LexisNexis Corporate & Securities Law Community 2011 Top 50 Blogs

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Megabanks and the Need for Glass Steagall

Politico has a piece on why the big banks should not be dismantled.  See Don't Break Up the Megabanks  The article asserts that doing so is radical, costly, and will not necessarily enhance stability.  The article also asserts that reform is working and community banks have more influence than the megabanks.  

Much of the discussion addresses straw arguments.  For example, in describing a breakup as "radical," the article asserted that the "United States government does not normally cap the size of private firms, even gigantic firms like Apple or Wal-Mart. Who would invest in a company that’s legally prohibited from growing?"   It would be unusual and logistically difficult to impose an arbitrary limit on size.  This is, therefore, a highly unlikely method of downsizing megabanks.  

A more likely method would be to limit the types of activities that can be conducted by the megabanks.  Thus, they could grow but not in all segments.  The Volcker Rule was a half hearted step in this direction.    

More directly, however, the article missed the single most important reason altering the size and activities of the megabanks.  Back in 1996, I wrote a piece predicting that, with the repeal of Glass Steagall, investment banks as a separate class of intermediaries would disappear and that the market niche would become dominated by commercial banks.  See The "Great Fall": The Consequences of Repealing the Glass-Steagall Act 

This wasn't a guess; the process had been underway when Congress halted it by adopting Glass-Steagall in the 1930s.  Moreover, over the long term, commercial banks have inherent advantages, including access to deposits and the discount window.  Without artificial barriers, commercial banks will eventually squeeze out the investment banks.  

This prediction made in 1996 came to pass a bit over a decade later.  When the 2008 crisis began, there were five world class investment banking firms in the US.  That quickly changed.  There was the sale of Bear Sterns to JP Morgan, the purchase of Merrill by BofA, and the collapse of Lehman.  Goldman and Morgan Stanley converted to commercial banks.  

Does this matter?  When investment banks existed, they essentially made their profits through risk taking in the the securities markets.  This benefited the markets and made them more dynamic.  Commercial banks are by definition more conservative both because of the oversight by bank regulators (who are permanently on site) and the need to protect deposits.  As a result, the elimination of investment banks as a separate class of intermediaries has likely resulted in reduced risk taking in the securities markets.  This has the potential to cause long term harm to the securities markets. 

Policies with respect to the megabanks should be designed with an eye towards strengthening the securities markets.  Reducing the megabank footprint in the investment banking space would make them smaller and less risky.  It would also allow for the reeemergence of a class of intermediaries designed to ensure the vibrancy of the US securities markets.   


Special Projects Segment: Equity Crowdfunding for Accredited Investors in 2015—An Update

We are discussing equity crowdfunding under Title II of the Jumpstart Our Business Startups (“JOBS”) Act of 2012.

Under Title II of the JOBS Act, accredited investors may invest in projects through crowdfunding platforms or portals, which are regulated by the Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”). According to a recent article, equity crowdfunding reached $662 million in the first quarter of 2015, a $179 million increase from the final quarter in 2014. Industry experts anticipate equity crowdfunding will double on a yearly basis as investors become more knowledgeable about prominent platforms and successful investment sectors.

Crowdnetic, an online platform that tracks equity investments in real-time, publishes quarterly reports on equity crowdfunding data and recently released its report for the first quarter of 2015. The financial sector led capital investments through crowdfunding raising $172.8 million, with the technology and services sectors following closely behind.

Real estate investments, which are included in the financial sector, boasted two of the three largest equity crowdfunded deals to date. 17 John Street utilized for its crowdfunding campaign Prodigy Network, a specialized portal for accredited investors seeking prime Manhattan real estate assets, and has raised $35 million as of April 16, 2015. 17 John Street is thus far the largest equity crowdfunded deal according to Crowdnetic. HLR Properties, a Denver-based oil and gas company, is the second largest equity crowdfunded deal, raising $25 million.

Real estate equity crowdfunding is trending upwards towards larger offerings. Crowdnetic’s report indicated that real estate development and other real estate investments were the largest industries in terms of recorded capital investments with $86 million and $38.7 million, respectively. Eric Smith, director of data analytics at Crowdnetic, noted real estate investments are popular with accredited investors because “‘[i]t’s something they understand. It’s a solid asset.’”

Despite the growing popularity of real estate investments, accredited investors should still consider the risks associated with crowdfunding. Scott Picken, the founder and CEO of Wealth Migrate, a global real estate crowdfunding portal, addressed why many real estate crowdfunding platforms will fail in the saturated market in this article. Picken emphasized the importance of considering investments driven by long-term growth and income rather than securing deals with “best name recognition or publicity value” because real estate deals can take anywhere from two to five years before coming to fruition and sometimes longer. For this reason, among others, investors should be cautious about the collective knowledge and experience of the teams running the real estate deals.

Protecting investors from fraud and providing them with adequate disclosure is a recurring theme with crowdfunding. The SEC has put considerable emphasis on the “wisdom of the crowd” and its ability to determine whether a proposed crowdfund offering is credible. As Eric Smith with Crowdnetic intimated, the investment sector will continue to grow exponentially when accredited investors become familiarized with the platforms and real estate investments, and so investors should remain cautious even in light of the “wisdom of the crowd.”

More on various CEO’s 2015 prediction on real estate crowdfunding can be read here


Preferred Product Placement Corp. v. Right Way Nutrition, LLC: Summary Judgment and Alter Ego Theory

Preferred Product Placement Corp. v. Right Way Nutrition, LLC, Case No: 2:11-cv-00496 (D. Utah Feb. 17, 2015) arose out of a breach of contract dispute between Preferred Product Placement Corporation (“PPPC”) and HCG Platinum, LLC (“Platinum”). In the dispute, PPPC brought counterclaims alleging breach of two contracts. PPPC then amended its counterclaims using the alter ego doctrine to bring claims against Right Way Nutrition, LLC, and its ownership group: Julie Mattingly; Ty Mattingly; Annette Wright; Kevin Wright, LLC; Primary Colors, LLC; and Weekes Holdings, LLC (collectively, the “Third-Party Defendants”). The Third-Party Defendants subsequently moved for summary judgment.

PPPC’s counterclaim alleged the Third-Party Defendants breached two separate contracts. One was subject to the law of Utah; the other the law of California.  The alter ego doctrine allows PPPC to pierce Platinum’s corporate veil and potentially obtain judgments against the Third-Party Defendants. 

The Third-Party Defendants’ moved for summary judgment. Summary judgment is granted when “there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Because one was governed by Utah law and the other by California law, the court analyzed the alter ego standard under the laws of both states.  The court noted, however, that an alter ego’s fact intensive and factor heavy analysis was “not often amenable to summary judgment.”

Under Utah law, an alter ego claim must meet formality and fairness requirements. To aid in this determination, the Utah Supreme Court adopted an eight-factor test. These factors include:

(1)  undercapitalization of a one-man corporation;

(2)  failure to observe corporate formalities;

(3)  nonpayment of dividends;

(4)  siphoning of corporate funds by the dominant stockholder;

(5)  nonfunctioning of other officers or directors;

(6)  absence of corporate records;

(7)  the use of the corporation as a façade for operations of the dominant stockholder or stockholders; and

(8)  the use of the corporate entity in promoting injustice or fraud.

To withstand summary judgment, “evidence of even one of the factors may be sufficient to suggest both elements of a party’s alter ego theory.” The court found PPPC’s evidence sufficient to create a genuine issue of material fact.  Allegations raised an issue of fact as to whether HCG Platinum and Right Way “had merged without observing corporate formalities.” In addition, a genuine issue of material fact excisted over the possible “siphoning of corporate funds by a dominant stockholder.”

Under California law, the corporate form could be disregarded where its affairs were conducted in a manner that made it “merely an instrumentality, agency, conduit, or adjunct of another corporation.” To make this determination, California courts used a non-exhaustive list of factors. The court did not engage in an exhaustive analysis of those factors and simply found that PPPC’s evidence created a genuine dispute of material fact involving more than one factor.

Accordingly, the court denied the Third-Party Defendant’s motion for summary judgment regarding both contracts.

The primary material for this case can be found on the DU Corporate Governance website.


FHFA v. Nomura: Disclosure Violations, Financial Crisis, and the Conclusions of a Fact Finder

FHFA v. Nomura, No. 11cv6201 (DLC) (SD NY May 11, 2015) involved claims arising out of the financial crisis. 

The FHFA brought a number lawsuits against banks and related entities and individuals to recover damages on behalf of Fannie Mae and Freddie Mac arising out of their "investments in residential mortgage-backed securities (“RMBS”), specifically their investment in so-called private-label RMBS (“PLS”)."  The FHFA alleged violations of the securities laws and blue sky statutes.   

Only one of the lawsuits actually went to trial, the one involving Nomura.  A bench trial lasted from March 16 to April 9, 2015.  A week or two ago, the court issued finding of facts and conclusions of law.  The decision is lengthy and detailed.  We note only this paragraph:

  • This case is complex from almost any angle, but at its core there is a single, simple question. Did defendants accurately describe the home mortgages in the Offering Documents for the securities they sold that were backed by those mortgages? Following trial, the answer to that question is clear. The Offering Documents did not correctly describe the mortgage loans. The magnitude of falsity, conservatively measured, is enormous.

There has been a considerable amount written about the need for criminal actions against individuals involved in transactions that led to or caused the financial crisis.  But perhaps what was really needed was more trials and more findings by neutral fact finders as to what actually happened in the period leading up to the financial crisis.  Such findings may have been able to determine whether the "enormous" "magnitude of the falsity" was more the rule than the exception.   


In re Crimson Exploration Inc. Stockholder Litigation: Court Clarifies Application of Entire Fairness Standard

The Delaware Chancery Court dismissed Crimson Exploration, Inc. stockholders’ (“Plaintiffs”) class action lawsuit challenging a stock-for-stock merger between Crimson Exploration, Inc. (“Company”) and Contango Oil & Gas Co. (“Contango”). In re Crimson Exploration Inc. Stockholder Litig., 2014 BL 300486 (Del. Ch. Oct. 24, 2014).

Plaintiffs’ alleged the merger undervalued the Company and deprived stockholders from receiving a fair value for their shares. Plaintiffs argued the entire fairness standard should be applied to the transaction to determine whether the Company’s largest shareholder, Oaktree Capital Management L.P. (“Oaktree”), constituted a controlling shareholder who caused the Company to be sold for inadequate value in exchange for side benefits. The entire fairness standard involves an evaluation of fair dealing and fair price to evaluate the transaction as a whole to determine the overall fairness to the shareholders. In addition, the Plaintiffs’ asserted that the controlling shareholder and the Company’s board breached their fiduciary duties to the shareholders in executing the merger transaction.

The Company, Contango, Oaktree, and Company directors (collectively the “Defendants”) argued Oaktree was not a controlling shareholder and, further, that Plaintiffs had not pleaded sufficient facts to trigger entire fairness review.

First, the court analyzed what constituted a controlling shareholder. It noted that although Oaktree owned less than 50 percent of the Company, it could still be considered a controlling shareholder if it “exercises control over the business affairs of the corporation.” The Vice Chancellor noted that a large shareholder will not be considered a controlling shareholder unless it actually controlled the Company’s board’s decision over the conflicted transaction. A conflicted transaction can occur when a controlling shareholder is on both sides of the transaction or when the controlling shareholder receives some benefit that competes with the common shareholders’ consideration.

Plaintiffs conceded that Oaktree was not on both sides of the transaction, instead alleging that it received some additional considerations from the merger transaction. The court rejected Plaintiffs’ allegations stating that they failed to present specific facts to overcome the presumption that shareholders have an incentive to seek the highest price for their shares. Accordingly, the court declined to apply the entire fairness standard.

Because a majority of the Company’s board were independent and disinterested in the transaction, the court held that the business judgment rule applied. The court ultimately dismissed Plaintiffs’ claims, holding they did not present sufficient facts to rebut the business judgment rule.

The primary materials for this case can be found on the DU Corporate Governance Website.



Intercept Pharmaceuticals Securities Litigation Continues: Plaintiffs Adequately Alleged Scienter Regarding Defendants’ Failure to Disclose Safety Issues

A purported class of investors (“Plaintiffs”) brought actions pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 against Intercept Pharmaceuticals, Inc. (“Intercept”) and its Chief Executive Officer and Chief Medical Officer (collectively, “Defendants”) in the United States District Court for the Southern District of New York alleging the omission of negative information from drug trial results in a press release. In re Intercept Pharmaceuticals, Inc. Securities Litigation., No. 14 Civ. 1123, 2015 BL 58016 (S.D.N.Y. Mar. 4, 2015).

Defendants moved to dismiss the Consolidated Amended Complaint (“CAC”) under Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure and pursuant to 15 U.S.C. § 78u-4 of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), arguing the Plaintiffs failed to adequately allege scienter. The court found the pleading sufficient and denied the Defendants’ Motion to Dismiss.

According to the allegations, Intercept is a publicly traded biopharmaceutical company that was developing obeticholic acid (“OCA”) as a treatment for liver ailments, including nonalcoholic steatohepatitis (“NASH”), for which there is no approved drug. The National Institute of Diabetes and Digestive and Kidney Diseases (“NIDDK”) conducted a trial, known as “FLINT,” to test OCA as a treatment for NASH. The trial was stopped early on the basis of “efficacy” and “significant lipid abnormalities” in patients.

After becoming aware of the findings through a series of conversations and emails between the Chief Medical Officer and NIDDK’s Scientific Advisor, according to the allegations, Intercept issued a press release and held a conference call with analysts and investors regarding the conclusion of the FLINT trial. The Company did not mention the finding of lipid abnormalities. Following the release, Intercept’s stock price rose from $73.39 to $497 per share between January 9 and 10, 2014, ultimately closing at $445.83. After receiving media requests for additional information, NIDDK released a statement disclosing the findings of lipid abnormalities, causing Intercept’s stock price to drop to $190.71 per share by January 13, 2014.

Plaintiffs filed suit alleging, among other things, that Intercept violated the antifraud provisions by omitting to mention the  “the significant lipid abnormalities” identified in the trial.  Defendants moved to dismiss, arguing Plaintiffs failed to adequately plead scienter.

Under FRCP 9(b), the pleading requirements for securities fraud are heightened. In addition, the PSLRA requires a plaintiff to allege particular facts that “give rise to a strong inference that the defendant acted with the required state of mind.” This inference can be established by alleging facts that demonstrate the “defendants had both motive and opportunity to commit fraud” or “strong circumstantial evidence of conscious misbehavior or recklessness.”

The court found Intercept’s alleged failure to mention the lipid abnormalities gave rise to “a sufficient inference of scienter.” Intercept was informed the trial was stopped on the basis of a positive and a negative development (lipid abnormalities), and Intercept chose to selectively report only the positive development, which created a “real possibility of misleading investors.” Concerned the information would “cause issues,” Intercept sought approval for the selective disclosure, evidencing the decision was made knowingly.

Because the court found that the allegations in the complaint were sufficient to establish that Intercept acted consciously and recklessly in failing to disclose the lipid abnormalities, Plaintiffs’ allegations were deemed sufficient to adequately plead scienter pursuant to Rule 9(b) and the PSLRA. Accordingly, the court denied Defendants’ Motion to Dismiss.

Primary materials for this case may be found on the DU Corporate Governance website.


WTO Rules Against United States Country of Origin Labeling Rule

In a widely-anticipated move, the World Trade Organization’s Appellate Body on May 18th ruled against the U.S. Country of Origin Labeling (“COOL”) rule for meats, upholding the compliance panel’s report that the rule discriminates against Canada and Mexico.  As has been discussed in prior posts (here and here), the COOL rules have been the subject of litigation brought by the American Meat Institute (“AMI”).  The AMI lost its court fight (or at least abandoned the effort after several actions) but now may have won the larger battle.  Retaliation by Canada and Mexico is likely unless steps are taken to amend the offending portions of the rule.

Not surprisingly some industry insiders are in a backwards way, pleased with this outcome as it may lead to changes in the law. National Cattlemen’s Beef Association President and Chugwater, Wyoming cattleman, Philip Ellis said:

We have long said that COOL is not just burdensome and costly to cattle producers, it is generally ignored by consumers and violates our international trade obligations “Now that the WTO has ruled for a fourth time that this rule discriminates against Canadian and Mexican livestock, the next step is retaliation by Canada and Mexico. Retaliation will irreparably harm our economy and our relationships with our top trading partners and send a signal to the world that the U.S. doesn't play by the rules. It is long past time that Congress repeal this broken regulation.”

The NCBA calls on Congress to fix this broken rule and supports legislation to repeal COOL before retaliation is awarded. Canada has released detailed proposed targets for retaliatory tariffs by state here.


Similarly, the AMI reacted strongly to the ruling:

If there ever was any question that that mandatory country-of-origin labeling is a trade barrier that violates our international agreements, the World Trade Organization’s (WTO) ruling against the United States today should lay those doubts to rest. The WTO has spoken not once, not twice, not three times, but four times in panel and appellate body decisions. All four rulings found against the U.S.

Now, after years of grappling with this costly and onerous rule – a rule that USDA’s own economic analysis says is a burden on livestock producers, meat packers and processors with no consumer benefit – it is clear that repealing the statute is the best step forward.

While the WTO action says nothing about US disclosure laws, it shows the many avenues of attack that US business have against compelled commercial speech.  What the AMI could not achieve through the US courts was handed to them by this international body.  The decision thus leaves open the question of precisely where the boundaries lie under US for mandated disclosure.


Independent Directors May Be Dismissed Under Exculpatory Provisions Regardless of Standard of Review

In In re Cornerstone Therapeutics Inc. Stockholder Litigation, Nos. 564, 2014 & 706, 2014 (Del. May 14, 2015), the Delaware Supreme Court resolved two consolidated interlocutory appeal in favor of defendant directors.  Try not to be too surprised.  The cases were consolidated because, as noted by Chancellor Strine 

  • they turn on a single legal question: in an action for damages against corporate fiduciaries , where the plaintiff challenges an interested transaction that is presumptively subject to entire fairness review, must the plaintiff plead a non-exculpated claim against the disinterested, independent directors to survive a motion to dismiss by those directors? 

In the prior cases, the Delaware Court of Chancery had refused to dismiss claims against independent directors who were arguably protected by an exculpatory clause at the pleading stage.  For example, in one of the underlying cases, In re Cornerstone Therapeutics Stockholder Litigation, C.A. No. 8922-VCG (Del. Ch. Sept. 9, 2014) plaintiffs challenged the acquisition of the minority interest in Cornerstone Therapeutics by its controlling stockholder.  Defendant directors acknowledged that the transaction was subject to the entire fairness because it was between the corporation and its controlling shareholder, but claimed that because of the exculpatory provision, all claims against them must be dismissed in the absence of a pleaded non-exculpatory claim (which there was none). 

Plaintiffs claimed that because the challenged transaction was subject to entire fairness review, directors must remain parties to the action until the end of the litigation because there was a distinct possibility that discovery would produce evidence to support more serious bad-faith charges. 

The Chancery Court agreed with the plaintiffs and refused to dismiss the claims, noting that  Emerald Partners "made clear" that a controlling stockholder transaction was subject to entire fairness review ab initio, and therefore, any exculpatory clauses in the charter can only be applied after the basis for liability has been decided.

In the Supreme Court opinion, Chancellor Strine reversed and remanded the earlier cases holding that a 

  • plaintiffs seeking only monetary damages must plead non-exculpated claims against a director who is protected by an exculpatory charter provision to survive a motion to dismiss, regardless of the underlying standard of review for the board's conduct—be it Revlon, Unocal, the entire fairness standard, or the business judgment rule.
  • We hold that even if a plaintiff has pled facts that, if true, would require the transaction to be subject to the entire fairness standard of review, and the interested parties to face a claim for breach of the duty of loyalty, the independent directors do not automatically have to remain defendants. When the independent directors are protected by an exculpatory charter provision and the plaintiffs are unable to plead a non-exculpated claim against them, those directors are entitled to have the claims against them dismissed….  

The Court acknowledged that the law on the issue “presents a debate between two competing but colorable views of the law” and then ruled firmly in favor of directors finding multiple reasons not require independent directors to remain subject to the litigation if no non-exculpatory claim was brought against them.

The Court noted 

  • The plaintiffs argue that they should be entitled to an automatic inference that a director facilitating an interested transaction is disloyal because the possibility of conflicted loyalties is heightened in controller transactions, and the facts that give rise to a duty of loyalty breach may be unknowable at the pleading stage.  But  there are several problems with such an inference : to require independent directors to remain defendants  solely because the plaintiffs stated a non-exculpated claim against the controller and its affiliates would be inconsistent with Delaware law and would also increase costs for disinterested directors, corporations, and stockholders, without providing a corresponding benefit.

According to the Court, each director is entitled to be judged separately and is presumed to be acting loyally.  Further, simply because the controlling shareholder may be found to have acted disloyally, that does not entitle plaintiffs to argue that an independent director is not entitled to the business judgement rule.  In addition, the Court argued that allowing dismissal of claims against independent directors at the pleading stage is beneficial to minority shareholders: 

  • We decline to adopt an approach that would create incentives for independent directors to avoid serving as special committee members, or to reject transactions solely because their role in negotiating on behalf of the stockholders would cause them to remain as defendants until the end of any litigation challenging the transaction. 

The decision ends the uncertainty about the reach of Emerald Partners which some had believed applied in the context of these cases.  Chancellor Strine addressed this issue specifically and stated 

  • the Court in Emerald Partners was focused on a separate question; namely, whether courts can consider the effect of a Section 102(b)(7) provision before trial when the plaintiffs have pled facts supporting the inference not only that each director breached not just his duty of care, but also his duty of loyalty, when the applicable standard of review of the underlying transaction is entire fairness. [Therefore, the holding that director must remain parties to the litigation applies only when] referring to a case where there was a viable, non-exculpated loyalty claim against each putatively independent director.  

Directors should be very happy with this decision (and anyone familiar with the Delaware Supreme Court cannot be surprised).  The decision makes it clear that plaintiffs who seek to hold seemingly independent directors to account in a controlling party transaction must plead facts creating an inference that such directors approved the transaction through a breach of their duty of loyalty. This may be quite difficult at the initial stages of litigation and will in all likelihood end providing an avenue for early exit for allegedly disinterested and independent directors.


Executive Compensation and Entire Fairness: Calma v. Templeton (Part 2)

We are discussing Calma v. Templeton, a recent decision in which the Chancery Court held that the applicable standard of review for awards under a compensation plan was entire fairness.

The case took an interesting approach in addressing demand futility.  The court applied the standard from Rales.  As a result, demand excusal was met where shareholders created “a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.”  The applicable standard for the absence of disinterest was whether a director “appear[s] on both sides of a transaction [or] expect[s] to derive any personal financial benefit from it in the sense of self-dealing.”

According to the allegations, all of the directors in the case benefited from the plan and were, as a result, "on both sides" of the transaction.  Nonetheless, shareholders did not assert that the amounts received by the directors were material.  Instead: 

  • Plaintiff contends that where, as here, there are derivative claims challenging the compensation received by directors, those directors are interested for demand futility purposes because they “have a personal financial interest in their compensation for their service as directors,” regardless of whether the compensation they received was material to them personally.

While conceding that directors were generally not considered interested “simply because [they] receive compensation from the company”, the court found that in the context of a challenge to compensation it was enough to show that the directors received payments.  See Id.  ("in a derivative challenge to director compensation, there is a reasonable doubt that the compensation at issue—regardless of whether that compensation was material to them on a personal level—can be sufficiently disinterested to consider impartially a demand to pursue litigation challenging the amount or form of their own compensation").  

As a result, shareholders survived dismissal for failure to make demand without having to show materiality of the payments.  Nonetheless, the court viewed the analysis as limited to the compensation area.  Id.  ("But, a derivative challenge to director compensation is different because the law is skeptical that an individual can fairly and impartially consider whether to have the corporation initiate litigation challenging his or her own compensation, regardless of whether or not that compensation is material on a personal level."). 

To the extent that this become the general approach, compensation decisions will at least be more often addressed on the merits rather than dismissed as a result of a failure to show demand futility.  Moreover, the approach will likely permit more challenges to compensation to survive motions to dismiss.  The approach, therefore, is not particularly management friendly.  It will be interesting to see if the approach survives once it is reviewed by the Supreme Court.    


Executive Compensation and Entire Fairness: Calma v. Templeton (Part 1)

In Calma v. Templeton, shareholders challenged director compensation paid under a compensation plan. Shareholders asserted that the correct standard for review as entire fairness; the defendants argued for waste. The standard mattered.

The court found that the allegations were sufficient to make a claim for a lack of fairness but not for waste.  Id.  ("Although Plaintiff has stated a claim that the RSU Awards were not entirely fair to the Company in comparison to the compensation received by directors at Citrix’s peer group, the Complaint does not plead in my view the rare type of facts from which it is reasonably conceivable that the RSU Awards are so far beyond the bounds of what a person of sound, ordinary business judgment would conclude is adequate consideration to the Company.").  

Resolution turned upon the impact of shareholder approval.  Because all directors (including the three on the compensation committee) were alleged to have benefited from the plan, the court found that the transaction was not entitled to the presumption of the business judgment rule.  Id. ("The Compensation Committee approved the RSU Awards to the Company’s nonemployee directors in 2011, 2012, and 2013. These were conflicted decisions because all three members of the Compensation Committee received some of the RSU Awards.").  

Defendants, however, asserted that shareholder approval changed the standard of review to entire fairness to waste.  The court agreed that "valid ratification" resulted in the application of the waste standard.  Id.  ("valid stockholder ratification leads to waste being the doctrinal standard of review for a breach of fiduciary duty claim.").  Waste was the applicable standard because majority approval was insufficient for ratification. Id.  ("Approval by a mere majority of stockholders does not ratify waste because “a waste of corporate assets is incapable of ratification without unanimous stockholder consent.”).

The court ultimately concluded that ratification had not occurred and that the applicable standard was, therefore, entire fairness.  The court determined that ratification required approval either of the actual awards given under the plan or of a plan that contained meaningful limits on the amount of compensation that could be paid to the directors.  As the opinion stated: 

  • In my view, Defendants have not carried their burden to establish a ratification affirmative defense at this procedural stage because Citrix stockholders were never asked to approve—and thus did not approve—any action bearing specifically on the magnitude of compensation for the Company’s non-employee directors. Unlike in Steiner or Vogelstein, the Plan here does not set forth the specific compensation to be granted to non-employee directors. And, unlike in 3COM, the Plan here does not set forth any director-specific “ceilings” on the compensation that could be granted to the Company’s directors. 

Shareholders, therefore, garnered a victory by fending off a motion for dismiss.  Directors would have to show that the compensation paid under the plan was "fair."

In the broader scheme of things, the holding was likely to have little impact on the problem of escalating compensation.  Presumably boards can obtain the benefits of the waste standard simply by including in a plan limits on director awards.  Moreover, as long as the awards are not on their face unreasonable, it is unlikely that the limits need to be truly meaningful.

Nonetheless, the opinion contains a number of interesting and unexpected legal observations that may have some significance in future decisions.  We will discuss them in the next post.     


Omnicare Inc. v. Laborers District Council Construction Industries Pension Fund: Qualifying §11 Liability for Opinion Statements

Omnicare Inc. v. Laborers District Council Construction Industries Pension Fund, 135 S.Ct. 1318 (2015) involved alleged liability under §11 of the Securities Act of 1933 (“§11”) on the part of Omnicare Inc. (“Omnicare”).  Professors Brown and Taylor, both regular contributors to this Blog, contributed to an amicus brief on behalf of law and business faculty in this case.  A copy of the Brief can be found here:   

Pension funds that purchased Omnicare stock in a public offering (the “Respondents”) filed suit claiming that the Company’s registration statement contained, among other things, false statements of opinion. Specifically, Respondents asserted that a statement of belief about the Company’s compliance with the law was a “materially false.”   Defendants, in contrast, argued that an opinion could only be false for purposes of Section 11 liability where the speaker did not actually believe that the opinion.  

The Court of Appeals for the Sixth Circuit held Respondents were only required to allege that the opinion statement was objectively false. With a division in the circuits over the appropriate standard for the falsity of an opinion under the federal securities laws, the Supreme Court granted certiorari. 

The Court held that an expression of opinion could be false when the speaker did not honestly hold the stated belief.  In addition, opinions could also include “embedded statements of fact” that could be false.   Id. (“Accordingly, liability under §11’s false-statement provision would follow (once again, assuming materiality) not only if the speaker did not hold the belief she professed but also if the supporting fact she supplied were untrue.”). Thus, because Respondents did not contest Omnicare’s opinion was honestly held, it could not avail itself to sue under the false-statement provision.

An opinion could, however, also be misleading as a result of omissions.  Some opinion statements could lead investors to conclude the issuer relied on facts about the speaker’s basis for holding that view.  Id. (“a reasonable investor may, depending on the circumstances, under- stand an opinion statement to convey facts about how the speaker has formed the opinion—or, otherwise put, about the speaker’s basis for holding that view.”).  To the extent that the speaker did not have the requisite basis (and failed to disclose this lack of basis), the statement of opinion could still mislead.  See Id. (where issuer makes statement about legal compliance “without having consulted a lawyer, it could be misleadingly incomplete”).  Likewise an opinion might be false where the speaker possessed information  “incompatible with [the] opinion.” 

The Court found that meeting the pleading standards was “no small task for an investor.”  As the Opinion reasoned: 


  • the investor cannot just say that the issuer failed to reveal its basis. Section 11’s omissions clause, after all, is not a general disclosure requirement; it affords a cause of action only when an issuer’s failure to include a material fact has rendered a published statement misleading. To press such a claim, an investor must allege that kind of omission—and not merely by means of conclusory assertions. To be specific: The investor must identify particular (and material) facts going to the basis for the issuer’s opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context. (Citations omitted) 


The Court vacated the court of appeals’ decision and remanded the case because the lower courts did not consider Respondent’s omissions theory under the correct standard.

The primary material for this case can be found on the DU Corporate Governance website.  


NYSA Series Trust v. ESPSCO Syracuse, LLC: Court Dismisses Complaint Alleging Section 10(b) Violation

In NYSA Series Trust v. ESPSCO Syracuse, LLC, No. 5:14-CV-1089, 2015 BL 2727 (N.D.N.Y. Feb. 3, 2015), the United States District Court for the Northern District of New York dismissed fraudulent misrepresentation claims with prejudice, holding twenty-two purchasers of debt securities (“Plaintiffs”) failed to offer anything more than conclusory allegations in support of their claims. The court also held, even if adequately pled, the claim was barred by the statute of limitations.

According to the allegations, Patrick Dessein, Dr. Brett Greenky, Dr. Seth Greenky, and Dr. Glenn Axelrod served as founders and managing members of ESPSCO Syracuse, LLC (“ESPSCO” and collectively with the listed individuals “Defendants”) to raise funds for an affiliated entity known as Syracuse Packaging International, LLC (“SPI”). ESPSCO sought funds by offering $1,700,000 in notes to accredited investors, including Plaintiff, in a private offering.  On January 1, 2012, ESPSCO defaulted on its obligation to pay interest on the notes, and SPI failed to honor its obligation as guarantor.

Plaintiffs filed suit, alleging, along with state law claims, that Defendants violated Section 10(b) of the Securities Exchange Act of 1934 by making fraudulent misrepresentations in the offering materials used in connection with the sale of the notes. Plaintiffs asserted misrepresentations or omissions regarding (1) the adequacy of the minimum investment amount to fund the proposed operation of ESPSCO; (2) the fact that funds would be “diverted” to SPI; and (3) the adequacy of SPI’s capitalization for purposes of guaranteeing the investment. Defendants filed a motion to dismiss for failure to state a claim.

 Section 10(b) forbids the making of any untrue statement of a material fact or the omission of any material fact necessary to not be misleading. To state a claim for securities fraud under Section 10(b), a plaintiff must allege: (1) a material misrepresentation or omission; (2) scienter; (3) a connection to the purchase or sale of a security; (4) reliance upon the misrepresentation; (5) economic loss; and (6) a causal connection between the misrepresentation or omission and economic loss.

 Plaintiffs argued the statement, “[a] minimum amount of $200,000 shall be required to be raised in order for the Company to complete a closing hereunder,” falsely suggested that the amount would be sufficient to fund ESPSCO’s operations for a reasonable period of time. The court disagreed. The court reasoned the statement did not speak to the adequacy of funding for ESPSCO’s operations, much less guarantee stability for any period of time. Rather, the materials simply explained that $200,000 was required before the closing could occur.

Second, Plaintiffs asserted that language providing for the use of proceeds in the offering “(a) to acquire the accounts receivables of SPI for factoring, (b) to enter into a commercial loan with SPI, and (c) for general operating expenses of the Company” was misleading because it implied that the highest priority for proceeds was acquiring the SPI accounts receivable for factoring. Plaintiffs also asserted the provision failed to advise them of ESPSCO’s ability to divert the proceeds to SPI. The court rejected this argument, finding the provision did not prioritize how the proceeds would be used and the second enumerated use specifically anticipated diverting SPI funds through a commercial loan.

Finally, Plaintiffs asserted that  language in the offering materials was misleading because it created an implication SPI was  capitalized sufficiently to unconditionally guarantee the “punctual payment” of the notes. See Offering Materials (“If the Company fails to make any payment when due under the notes, the sole remedy of the noteholders will be limited to proceeding against SPI to recover full payment thereon.”). The court disagreed, explaining that this statement merely identified SPI as guarantor and provided for the sole remedy in the event payment was not made, rather than promising an unconditional guarantee. The court also noted the “Form of Guaranty” explicitly stated it was a “guaranty of payment,” not a “guaranty of collection.”

In sum, the United States District Court for the Northern District of New York found nothing but conclusory allegations, which were belied by the language of the documents. Accordingly, the court dismissed the complaint with prejudice and dismissed the remaining state claims without prejudice for a lack of jurisdiction.

The primary materials for this post can be found on the DU Corporate Governance website


National Credit Union Administration Board v. Barclays Capital, Inc.: Court Permits Tolling Under Extender Statute

In National Credit Union Administration Board v. Barclays Capital Inc., No. 13-3183, 2015 WL 876526 (10th Cir. Mar. 3, 2015), the United States Court of Appeals for the Tenth Circuit held the claims brought by the National Credit Union Administration Board (“Plaintiff”) were barred by the statute of limitations. The court further held, however, the statute of limitations defense was unavailable to Barclays Capital, Inc., BCAP LLC, and Securitized Asset Backed Receivables LLC (together, the “Defendants”) as a result of their express promise not to assert it.

As an independent federal agency, Plaintiff regulates federally insured credit unions. Plaintiff may serve as conservator and liquidating agent when a credit union under conservatorship fails. While serving as conservator for U.S. Central Federal Credit Union and Western Corporate Federal Credit Union, Plaintiff alleged that the credit unions failed because they invested certain residential mortgage-backed securities (“RMBS”) based upon misleading “offering documents that misrepresented the quality of their underlying mortgage loans.” The RMBS were eventually downgraded to “junk status.”  

Plaintiff sought to recover from the issuers of the RMBS securities on behalf of the credit unions. Plaintiff and Defendants entered into a series of tolling agreements that would exclude time spent in settlement negotiations from any calculation of the statute of limitations. The Defendants also agreed not to “argue or assert” a statute of limitations defense in any future litigation.

After the negotiations failed, Plaintiff filed claims against the Defendants asserting violations of Sections 11 and 12(a)(2) of the Securities Act of 1933. Plaintiff alleged the securities’ offerings contained material misrepresentations about the quality of the underlying mortgage loans. The Defendants moved to dismiss the complaint for failure to state a claim, arguing Plaintiff’s federal claims were untimely under the Securities Act’s three-year statute of repose.

Plaintiff argued that the three-year period began on the date of the commencement of the conservatorship under the Federal Credit Union Act’s “Extender Statute.” Although filing suit more than three years after becoming the conservator, Plaintiff asserted that the time excluded by the tolling agreements made the filing timely and within the three-year period.   

The lower court rejected the Defendants’ argument that Plaintiff’s claims were time-barred and dismissed Plaintiff’s suit under the three-year limitations period of the Extender Statute. The court held the Extender Statute’s three-year limitations period could not be extended by a tolling agreement, and the Defendants’ promise not to assert a tolled limitations defense did not bar application of the unmodified limitation period in the Extender Statute.

On appeal, the court agreed that the limitations period in the Extender Statute could not be lengthened by a tolling agreement. Nonetheless, the court held that the Extender Statute was a statute of limitations, not a statute of repose. A statute of repose ended a cause of action, while a statute of limitations created an affirmative defense. A statute of limitations, unlike a statute of repose, could be waived. 

Whether a time period was a statute of limitation or period of repose depended upon a multifactor test. With respect to the Extender Statute, the provision (1) referred to itself as a “statute of limitations” and never used the term “repose”; (2) referred to the date a claim accrued, implicating a limitations-like analysis; (3) tied the limitations period to a variable dependent on an individual claimant’s cause of action; and (4) used phraseology indicating Congress’s intent to create a statute of limitations. In addition, the purpose and legislative history of the Extender Statute implied that it was “amenable to tolling, waiver, and estoppel agreements.”  

Although a limitations period could be tolled by agreement, the court found that this was not permitted under the language of the statute. The statute did not, however, preclude application of the promise made by Defendants not to assert a statute of limitations defense. The court found that the promise estopped the Defendants from raising the defense. 

  • It is often the case that an affirmative defense is meritorious and would be successful if raised, but the defense is nevertheless unavailable to the party seeking to assert it, either because that party neglected to raise it in the timely fashion or because that party is estopped from asserting it. This is true even for many constitutional rights. So it is unremarkable that a party can be estopped from asserting a statute of limitations defense, particularly when its promise not to do so is limited in scope, between two parties of equal bargaining strength, and facilitates a strong public policy of encouraging settlements. Such is the case here. Thus, while it is true that the NCUA's claims are outside the statutory period and therefore untimely, that argument is unavailable to Barclays because the NCUA reasonably relied on Barclays's express promise not to assert that defense. (citation omitted). 


In sum, the United States Court of Appeals for the Tenth Circuit found the Defendants’ argument that Plaintiff’s claims were outside the statutory period was unavailable due to the Defendants’ express promise not to assert that defense. Accordingly, the court reversed and remanded for further proceedings.

The primary materials for this post can be found on the DU Corporate Governance website.


Court Again Applies Garner in a Section 220 Records Request but Exact Reach of Section Remains Unclear

As discussed in an earlier post, the Delaware Court of Chancery in Indiana Electrical Workers Pension Trust Fund IBEW v. Wal-Mart Stores Inc. found that the Garner exception to attorney-client privilege applies to Section 220 records requests, meaning that attorney-client privilege will not necessarily prevent an order being granted requiring their production. In In Re Lululemon Athletica Inc. 220 Litigation, confirmed this approach but left the exact reach of the section unclear.

At issue were two sets of emails—some that Lululemon claimed were subject to attorney-client privilege and therefore need not be produced in response to a Section 220 request and somecontained in non-employee personal emails that Lululemon claimed were outside the reach of Section 220. 

With regard to the emails asserted to be privileged, the Court confirmed the finding of Indiana Electrical Workers Pension Trust Fund IBEW v. Wal-Mart Stores Inc. stating that those emails were

properly designated as privileged, and that privilege was not waived as to either  [but that] Plaintiffs have shown good cause to access those documents under the fiduciary exception as articulated in Garner and Wal-Mart.

Underlying the fiduciary exception is the importance of ―balanc[ing] the legitimate assertion of the attorney-client privilege by corporate fiduciaries in furtherance of full and frank communications with counsel on the one hand, with the right of a [stockholder] to discover what advice was given . . . when a breach of duty by those same fiduciaries is alleged.

Garner itself enumerated a number of factors that illustrate ―good cause to set aside privilege. The Supreme Court in Wal-Mart adopted and applied that analysis, identifying the following as relevant factors:

 [1] the number of shareholders and the percentage of stock they represent; [2] the bona fides of the shareholders; [3] the nature of the shareholders‘ claim and whether it is obviously colorable; [4] the apparent necessity or desirability of the shareholders having the information and the availability of it from other sources; [5] whether, if the shareholders‘ claim is of wrongful action by the corporation, it is of action criminal, or illegal but not criminal, or of doubtful legality; [6]whether the communication is of advice concerning the litigation itself; [7] the extent to which the communication is identified versus the extent to which the shareholders are blindly fishing; and [8] the risk of revelation of trade secrets or other information in whose confidentiality the corporation has an interest for independent reasons.

Thus, it is clear that under Delaware law, if plaintiffs satisfy the requirements of showing good cause, attorney-client privilege will not block the production of documents.

With regard to the emails of the non-employee directors, the Court was less definitive.  It left the door open for both plaintiffs and defendants to argue over whether such documents should be subject to a Section 220 request, noting that a court would have to conduct a careful review of the circumstances of the case, and in particular the facts relating to whether the sought-after documents were within the corporation’s possession, custody, or control.

It did not engage in that analysis in this case (and hence did not resolve whether such documents could be reached) because it found that non-employee emails were not necessary for plaintiff’s proper purpose (because plaintiffs could obtain the same information from other emails subject to a production order.)  Importantly however, the Court did not say that such emails could never be subject to a Section 220 production order and hence one can anticipate a future claim of this sort.  In fact, the Court was careful to note that the issue remains open

In Wal-Mart, this Court ordered that certain officers and directors who were designated as custodians in the Section 220 discovery had to search their personal devices and computers for responsive documents. (Defendant shall: . . . Collect and review data from the personal computers and devices of all Custodians.) Then -Chancellor Strine‘s ruling in Wal-Mart I did not announce a per se rule that directors‘ personal emails always are subject to discovery under Section 220; rather, it left open the possibility that, depending on Wal-Mart‘s policy for use of company information and documents on non-company devices, information residing in the directors‘ personal computers may or may not have to be produced.

Furthermore, while the Delaware Supreme Court affirmed then-Chancellor Strine‘s judgment en toto, the specific issue of whether Section 220 reaches directors‘ personal documents was not briefed or argued by the parties on appeal.

Given the importance of Section 220 actions, any open issue is bound to be the subject of future claims.  So where are we now?  We know that attorney-client privilege will not necessarily block the production of some documents, but are left unsure of whether non-employee documents can be obtained or not.  I trust we will see the issue played out at some point in the future.


PricewaterhouseCoopers International Limited Terminated as a Party to NQ Mobile, Inc. Securities Litigation Based on the Failure to Plead Facts Necessary to Sustain “control” and “culpable participation.”

In In re NQ Mobile, Inc. Securities Litigation, No. 13cv7608, 2015 BL 87523 (S.D.N.Y. 2013), the United States District Court for the Southern District of New York granted PricewaterhouseCoopers International Limited’s (“PwC International”) motion to dismiss for failure to state a claim after determining that Lead Plaintiffs, who filed on behalf of persons who acquired American Depository Shares of NQ Mobile, Inc. (“NQ”), failed to plead facts necessary to sustain “control” and “culpable participation” by PwC International under Section 20(a) of the Securities Exchange Act of 1934 (the “Act”). 

Lead Plaintiffs brought a federal securities class action against Defendants NQ, various present and former NQ executives, NQ’s auditors PricewaterhouseCoopers Zhong Tiang (“PwC China”), and PwC International, the coordinating entity of PwC member firms. In the complaint, Lead Plaintiffs alleged that PwC International acted as a “controlling person” based on an underlying violation by PwC China of Section 10(b) and Rule 10b-5 of the Act. PwC International moved to dismiss under FRCP 12(b)(6).   

NQ, a Chinese company specializing in security and privacy-related mobile internet services, allegedly overstated its performance and concealed adverse facts about the business in public filings. Lead Plaintiffs alleged PwC China “issued unqualified audit opinions on NQ’s year-end financial statements for FY 2011 and 2012,” and PwC International acted as a “controlling person.”

To establish a prima facie case of control person liability, a plaintiff must show a primary violation, control of the perpetrator by the defendant, and culpable participation in the fraud in some meaningful way. “Control” is established by alleging the defendant possessed the power to direct the management and policies of the controlled person. “Culpable participation” is established by alleging particularized facts of the controlling person’s conscious misbehavior or recklessness.

The court found Lead Plaintiffs’ allegations conclusory, determining that control under Section 20(a) was not satisfied by a coordinating entity merely setting “professional standards and principles” under which the individual offices must operate. Furthermore, because PwC International did not provide any actual professional services for third parties, and the control person must have had actual control over the transaction in question, Lead Plaintiffs did not sufficiently plead that PwC International exerted actual control over the 2011 and 2012 NQ audits.

Lastly, after considering contrary district court opinions, the court reasoned a plaintiff must allege “culpable participation” and plead that element with particularity. Under these standards, the court found Lead Plaintiffs did neither because they failed to allege facts showing direct participation by PwC International in the NQ audits or that “PwC International acted with a culpable state of mind.”

Because the court found Lead Plaintiffs failed to plead facts necessary to sustain the elements of “control” and “culpable participation,” the court held Lead Plaintiffs failed to plead PwC International acted as a “controlling person.” Therefore, the court granted the motion to dismiss the Section 20(a) claim and terminated PwC International as a party.

Primary materials for this case may be found on the DU Corporate Governance website.


ATP, Chevron and the Inevitable Consequences: Bylaws Restricting Shareholder Proposals (Part 4)

This bylaw applies to director nominations and proposals to be considered at an annual meeting of stockholders.  The relationship between the bylaw and Rule 14a-8 is not entirely clear.  To the extent that the 1% threshold seeks to change the eligibility under Rule 14a-8 for the submission of proposals, it is presumably preempted.  

The bylaw does not, however, specifically reference Rule 14a-8.  Moreover, a description of the impact of the bylaw appears in a provision that describes proposals "that a stockholder intends to present to stockholders other than by inclusion in our proxy statement for the 2016 annual meeting".   The provision does not, therefore, appear to change the eligibility of shareholders to submit proposals under Rule 14a-8 but does will affect what shareholders can do at a meeting.

Of course, the restriction may provide a basis for arguing that proposals submitted by shareholders owning less than 1% can be excluded under Rule 14a-8. The Rule permits the exclusion of proposals that are "[i]mproper under state law." 17 CFR 240.14a-8(c)(1). The argument would be that a proposal is improper because the shareholder lacks the authority to make the proposal.  Moreover, Rule 14a-8 requires that the shareholder (or a representative) "attend the meeting to present the proposal."  Under the bylaw, however, the shareholder would presumably be prohibited from presenting a proposal that he or she had no authority to make.  

Even if the proposal remained in the proxy statement under Rule 14a-8, there is room to argue that the votes need not be counted since the shareholder lacks the authority to make the proposal.  Companies are, however, required to disclose voting rules in a Form 8-K for "any matter [that] was submitted to a vote of security holders".  See Item 5.07 of Form 8-K.  This suggests that matters submitted to shareholders under Rule 14a-8 must be reported.

Despite the uncertain relationship between the bylaw and Rule 14a-8 and issues of legality, the staff does not appear to have made significant comments.  The proposal was prefiled.  There are differences between the draft and the final version but they are modest and do not look like the types of changes that would arise from a close staff inspection.   

For a recent piece on Fee Shifting Bylaws and the approach taken by the Delaware courts to bylaws, see The Future Direction of Delaware Law (Including a Brief Exegesis on Fee Shifting Bylaws)


ATP, Chevron and the Inevitable Consequences: Bylaws Restricting Shareholder Proposals (Part 3)

There are a number of things to observe with respect to the approach taken by Ashford.  First, issues exist with the company's authority to adopt the bylaw.    

Maryland allows bylaws that regulate the management and affairs of the corporation.  See MD Code Ann. § 2-110 (a) ("The bylaws may contain any provisions not inconsistent with law or the charter of the corporation for the regulation and management of the affairs of the corporation.").  The provision, therefore, says nothing about the right to impose limits on shareholders.  Limits are, however, expressly permitted in the articles.  MD Code Ann. § 2-104(b)(1) ("Any provision not inconsistent with law that defines, limits, or regulates the powers of the corporation, its directors and stockholders").    

Second, management controls a sizeable block of stock that can influence the approval process.  The bylaw requires only the support of a majority of the votes cast.  See Proxy Statement, at 47 ("Approval of the Proposed Bylaw Amendment requires the affirmative vote of the holders of a majority of all of the votes cast at the annual meeting.").  Management, however, owns almost 24% of the shares.  While there are other large shareholders, they are mostly large mutual funds.

Third, the proposed bylaw would eliminate proposals by all small shareholders.  To the extent this suggests that proposals by small shareholders (including unions) are unlikely to attract widespread support, the practice at Ashford does not bear this out.  In 2014, UNITE, a shareholder owning a small number of shares, submitted a proposal that urged "the Board of Directors to take all steps necessary under applicable law to cause the Company to opt out of Maryland's Unsolicited Takeover Act".  

The proxy statement pointed out the small size of UNITE's holdings.  Id. (noting that the proposal came from a shareholder holding "153 shares of common stock, which represents 0.0006% of the total shares outstanding on the record date.").  The company recommended that shareholders vote against the proposal.  Nonetheless, the proposal passed overwhemlingly, receiving 12,318,303 votes for and 6,857,642 against.

Presumably had the 1% bylaw for shareholder proposals been in place, this proposal would have been excluded.

For a recent piece on Fee Shifting Bylaws and the approach taken by the Delaware courts to bylaws, see The Future Direction of Delaware Law (Including a Brief Exegesis on Fee Shifting Bylaws)


Name and Address of Beneficial Owner
 Amount and
Nature of
 Percent of

Ashford Hospitality Limited Partnership

    4,977,853     17.18 %

Monty J. Bennett

    1,308,207     5.23 %

David A. Brooks

    367,854     1.51 %

Douglas A. Kessler

    301,359     1.24 %

Mark L. Nunneley

    177,642     *  

Jeremy J. Welter

    74,380     *  

Deric S. Eubanks

    40,206     *  

W. Michael Murphy

    16,360     *  

Matthew D. Rinaldi

    7,200     *  

Stefani D. Carter

    6,400     *  

Curtis B. McWilliams

    6,800     *  

Andrew L. Strong

    6,400     *  

All directors and executive officers as a group (12 persons)

    7,290,590     23.68 %

Denotes less than 1.0% 

ATP, Chevron and the Inevitable Consequences: Bylaws Restricting Shareholder Proposals (Part 2)

We are discussing a bylaw submitted for shareholder approval at Ashford Hospitality Prime, Inc. that would restrict shareholder proposals to shareholders owning 1% of the outstanding shares for at least a year.  The proxy statement with the proposed bylaw is here.  

The company viewed the restriction as necessary given that some proposals could be "expensive and disruptive to the company's normal business operations."  The company mentioned that "some stockholders in the past may have abused the Stockholder Proposal process by submitting Stockholder Proposals with the intent of interfering with the board's management of the business and affairs of the company."  Imposing the requirements would " help ensure against frivolous, self-interested proposals which tend to abuse the corporate governance process."

The company's concern, however, appeared to be the activities of a single union.  As the proxy statement asserted:     

  • a large labor union has targeted the company, Ashford Trust and Ashford Inc. with stockholder proposals, and at Ashford Trust, a solicitation of written requests for a special meeting of Ashford Trust's stockholders, in what our board and the boards of Ashford Trust and Ashford Inc. believe is an attempt by this stockholder to assert its influence in a labor dispute at one of Ashford Trust's hotels. Our board believes that the proposals submitted by this union have motivations other than the best interests of the company's stockholders in mind. Our board believes the union's true motive is to further its own personal interests, at considerable expense to the company, and to the detriment of its stockholders.

The company indicated a belief that the union engaged in a practice with other companies of using proposals not to "enhance corporate governance practices" but to "gain leverage in labor negotiations." 

  • The union has a long history of using a nominal holding in company stock in what we believe is an effort to manipulate corporate governance for its bargaining advantage in other matters and so as to have a basis to provoke governance fights with corporate boards and management. Over the past decade, this union has submitted at least 32 stockholder proposals (not counting the proposals sent to the company, Ashford Trust and Ashford Inc.) to companies in the financial, hospitality, gaming and food sectors, the very sectors in which the union attempts to organize workers. We believe that this union holds negligible shares in various public companies, not for investment purposes, but for the sole purpose of being able to make stockholder proposals, which require significant management attention and corporate resources and cause management to focus on matters other than the operation of the business. Historically, this union has acquired shares in, and submitted stockholder proposals with respect to, public companies in which it holds a negligible economic interest but in which union activity by such public companies would have a significant economic impact on the union and its members. Based on these past actions, we believe that this union views the Stockholder Proposal process as a means to further its own goals and gain leverage in labor negotiations, rather than to enhance corporate governance practices. 

The proxy statement included a number of examples of the union submitting unsuccessful proposals to the company.  

  • On several prior occasions, the union has tried this same tactic with Ashford Trust. The union has attempted to pass proposals twice that, if passed, would affect Ashford Trust's corporate governance. For each of these proposals, Ashford Trust has had to expend resources and efforts on correcting misstatements by the union and ensuring that its stockholders were fully informed of the ramifications of the union's proposals. For example, in May of 2009, the union attempted to separate the roles of the Ashford Trust's Chairman and Chief Executive Officer, which Ashford Trust's board had determined was in the best interests of its company to combine the roles. This proposal was voted down by Ashford Trust's stockholders. Undeterred, four years later, in May of 2013, the union again sought to separate the roles of Ashford Trust's Chairman and Chief Executive Officer positions. Ashford Trust's stockholders voted this proposal down, too. That same year, Ashford Trust requested permission from the SEC to omit two of the union's other proposals from its 2013 proxy materials. In both instances, the SEC determined that it would not recommend enforcement action if Ashford Trust omitted the proposals. It seems clear that these sorts of proposals are not submitted with a view towards protecting or maximizing return on the union's nominal investment in any of Ashford Trust, Ashford Inc. or our company, or that of other stockholders, but rather to further the union's goals in labor negotiations.

The "substantial costs" associated with the proposals included the expending of "significant resources on protracted litigation".    

  • This year alone, the union has submitted nine separate proposals to the company, Ashford Trust and Ashford Inc. This abuse, instead of advancing the collective interests of the company's stockholders, needlessly wastes company resources. Our company, Ashford Trust and Ashford Inc. have incurred substantial costs in defending against these frivolous proposals. In addition, our board, management team and other employees have spent countless hours of their valuable time dealing with these proposals that could have otherwise been spent advancing the interests of the company and all of its stockholders. For example, Ashford Trust is currently expending significant resources on protracted litigation in Maryland state court to defend against seven improper proposals the union is attempting to raise at Ashford Trust's 2015 annual meeting of stockholders. These proposals were not brought properly or timely under Ashford Trust's bylaws and many of them simply attempt to usurp the responsibilities of Ashford Trust's management team and board of directors' obligations to manage the business and affairs of the company. We believe it is clear from these proposals that the true intent of the union is to harass Ashford Trust in an effort to achieve leverage in an unrelated labor dispute. It is this sort of abuse and waste of company resources that we wish to eliminate by approval of the Proposed Bylaw Amendment. 

The interaction with the union apparently convinced the company that no small shareholder should be allowed to submit proposals.  See Proxy Statement ("The board believes that a stockholder without a meaningful stake in the company should not be entitled to submit Stockholder Proposals, particularly, as we have seen historically, when those proposals are submitted to advance the interests of such stockholders, interests which may not be shared by the majority of stockholders of the company. The board strongly believes that stockholders who have a meaningful and long-term interest in the company are the stockholders that submit proposals more likely to be in the best interest of the company and its stockholders. Accordingly, those are the stockholders that should be entitled to submit Stockholder Proposals.").

For a recent piece on Fee Shifting Bylaws and the approach taken by the Delaware courts to bylaws, see The Future Direction of Delaware Law (Including a Brief Exegesis on Fee Shifting Bylaws)


ATP, Chevron and the Inevitable Consequences: Bylaws Restricting Shareholder Proposals (Part 1)

Delaware is a mangement friendly jurisdiction and the cases arising in the jurisdiction largely reflect this approach.  This is particularly true with respect to the recent spate of decisions governing bylaws.  

Chevron upheld forum selection bylaws.  ATP, in the context of a non-stock company, upheld a fee shifting bylaw. In both cases, the courts allowed management to adopt bylaws for the first time that restricted shareholder rights in the context of judicial recourse.  The language of the decision was excessively broad, unmooring bylaws from any statutory language of the DGCL or the common law.    

It was only a question of time before the broad language would be used in other ways in order to limit shareholder rights.  Moreover, given Delaware's influence, it was also likely that the authority would be inovoked corporations formed in other states. 

This can be seen with respect to the proposal submitted by management of Ashford Hospitality Prime, Inc., a Maryland corporation.  A proposal in the proxy statement, if adopted, would limit shareholder proposals to shareholders who own beneficially and of record at least 1% of the outstanding shares of the company.  The proposed bylaw would provide: 

  • (1)   Nominations of individuals for election to the Board of Directors and the proposal of other business to be considered by the stockholders may be made at an annual meeting of stockholders (i) pursuant to the Corporation's notice of meeting, (ii) by or at the direction of the Board of Directors or (iii) by any stockholder of the Corporation who: was a stockholder of record (a) has beneficially owned at least 1% of the outstanding shares of common stock of the Corporation (the "Required Shares") continuously for at least one year both at the time of giving of notice by the stockholder as provided for in this Section 11(a) andthrough and including at the time of the annual meeting (including any adjournment or postponement thereof)(b) who is a stockholder of record of the Corporation both at the time of giving of notice as provided for in this Section 11(a) and as of the time of the annual meeting (including any adjournment or postponement thereof), and (c) is entitled to vote at the meeting in the election of each individual so nominated or on any such other business and who has complied with this Section 11(a). 

The provision, therefore, imposes a significant threshold.   According to CII, the 1% threshold would require "about a $10 million position." In addition, however, the provision appears to impose procedural hurdles.  The language apparently disqualifies any street name owner from making proposals or nominating directors unless they hold the shares as record owners.  Street name owners would therefore have to withdraw shares from any nominee account (usually with a broker) and obtain a certificate.  Moreover, the provision does not, apparently, allow shareholders to aggregate their interests but instead allows only shareholders owning 1% or more of the shares to submit proposals.  The provision, therefore, effectively eliminates the right of small shareholders to make proposals.  

For a recent piece on Fee Shifting Bylaws and the approach taken by the Delaware courts to bylaws, see The Future Direction of Delaware Law (Including a Brief Exegesis on Fee Shifting Bylaws).  


The Direction of Delaware Law

The Online Law Review for the University of Denver will, for the third time, publish an entire issue of student papers on a common topic in the area of corporate law and governance.  This one examines "The Direction of Delaware Law."  Past issues have involved discussions of the JOBS Act and proxy plumbing issues.  The third issue for the first time looks at topics under Delaware law. 

The issue serves a number of purposes.  It is a learning exercise for students, both in developing strong writing skills and learning to thoroughly research a topic.  It provides online content for the Law Review, a place where law reviews have been struggling.  See Essay: Law Faculty Blogs and Disruptive Innovation.  And finally, it provides a mechanism for scholarship that can be quickly published.  The DU Law Review published this issue approximately six weeks after the last paper was completed.  

In this issue, students have explored in pithy but thorough papers assorted issues under Delaware law.  The papers address a myriad of subjects, not all of which can be fairly characterized as management friendly.  In this issue: 

Robin Alexander has written an article on director independence, particularly the cases that address the impact of business and personal relationships.  See Director Independence and the Impact of Business and Personal Relationships.

Riley J. Combelic has written an article that focuses on the obligations of the board of directors in connection with the selection and oversight of financial advisors.  See Rural Metro Corp and Ensuring Fairness in a Fairness Opinion

Charles Gass has looked at the development of the doctrine of waste, the safety value that allows actions even for board decisions that fall within the business judgment rule.  See Outer Limits:  Fiduciary Duties and the Doctrine of Waste.

Jennifer McLellan has written an article on appraisal rights and the multiple tests used by the courts in assessing share valuation.  See An Appraisal of Appraisal Rights in Delaware

Gabrielle Palmer has examined the right of shareholders to inspect corporate records in the context of socially responsible activity.  See Stockholder Inspection Rights and an “Incredible” Basis:  Seeking Disclosure Related to Corporate Social Responsibility

Patrick J. Rohl  has tackled the development of forum selection bylaws.  See The Reassertion of the Primacy of Delaware and Forum Selection Bylaws