotation marks omitted).
More recently, in New Jersey Carpenters Health Fund v. Residential Capital, LLC, No. 08 Civ. 8781, 2013 WL 6839093 (S.D.N.Y. Dec. 27, 2013), the Southern District of New York granted plaintiffs’ motion despite defendants’ argument that plaintiffs "failed to establish an appropriate damages formula" for their claims under Sections 11, 12 and 15 of the Securities Act of 1933. Id. at *5. The court did acknowledge that Comcast "is not limited to the anti-trust context" but is inapposite in this matter as damages "reflect liability by statutory formula" under Section 11(e). Id.
Despite the mixed results for defendants in 2013, Comcast-based challenges will likely continue in the coming year.
Certain policy and legal developments emerging in 2013 threaten to increase the frequency and costs of securities-related litigation. In a significant break with historical practice, the SEC announced and began to implement a change in its policy regarding defendants’ admissions of liability in connection with settlement agreements. Separately, a case currently pending before the U.S. Supreme Court could, depending upon the Court’s ruling, greatly expand litigation under an anti-retaliation provision of the Sarbanes-Oxley Act of 2002 (SOX). These and other developments are covered in depth in our 2013 Year-End Securities Enforcement Update.
Prior to this year, the SEC maintained a longstanding policy of allowing defendants to settle matters brought by the Commission without admitting or denying liability. The approach had the advantage, on the one hand, of facilitating more settlements and thereby conserving the Commission’s investigatory and litigation resources and, on the other, of sparing the settling defendant the often substantial exposure to private litigation resulting from an admission of liability. But in late 2011, Federal District Judge Jed Rakoff (S.D.N.Y.) famously criticized the policy, finding that it "deprive[d] the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact." Sec. & Exch. Comm’n v. Citigroup Global Mkts. Inc., 827 F. Supp. 2d 328, 332 (S.D.N.Y. 2011). In the past six months, the new policy has resulted in two significant settlements that included admissions of liability. In August 2013, hedge fund manager Philip A. Falcone entered into the first settlement with the SEC that included an admission of liability pursuant to the new policy. See Consent of Defendants Philip A. Falcone, et al., dated Aug. 16, 2013, available at http://www.sec.gov/litigation/litreleases/2013/consent-pr2013-159.pdf. Separately, in September JPMorgan Chase & Co. settled SEC claims arising from the $6.2 billion "London Whale" trading loss. JPMorgan affirmatively admitted that it violated federal securities laws when it failed to catch traders masking losses in 2012. SEC Press Release, JPMorgan Chase Agrees to Pay $200 Million and Admits Wrongdoing to Settle SEC Charges (Sept. 19, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539819965; see also Joshua Gallu, JPMorgan Guilty Admission a Win for SEC’s Policy Shift, Bloomberg News (Sep. 19, 2013), available at http://www.bloomberg.com/news/2013-09-19/jpmorgan-s-guilty-admission-marks-victory-in-sec-s-policy-shift.html. Notably, this settlement included admissions concerning failed internal controls, rather than fraud allegations likely to spawn substantial private litigation.
The SEC’s new policy has already had collateral consequences. For example, plaintiffs in an ongoing derivative action against Mr. Falcone and Harbinger Capital Partners relied on the admissions in recent filings in the matter. In re Harbinger Capital Partners Funds Investor Litig., No. 12-cv-01244-AJN, 2013 WL 5441754 (S.D.N.Y. Sept. 30, 2013). And in October, New York’s insurance regulator, the Department of Financial Services, announced that it was banning Philip Falcone from exercising direct or indirect control over any New York-licensed insurer for seven years, including Fidelity & Guaranty Life Insurance Company of New York, which is owned by the publicly traded company run by Falcone. The New York regulator’s decision specifically relied on the admissions contained in Mr. Falcone’s settlement with the SEC two months earlier. Press Release, N.Y. Dept. of Fin. Servs., DFS Announces Ban of Harbinger Capital’s Philip Falcone From Involvement in Operations of All New York-Licensed Insurers, Including Fidelity New York (Oct. 7, 2013), available at http://www.dfs.ny.gov/about/press2013/pr1310071.htm.
A case currently pending before the U.S. Supreme Court threatens to expand dramatically the scope of whistleblower lawsuits under Section 806 of SOX. 18 U.S.C. § 1514A. Section 806–entitled "Protection for Employees of Publicly Traded Companies Who Provide Evidence of Fraud"–authorizes an employee of a public company to bring a civil action for retaliation against his or her employer and their designated representatives where the employee can allege an adverse employment decision resulting from the employee’s provision of information or assistance in uncovering a fraud to shareholders or violation of an SEC rule. At issue in Lawson v. FMR LLC, U.S. Supreme Court Docket No. 12-3, is whether the courts should extend the cause of action created by section 806 to employees of certain companies that are not public companies subject to SOX.
The plaintiffs-petitioners in Lawson v. FMR LLC are former employees of private companies that are contractors to public mutual fund companies subject to SOX. One petitioner was terminated for poor job performance, and the other resigned after being passed over for a promotion. Both assert that the adverse employment actions constituted retaliation under Section 806 for reporting problems relating to the public mutual fund companies. The petitioners’ proposed interpretation of Section 806 would significantly broaden its reach, extending the private right of action from the employees of about 4,500 publicly traded companies to those of more than 6 million private companies. In 2012, the U.S. Court of Appeals for the First Circuit rejected this interpretation, holding that the term "employee" in Section 806 encompasses only employees of public companies. Lawson v. FMR LLC, 670 F.3d 61 (1st Cir. 2012).
The Supreme Court took up the case and heard oral arguments on November 12, 2013. The U.S. Solicitor General has filed an amicus brief and argued that the cause of action created by Section 806 should be extended to the employees of contractors. The Court has not yet ruled. A ruling by the high Court in favor of the petitioners would, in effect, provide a new retaliation cause of action to millions of employees who might claim a connection between their work for contractors of public companies and adverse employment decisions, potentially resulting in a wave of litigation.
As discussed in our 2013 Mid-Year Securities Litigation Update and earlier updates, 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 "ultimate authority" over the statement’s "content" and "whether and how to communicate it." 131 S. Ct. 2296, 2307 (2011). 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 second half of 2013, a few courts have continued to confront the question of who "makes" an allegedly false statement in the wake of Janus.
During the past six months, a number of courts have found allegations of "making" a statement sufficient under Janus. For example, in SEC v. Levin, No. 12-21917, 2013 WL 5588224, at *14 (S.D. Fla. Oct. 10, 2013), the court found that an allegation that the individual defendant, as the managing member and owner of an LLC, had ultimate control over the content of the statements issued by the LLC was sufficient to qualify the defendant as a "maker" of the statements under Janus.
Similarly, in In re Nevsun Resources Ltd., No. 12 Civ. 1845, 2013 WL 6017402, at *11 (S.D.N.Y. Sept. 27, 2013), the district court found that an issuer was the "maker" of the allegedly false estimates even though such estimates were prepared by and attributed to an independent expert. The court noted that, although defendants "purported to rely on" the expert’s report for certain statements, the complaint alleged that defendants "adopted those statements, filed them with the SEC, and thereafter repeated them to investors."
In SEC v. Pentagon Capital Mgmt. PLC, 725 F.3d 279, 286-87 (2d Cir. 2013), an investment advisor was accused of late trading in the mutual fund market. Defendants argued that because they never communicated directly with the mutual funds, they could not be held liable as "makers" of any false statements. The Second Circuit rejected this argument, holding that while the brokers "may have been responsible for the act of communication," defendants "retained ultimate control over both the content of the communication and the decision to late trade."
Conversely, at least one court applying the Janus decision declined to impose liability on third parties who did not actually make the allegedly misleading statements. In WM High Yield Fund v. O’Hanlon, No. 04-3423, 2013 WL 3231680, at *7-8 (E.D. Pa. June 27, 2013), the court held that an audit partner at Deloitte & Touche LLP was not the "maker" of any statements. Applying Janus, the court found that Deloitte was the maker of its own audit opinions and the issuer was the maker of its own financial statements. There was nothing within the audit opinions or implicit from surrounding circumstances that would inform investors that plaintiff had anything to do with the audit opinions. The record did not suggest that plaintiff had ultimate control over the audit opinions, including their content and whether and how to communicate them.
Courts are still split as to whether corporate insiders can be held liable for corporate statements under Section 10(b). In In re Questcor Sec. Litig., No. 12-01623, 2013 WL 5486762, at *9 (C.D. Cal. Oct. 1, 2013), the court stated that the Ninth Circuit "has yet to address whether the group pleading doctrine survives Janus," but noted that district courts in the Ninth Circuit "have largely concluded that the doctrine is incompatible with the PSLRA." See also In re Lehman Brothers Sec. & ERISA Litig., No. 11 Civ. 5112, 2013 WL 5730020, at *2 (S.D.N.Y. Oct. 22, 2013) (CEO and CFO "undoubtedly" had "ultimate authority" over SEC filings even though filings were attributed to issuer rather than defendants); WM High Yield Fund v. O’Hanlon, No. 04-3423, 2013 WL 4051260, at *19 (E.D. Pa. Aug. 12, 2013) (director did not have "ultimate authority" over SEC filing that he signed); SEC v. Goldstone, No. 12-0257, 2013 WL 3456875, at *153 (D.N.M. July 8, 2013) (allegations that officers signed and certified Form 10-K were sufficient to hold officers primarily liable for the allegedly false statements contained therein).
In recent years, several courts have held that statements of "opinion" are actionable under Sections 11 and 12 of the Securities Act and Sections 10 and 20 of the Securities Exchange Act only where a statement is alleged to be both objectively false and subjectively disbelieved by the speaker at the time it is made. This logical extension of the U.S. Supreme Court’s holding in Virginia Bankshares v. Sandberg, 501 U.S. 1083, 1095-96 (1991), while limited there to claims under Section 14 of the Securities Exchange Act, appears to continue to gain ground. In the Ninth Circuit, for example, opinions "can give rise to a claim under section 11 only if the complaint alleges . . . that the statements were both objectively and subjectively false or misleading. Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156, 1162 (9th Cir. 2009). Similarly, the Third Circuit has held that "statements of ‘soft’ information may be actionable misrepresentations [under Section 11] [only] if the speaker does not genuinely and reasonably believe them." In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 368-69 (3d Cir. 1993).
As we reported previously, two Second Circuit opinions brought renewed focus to the requirements of pleading falsity of an opinion under the securities laws. In Fait v. Regions Fin. Corp., 655 F.3d 105, 110 (2d Cir. 2011), the Second Circuit affirmed the dismissal of claims brought under Sections 11 and 12 of the Securities Act, holding that statements in offering documents about goodwill valuation and provision for loan loss reserves constituted "opinions" and that, as such, "liability lies only to the extent that the statement was both objectively false and disbelieved by the defendant at the time it was expressed." The Second Circuit subsequently extended its opinion in Fait to claims brought under Section 10 of the Securities Exchange Act relating to alleged misstatements regarding goodwill valuation. City of Omaha, Neb. Civilian Employees’ Ret. Sys. v. CBS Corp., 679 F.3d 64, 67-68 (2d Cir. 2012).
In the wake of these recent Second Circuit decisions, two important issues have emerged. The first issue is what constitutes an opinion. The second issue is the standard for pleading falsity for statements of opinion.
This year, the Second Circuit provided important guidance regarding what constitutes an "opinion." In Fait, the Second Circuit found that loan loss reserves were "opinions" because they "reflect management’s opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collected." 655 F.3d at 113. Predictably, following Fait and City of Omaha, plaintiffs attempted to limit the holdings in those cases to their particular facts–namely, statements regarding goodwill valuation, provision for loan loss reserves, and other accounting-related pronouncements.
The Second Circuit, however, recently confirmed that the holdings in Fait and City of Omaha extend to other statements of opinion regardless of the context. In Freeman Grp. v. Royal Bank of Scotland Grp., No. 12-3642-cv, 2013 WL 5340476 (2d Cir. Sept. 25, 2013) (summary order), the Second Circuit affirmed the dismissal of a securities fraud complaint, holding that the defendants’ statements about the "strength of RBS’s capital base," characterization of RBS’s risk management procedures as "effective," and expected benefits from an acquisition were statements of opinion. Id. at *2-3; see also Freidus v. ING Groep, N.V., No. 12-3748-cv, 2013 WL 6150769, at *1 (2d Cir. Nov. 22, 2013) (summary order) (finding ING’s statement that it considered its assets to be of "relatively high quality" was a statement of opinion). The Second Circuit also affirmed dismissal where plaintiffs failed to plead scienter adequately as to defendants’ optimistic statements characterizing otherwise publicly available information. Jones v. Perez, No. 13-2195-cv, 2013 U.S. App. LEXIS 25668, at *3-4 (2d Cir. Dec. 26, 2013).
With this guidance from the Second Circuit, one court found that statements that "things are going very well," that an issuer’s mine had an "impeccable track record," that the issuer was "well positioned," and that "2011 was a very successful year" were non-actionable statements of opinion. In re Nevsun Resources Ltd., 2013 WL 6017402, at *10. (Gibson Dunn represents the defendants in this case.) See, also, City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Align Technology, Inc., No. 12-cv-06039-WHO, 2013 WL 6441843, at *8 (N.D. Cal. Dec. 9, 2013) (goodwill calculations are opinions); In re MF Global Holdings Limited Sec. Litig., No. 11 Civ. 7866 (VM), 2013 WL 5996426, at *25 (S.D.N.Y. Nov. 12, 2013) (statements about the realization of deferred tax assets are statements of opinion); In re OSG Sec. Litig., No. 12 Civ. 7948 (SAS), 2013 WL 4885890, at *6 (S.D.N.Y. Sept. 10, 2013) (auditor’s opinions endorsing the accuracy of a company’s tax liabilities are not "inherently subjective" opinions).
This past year, a circuit split emerged with respect to pleading falsity for statements of opinion. Specifically, the Sixth Circuit rejected the Ninth Circuit’s opinion in Rubke and the Second Circuit’s opinion in Fait. In Ind. State Dist. Council of Laborers and Hod Carriers Pension and Welfare Fund et al. v. Omnicare Inc. et al., 719 F.3d 498 (6th Cir. 2013), the Sixth Circuit reversed the dismissal of a Section 11 claim alleging that a registration statement falsely stated that the issuer was in material compliance with applicable laws and regulations. The Sixth Circuit held that by requiring plaintiff to plead defendants’ subjective knowledge of the falsity of the statement, the district court had improperly added a scienter requirement to the Section 11 claim. Accordingly, in the Sixth Circuit, a plaintiff only needs to plead objective falsity in order to sufficiently allege a Section 11 claim for a statement of opinion. On October 4, 2013, defendant Omnicare filed a petition for a writ of certiorari with the U.S. Supreme Court. A response to the petition was filed January 9, 2014.
In short, we expect that in the coming year, district courts will continue to struggle with questions whether alleged misrepresentations are statements of opinion, and whether such statements must be determined to be both objectively and subjectively false.
As we discussed in our 2013 Mid-Year Securities Litigation Update, appellate courts have applied inconsistent standards of review when reviewing cases dismissed due to a plaintiff’s failure to make a demand or plead demand futility. Some courts review such dismissals deferentially under the abuse-of-discretion standard. See, e.g., Potter v. Hughes, 546 F.3d 1051, 1056 (9th Cir. 2008); Kanter v. Barella, 489 F.3d 170, 175 (3d Cir. 2007). Other courts, however, have applied the de novo standard, holding that such dismissals are entitled to no deference on appeal. See, e.g., Unión de Empleados v. UBS Fin. Serv. Inc. of Puerto Rico, 704 F.3d 155, 162–63 (1st Cir. 2013); see also Brehm v. Eisner, 746 A.2d 244, 253–54 (Del. 2000).
Following the First Circuit’s ruling, the defendant petitioned the Supreme Court for a writ of certiorari to determine the proper appellate standard of review for judgments of dismissal due to a derivative plaintiff’s failure to plead demand futility adequately. In June of 2013, the Supreme Court granted the petition, 133 S. Ct. 2857, 2858 (2013), however, the Court dismissed the appeal under Supreme Court Rule 46.1, which provides for dismissal when all parties to an appeal agree in writing that it should be dismissed. See 134 S. Ct. 40 (2013). The parties agreed to dismissal because the plaintiffs had lost standing by selling their shares in 2012. Unión de Empleados v. UBS Fin. Serv. Inc. of Puerto Rico, No. 10-1141 (ADC), slip op. at 4, 12 (D.P.R. July 9, 2013). Plaintiffs had sold their shares in UBS investment funds "during the pendency of the appeal [and] unbeknownst to plaintiffs[‘] counsel." Id. at 6. The district court found that the plaintiffs’ sale of their shares violated the requirement established by Federal Rule of Civil Procedure 23.1 and Delaware corporate law that shareholder derivative plaintiffs maintain "continuous ownership" of "their shares in the nominal defendant corporation throughout the pendency of the suit." Id. at 7–8. Therefore, the district court held that it had been divested of subject matter jurisdiction and granted UBS’s motion to dismiss the case for lack of standing. Id. at 12–13. Consequently, the division of authority over the appellate standard of review for dismissals for failure to plead demand futility will remain unresolved for the time being.
In the second half of 2013, numerous shareholder derivative plaintiffs claimed that board members faced a "substantial likelihood of director liability" in an effort to establish demand futility. Many of these cases were dismissed for failure to adequately plead demand futility. For example, courts chose not to excuse plaintiffs’ failure to demand when they could not allege with particularized facts that board members knew of the allegedly fraudulent conduct. See, e.g., Maurras v. Bronfman, Nos. 12 C 3395, 12 C 6019, 2013 WL 5348357, at *20 (N.D. Ill. Sept. 24, 2013) ("Plaintiffs have failed to allege that [the board] intentionally broke the law, intentionally caused [the company] to do so, or knowingly permitted [the company] to do so."); In re Bank of New York Mellon Corp. Forex Transactions Litig., No. 12 MD 2335 (LAK), 2013 WL 3358028, at *3 (S.D.N.Y. July 2, 2013) (finding that plaintiffs had failed to allege that the board had any awareness or indication that the company was making misrepresentations to its customers).
Courts also rejected the argument that a board’s knowledge "can be presumed because the [c]ompany’s corporate governance structure requires that notice of [the alleged fraudulent conduct] reach the [b]oard." Gulbrandsen v. Stumpf, No. 12-5968 JSC, 2013 WL 6406922, at *6 (N.D. Cal. Dec. 6, 2013); see also In re Capital One Derivative S’holder Litig., No. 1:12CV1100, 2013 WL 5551898, at *11–12 (E.D. Va. Oct. 8, 2013) (holding that plaintiffs’ allegations failed to give rise to an inference that the board of directors "fail[ed] to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities") (citation omitted).
In Gulbrandsen, the plaintiff had argued that "[t]aken in their totality, the magnitude, rates, and duration" of the allegedly fraudulent behavior together with the corporate structure of the company demonstrated that the board was conscious of the alleged illegalities. 2013 WL 6406922, at *5. The district court concluded that plaintiff had made no "particularized allegations" that the board knew anything about the alleged conduct and reiterated that an inference of awareness based on corporate structure or designated roles and responsibilities is insufficient to prove demand futility. Id. at *6–8. The Gulbrandsen case is also illuminating because the court rejected plaintiff’s allegation that the board’s "internal investigation" in 2004 into the company’s lending practices constituted active knowledge on the part of the board. Id. at *8. The court stated that the plaintiff did "not allege any specific information obtained by the [b]oard as a result of the purported investigation or what directors (if any) received the information." Id.
Courts also continued to uphold the high pleading burdens for shareholder derivative plaintiffs asserting Caremark claims, which involve allegations that the board of directors has failed to properly manage and oversee the company. See, e.g., In re China Auto. Sys. Inc. Derivative Litig., No. 7145-VCN, 2013 WL 4672059, at *7 (Del. Ch. Aug. 30, 2013) (citing In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996)). The court in China Automotive reaffirmed the longstanding notion that Caremark claims are considered "’possibly the most difficult theory in corporate law’ to support a shareholder derivative action." Id. (citation omitted). Therefore, plaintiffs must allege particularized facts showing bad faith or a "sustained or systematic failure of the board to exercise oversight." Id. at *9 (citation omitted).
Cases in which courts denied motions to dismiss on demand futility grounds typically involved highly particularized allegations of board conduct that would constitute unambiguous violations of board duties. Compare Pfeiffer v. Leedle, No. 7831-VCP, 2013 WL 5988416, at *8–10 (Del. Ch. Nov. 8, 2013) (finding that plaintiffs’ allegations supported an inference that the board "knowingly or intentionally" violated the terms of a stock incentive plan when the company CEO was awarded 449,436 and 285,000 stock options in 2011 and 2012 respectively, an "unambiguous" violation of a term limiting awards to no more than 150,000 shares in any calendar year); and Halpert v. Zhang, No. 12-1339-SLR, 2013 WL 4047153, at *4–5 (D. Del. Aug. 7, 2013) (finding that plaintiffs alleged a prima facie case that the board violated an unambiguous limitation on the number of stock options that the board could grant per year) with Abrams v. Wainscott, No. 11-00297-RGA, 2013 WL 6021953, at *4 (D. Del. Nov. 13, 2013) ("Plaintiff’s cited cases do not convince the Court of the blanket proposition that a shareholder need only allege a violation of a compensation agreement to excuse demand, without additional allegations of knowledge and intent.").
As discussed in our 2013 Mid-Year Securities Litigation Update, on June 25, 2013, Chancellor Strine of the Delaware Court of Chancery upheld the facial validity of corporate bylaws that select the Delaware Court of Chancery as the exclusive forum for litigation relating to the company’s internal affairs, including shareholder derivative suits. See Boilermakers Local 154 Retirement Fund v. Chevron Corp., et al., No. 7220-CS, 2013 WL 5869440 (Del. Ch. Oct. 28, 2013) and IClub Investment Partnership v. FedEx Corp., et al., 73 A.3d 934, 937, 939-40 (Del. Ch. June 25, 2013). Chancellor Strine explained that under Delaware law, corporations are permitted to adopt bylaws relating to their business and "internal affairs" and that the corporation can grant the board of directors "the power to adopt and amend the bylaws unilaterally." FedEx, 73 A.3d at 939. The plaintiffs in Boilermakers appealed the decision to the Delaware Supreme Court but later dismissed the appeal voluntarily. Plaintiffs’ Motion for Dismissal Without Prejudice ¶¶ 5-6, Chevron, 2013 WL 5869440. This decision provides an important tool for corporations to avoid expensive multijurisdictional litigation and forum shopping by channeling stockholder litigation into a single forum, and, at the same time, offering Delaware corporations the predictability of litigating Delaware law disputes in the forum best equipped to handle them.
In late 2010 and early 2011, the boards of both Chevron and FedEx adopted bylaws that designated the Delaware Court of Chancery as the sole forum for derivative suits, fiduciary duty suits, suits arising under the Delaware General Corporation Law ("DGCL"), and internal affairs suits, absent written corporate consent to the selection of an alternative forum in particular cases. The provisions were adopted "in response to corporations being subject to litigation over a single transaction or a board decision in more than one forum simultaneously, so called ‘multiforum litigation.’" FedEx, 73 A.3d at 943. As the defendants explained, such multiforum litigation "imposes high costs on the corporations and hurts investors by causing needless costs that are ultimately born by stockholders." Id. at 944. Chevron later amended its forum selection bylaw to provide that such suits could alternatively be filed in Delaware federal court (assuming the existence of federal jurisdiction). Many other corporations followed suit; in the last three years, "over 250 publicly traded corporations have adopted such provisions." Id.
In February 2012, plaintiffs filed lawsuits against Chevron, FedEx, and a host of other corporations whose boards adopted such bylaws. Plaintiffs attacked the facial validity of such bylaw amendments and claimed that these amendments were enacted in breach of the directors’ fiduciary duties. Id. at 945. Most of the defendant corporations repealed their forum selection bylaws (or withdrew their proposals from a stockholder vote) in response to these lawsuits. But Chevron and FedEx refused to budge.
On their motion for judgment on the pleadings, Chancellor Strine reached two conclusions. First, the Court held that the forum selection bylaws are authorized by 8 Del. C. § 109(b), which provides that bylaws may "contain any provision, not inconsistent with law or with the certificate of incorporation, 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." 8 Del. C. § 109(b). Delaware courts have observed that "bylaws typically do not contain substantive mandates, but direct how the corporation, the board, and its stockholders may take certain actions." FedEx, 73 A.3d at 951. Here, the Court held that the forum selection bylaws are not substantive mandates; rather, "[t]hey are process-oriented, because they regulate where stockholders may file suit, not whether the stockholder may file suit or the kind of remedy that the stockholder may obtain on behalf of herself or the corporation." Id. (emphasis in original).
Second, the Court held that, even though stockholders did not vote on the adoption of these bylaws, they were contractually valid and enforceable 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. Because 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." Id. at 955 (quoting Kidsco Inc. v. Dinsmore, 674 A.2d 483, 492 (Del. Ch. 1995)). 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." Id. at 956.
The enforceability of exclusive forum provisions was recently tested again in Edgen Group Inc. v. Genoud, C.A. No. 9055-VCL (Del. Ch. Nov. 5, 2013) (Trans.). There, a plaintiff, a purported shareholder, filed suit against Edgen Group Inc. in Louisiana to challenge an all-cash and premium sale to unrelated third-party buyer. The company’s charter had a forum selection provision providing that Delaware was the exclusive jurisdiction for plaintiff’s suit. Id. at 26. In response to the complaint, Edgen moved to dismiss the case in Louisiana and also filed suit against plaintiff Genoud in Delaware seeking an anti-suit injunction against the Louisiana litigation, which Edgen claimed was brought in violation of the forum selection provision in the company’s charter. Id. While Vice Chancellor Laster ultimately denied Edgen’s request for a temporary injunction–concluding that comity concerns tipped the balance of equities against granting an injunction–the Court made clear that "the forum selection provision in the charter is valid as a matter of Delaware corporate law," and noted that the case "really exemplifies the interforum dynamics that have allowed plaintiff’s counsel to extract settlements in M&A litigation and litigation challenging transactions." Id. at 19, 28-29.
Thus, the Edgen decision, following on the heels of Chancellor Strine’s decision in the FedEx and Chevron case, has solidified the validity of forum selection bylaws or charter provisions under Delaware law, and provides further support for boards of Delaware corporations that wish to litigate in a forum that offers judicial expertise and predictability in litigating shareholder disputes.
As we have previously reported, virtually every M&A transaction of any significant size results in a shareholder strike suit (and usually more than one) challenging the deal price and process and alleging that the target board breached its fiduciary duties in connection with agreeing to the deal. While the claims in these suits typically are not strong (filed, as they usually are, on the heels of an announced transaction), defendant companies often choose to settle these kinds of cases early in exchange for additional disclosures to avoid the hassle of ongoing litigation post-closing.
Another form of shareholder suit has emerged that poses a different kind of nuisance to companies engaged in M&A transactions: appraisal lawsuits brought by shareholders who claim that they received less than "fair value" for their shares. While appraisal actions do not threaten to postpone or derail a transaction in the same way as traditional strike suits, these actions risk driving up the consideration paid by the acquiring corporation in the transaction. Given the substantial interest payment on appraisal awards that must be paid to appraisal petitioners under the Delaware appraisal statute, investors holding significant stakes in Delaware companies sold in all-cash deals have begun to more aggressively exercise (or threaten to exercise) their appraisal rights, creating a new and often very expensive headache for companies acquiring Delaware-incorporated companies.
The right of stockholders of Delaware corporations to exercise their appraisal rights is set out under Section 262 of the Delaware Corporations Code. Under this section, stockholders who exercise their appraisal rights are entitled to a judicial determination of the "fair value" of their shares–an award that may be higher or lower than the per share merger consideration. Unlike traditional litigation, appraisal actions proceed directly from discovery to trial–a trial that does not concern the liability of one party or another, but rather resolves the question of what is the "fair" price of the shares at issue. An appraisal trial typically involves expert testimony from valuation experts, and the Chancery Court has wide discretion to determine the fair value of shares based on a variety of valuation methodologies or metrics. Importantly, the statute also provides that stockholders exercising their appraisal rights are entitled to interest on the award of five percent above the Federal Reserve discount rate, compounded quarterly. This provision creates a significant incentive for stockholders to exercise their appraisal rights in order to earn the above-market interest payment on the eventual award. Given the guaranteed interest payment, the potentially significant litigation costs for corporations to litigate appraisal actions through trial, and the unpredictability of judicial determinations of "fair value," appraisal actions present both an investment opportunity for stockholders of Delaware target corporations and a potential financial risk to acquiring corporations.
It should come as no surprise, then, that investors have taken advantage of this stockholder-friendly statute as a vehicle for increasing the return on their investments in Delaware corporations that have been acquired in cash-out mergers. Some institutional investors now acquire shares of target corporations after the deal has been announced, but before it has closed, with an eye toward exercising appraisal rights–a tactic that the Chancery Court has sanctioned. See In re Appraisal of Transkaryotic Therapies, Inc., C.A. No. 1554-CC (Del. Ch. May 2, 2007). For example, in Merion Capital, L.P v. 3M Cogent, Inc., C.A. No. 6247-VCP (Del. Ch. Jul. 8, 2013), Merion Capital purchased approximately 2.6 million shares of Cogent, after Cogent announced an upcoming merger with 3M Company, and then exercised its appraisal rights, contending that the $10.50 per share price was too low. At trial, the Court applied a discounted-cash flow ("DCF") and comparative companies valuation methodologies to conclude that the fair value of Cogent was $10.87 per share. Even though this was only modestly above the merger consideration, the valuation increase plus the statutory interest netted Merion approximately $5.7 million on top of the merger consideration, or nearly a 20% return on Merion’s investment. Merion and other institutional investors have employed this same investment strategy by pursuing separate appraisal actions that are now pending in the Delaware Chancery Court. Indeed, some institutional investors have used the threat of an appraisal action to drive up a buyer’s merger consideration, as in the case of Carl Icahn’s recent effort to wrest a higher price for Dell shares in the recent buyout by Michael Dell.
While courts have historically relied on the DCF methodology for determining a company’s "fair value," one recent decision may provide some ammunition to companies in appraisal actions claiming that the merger price is the best determinant of a target company’s value. In Huff Fund Investment Partnership v. CKx, Inc., C.A. No. 6844-VCG (Del. Ch. Nov. 1, 2013), Vice Chancellor Glasscock recognized that the offered price in an arms-length transaction is a strong indicator of the fair value. Before its merger with Apollo, CKx owned the rights to shows including "American Idol" and "So You Think You Can Dance." Despite receiving a bid at $5.60 per share, CKx accepted Apollo’s lower bid of $5.50 per share because of other benefits such as better deal security. After the deal closed, a large holder of CKx shares brought an appraisal action.
As the court acknowledged in CKx, the law requires the court to consider "all relevant factors" in determining fair value, and it is not required to defer to the offered price. See Golden Telecom, Inc. v. Global GT LP, 11 A.3d 214 (Del. 2010). After trial, however, Vice Chancellor Glasscock concluded that the merger price presented the best evidence of CKx’s value at the time of the merger. While the decision was driven in part by the unique circumstances of the CKx acquisition–there were no comparable companies of a similar size, assets, or business model on which to base a valuation, and the DCF analysis was based on management projections that were created in anticipation of litigation and not in the ordinary course–the decision is sure to be cited by companies arguing that the merger consideration was the best indicator of fair value.
It is too early to tell whether other courts, after CKx, will choose to rely on the merger consideration as a key factor in determining the fair value in appraisal cases. But one thing is clear: companies engaged in cash deals for Delaware corporations should expect not only a breach of fiduciary duty suit, but also an appraisal petition.
In late 2013, the Delaware Supreme Court issued a rare bench ruling reversing a Chancery Court decision enjoining an $8 billion corporate reorganization of Activision Blizzard, Inc. ("Activision"), whereby Vivendi, S.A. ("Vivendi") divested its majority interest in the videogame maker. While the ruling itself may have little precedential value beyond the narrow question presented in that case–namely, whether the reorganization constituted a transfer of value that required shareholder approval–the decision by Delaware’s highest court is the latest indication that injunctions that prevent M&A transactions are exceedingly rare in Delaware and will not be imposed lightly.
The underlying dispute in Activision Blizzard, Inc. v. Hayes stemmed from Vivendi’s attempt to divest itself of a controlling interest in Activision Blizzard Inc. ("Activision"), the maker of the popular "Call of Duty" and "World of Warcraft" video game franchises. No. 497, 2013 WL 6053804 (Del. Nov. 15, 2013). Vivendi negotiated with a special committee of Activision’s independent board members to sell: (1) 38% of its shares through Activision’s acquisition of a Vivendi non-operating subsidiary and (2) an additional 172 million shares to an entity owned by two Activision board members. Id. at *2.
A class-action plaintiff filed suit months after the stock purchase alleging, among other things, that Activision’s charter required a stockholder vote to approve the stock purchase. Id. Section 9.1(b) of Activision’s charter required "approval of a majority of the stockholders unaffiliated with Vivendi with respect to any merger, business combination or similar transaction involving the Corporation . . . and Vivendi . . . ." Id. at *1 (internal quotations omitted). Plaintiff claimed that the acquisition of the Vivendi holding company and stock sale to the Activision board members were transactions that required a shareholder vote.
The Court of Chancery agreed with the plaintiff and enjoined the stock purchase. It reasoned that the company’s charter intended to grant minority shareholders a say regarding transactions that significantly transfer company control or value. A "value-moving" deal therefore qualified as a transaction requiring a shareholder vote under Activision’s charter. See id at *3. As noted by the Delaware Supreme Court, the Court of Chancery broadly interpreted "value-moving" transactions to be "merger[s], business combination[s], or similar transaction[s]" in order to "protect Activision’s minority stockholders from overreaching by Vivendi." Id. at *4. And, in light of an $8 billion reorganization that would transfer shares to board members and transform Vivendi’s stake in the company from a majority to 11.9%, the Court of Chancery found that value had likely been transferred.
On an expedited appeal, the Supreme Court summarily rejected this conclusion, issuing a decision from the bench with three principal findings. First, the result of the Activision stock purchase was practically "the opposite of a business combination." The Court noted that there would be no intermingling of the two companies’ businesses and the purchase would result in Vivendi having no "voting or board control" over Activision. Second, the acquisition of a Vivendi subsidiary was not a business combination. Despite Activision technically "combining" with the entity, the Vivendi subsidiary would never conduct any business; it was a nonoperating entity created solely for the purpose of transferring Vivendi’s shares to Activision. And third, a "value-moving" transaction did not trigger a shareholder vote under the charter. The Court noted that the bylaws did not state that large transfers of funds inherently constituted "business combination or similar transaction[s]," and there was no need to broadly interpret the bylaws to protect shareholders from Vivendi overreach because the company bylaws already included sufficient shareholder protection by requiring "a majority of independent directors to approve any related-party transaction, regardless of its form or magnitude." Id. at *4. The Court therefore lifted the injunction, allowing the reorganization to close.
The Supreme Court’s summary bench ruling is strong evidence that bylaws of Delaware corporations will not be broadly construed by the Delaware Supreme Court and that enjoining a major corporate transaction is a tough road to hoe for shareholders.
As we previously noted in our mid-year and year-end updates, proxy disclosure litigation emerged in 2012 as a notable trend in securities litigation. The general relief sought by such litigation, largely initiated by one plaintiffs’ law firm, is an injunction to prevent annual shareholder voting from proceeding. The premise of these lawsuits is that the proxy materials published in advance of the vote are somehow false or misleading. Shareholders usually file these lawsuits near the eve of the annual voting in order to extract a quick, nuisance-value settlement from the company. If the company amends its proxy disclosure to address the shareholders’ claim, their attorneys demand a fee for conferring that purported benefit–the amended proxy disclosure–to the company’s shareholders. Proxy disclosure litigation, in short, places companies in a no-win situation: companies must (1) settle the lawsuit, (2) moot the lawsuit by amending the proxy disclosure and paying fees to the shareholders’ attorneys, or (3) fight the lawsuit and risk delaying the annual shareholder voting.
In a number of cases filed in 2012 and the first half of 2013, shareholders attacked various aspects of proxy disclosures as insufficient, misleading, or false: (1) proposals to amend an equity incentive plan (often to increase the amounts of shares authorized for issuance); (2) the required disclosures under the Dodd-Frank Act’s "Say on Pay" provision; (3) incentive compensation plans designed to maximize favorable tax treatment under Internal Revenue Code § 162(m); and (4) the "bundling" of several changes into a single vote. While plaintiffs experienced some early victories, results in the latter half of 2013 generally have been adverse to plaintiffs.
The second half of 2013 included a number of lawsuits to enjoin upcoming shareholder votes on the basis of inadequate, insufficient, or misleading proxy disclosures. See Todic v. Star Scientific, Inc., No. 1:13CV01994, 2013 WL 6434529 (D. Del. filed Dec. 4, 2013); Ruckert v. Nucor Corp., No. 9078, 2013 WL 6003135 (Del. Ch. filed Nov. 13, 2013); Banks v. FS Bancorp, Inc., No. 13-2-31865-2, 2013 WL 4962069 (Wash. Super. Ct. filed Sept. 6, 2013); Nguyen v. Immunocellular Therapeutics, Ltd., No. BC520236, 2013 WL 5172875 (Cal. Super. Ct. filed Sept. 4, 2013). But there was only one reported opinion in a case involving allegations related solely to proxy disclosures, and the claims were dismissed. In Morrison v. Hain Celestial Group, Inc., 40 Misc. 3d 812 (N.Y. Sup. Ct. 2013), plaintiffs filed suit to enjoin a shareholder vote on a new executive compensation package and an amendment to the company’s equity incentive plan. According to plaintiffs, the proxy disclosure was insufficient because it "failed to provide a ‘fair summary’ of the ‘key metrics and data’ relied upon by the Board with respect to both proposals[.]" Id. at 814–15. After denying plaintiffs’ motion for a temporary restraining order, the court granted defendant’s motion to dismiss for failure to make the requisite demand and for failure to identify any material omissions from the proxy disclosure. The court found that plaintiffs must allege with some level of specificity what should have been included in the disclosures, as opposed to an opaque demand for "more information." Id. at 819.
Proxy disclosure claims are frequently coupled with other securities claims but tend to fare no better than "stand alone" proxy disclosure cases. For example, in In re BioClinica Shareholder Litigation, Civ. A. No. 8272-VCG, 2013 WL 5631233 (Del. Ch. Oct. 16, 2013), plaintiffs brought a lawsuit to enjoin a shareholder vote on the company’s acquisition of another company. Plaintiffs brought inadequate-disclosure claims in conjunction with claims for breach of fiduciary duty and aiding and abetting of this breach. The court rejected plaintiffs’ claims, finding that (1) the company provided "management’s best estimates of future financials as of the time of the merger," which was all that was required; (2) the company provided a "fair summary of the inputs and procedure used to construct the fairness opinion," and plaintiffs were not entitled to further "granular details concerning why individual inputs were selected or rejected"; and (3) plaintiffs could not bring claims based on speculative clauses included or not included during the sales process. Id. at *9–10.
In another case, Abrams v. Wainscott, Civ. A. No. 11-00297-RGA, 2013 WL 6021953 (D. Del. Nov. 13, 2013), the plaintiff brought four derivative claims and one direct claim related to a shareholder vote on an incentive compensation plan. The plaintiff’s direct claim was based on the alleged "coercion" of her shareholder vote on the plan, based on the contents of the proxy disclosure. On both the direct and derivative claims, the court granted the company’s motion to dismiss, explaining that the plaintiff’s coercion claim rested on a mischaracterization of what the disclosure actually said. See id. at *7.
In sum, while proxy claims are an oft-used weapon in shareholder derivative suits, they have infrequently led to a successful outcome for plaintiffs.
 In October, JP Morgan settled separate related charges brought by the U.S. Commodity Futures Trading Commission (CFTC). CFTC Press Release, CFTC Files and Settles Charges Against JPMorgan Chase Bank, N.A., for Violating Prohibition on Manipulative Conduct In Connection with "London Whale" Swaps Trades (Oct. 16, 2013), available at http://www.cftc.gov/PressRoom/PressReleases/pr6737-13.
 For purposes of the Section 806 analysis, a "public" company is any company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934 or that files reports with the SEC pursuant to Section 15(d) of the 1934 Act.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following members of the Securities Litigation Practice Group Steering Committee:
Jonathan C. Dickey – Co-Chair, New York/Palo Alto (212-351-2399, 650-849-5370, firstname.lastname@example.org)
Robert F. Serio – Co-Chair, New York (212-351-3917, email@example.com)
Meryl L. Young – Co-Chair, Orange County (949-451-4229, firstname.lastname@example.org)
Thad A. Davis – Co-Chair, San Francisco (415-393-8251, email@example.com)
George H. Brown – Palo Alto (650-849-5339, firstname.lastname@example.org)
Jennifer L. Conn – New York (212-351-4086, email@example.com)
Ethan Dettmer – San Francisco (415-393-8292, firstname.lastname@example.org)
Gareth T. Evans - Orange County (949-451-4330, email@example.com)
Barry R. Goldsmith – New York (212-351-2440, firstname.lastname@example.org)
Mark A. Kirsch – New York (212-351-2662, email@example.com)
Monica K. Loseman – Denver (303-298-5784, firstname.lastname@example.org)
Brian M. Lutz – New York (212-351-3881, email@example.com)
Jason J. Mendro – Washington, D.C. (202-887-3726, firstname.lastname@example.org)
Wayne Smith – Orange County (949-451-4108, email@example.com)
Robert C. Walters – Dallas (214-698-3114, firstname.lastname@example.org)
Aric H. Wu – New York (212-351-3820, email@example.com)
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.