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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


Delaware Chancery Court Clarifies Limits of §220 Record Confidentiality

In a December 31, 2014 letter, the Delaware Chancery Court clarified that financial information some previously ordered produced by Winmill & Co. Incorporated (“Winmill”) was subject to confidentiality protection. The Ravenswood Inv. Co. v. Winmill & Co., C.A. No. 7048-VCN, (Del. Ch. Dec. 31, 2014). Specifically, the court concluded the financial statements produced by Winmill would remain confidential for one year following the production to Ravenswood Investment Co., L.P. (“Ravenswood”).

In Ravenswood Investment Co., L.P. v. Winmill & Co., C.A. No. 7048-VCN, 2014 BL 152126 (Del. Ch. May 30, 2014), Ravenswood initiated the suit seeking access to requested books, records, and financial statements pursuant to 8 Del. C. §220. Winmill proposed a trading restriction that would prohibit Ravenswood from trading in Winmill stock as a condition of inspection. The court, however, declined to impose the restriction, finding that the proposal was contrary to Delaware law and stockholders’ fundamental rights. The court held that Ravenswood did not meet the clear evidence standard of bad faith and, as a result, each party would bear the cost of its own attorneys’ fees.

In producing information, Winmill proposed the information produced remain confidential until it (a) became publicly available, (b) one year after Ravenswood received the documents, or (c) four years from the date of the document. Ravenswood objected to this proposal, wanting documents older than one year to be free from confidentiality restrictions. Winmill requested that Ravenswood’s access to books and records be conditioned upon an indemnification undertaking. Ravenswood objected and the matter returned to the Chancery Court.

The court concluded some confidentiality protection was appropriate. While difficult to establish the “correct” moment in time to treat information as public, the court found one year after the production to Ravenswood was a reasonable amount of time. Additionally, the court clarified that financial information did not warrant confidential treatment after three years. The court concluded that to add an indemnification condition to a right provided by Section 220 would unduly impair a shareholder’s rights.

The primary materials for this case may be found on the DU Corporate Governance website


Bourbonnais v. Ameriprise Fin. Servs. Inc.: Securities Fraud Investigation 

In Bourbonnais v. Ameriprise Financial Services., Inc., No. 14-C-966, 2015 BL 47543 (E.D. Wis. Feb. 24, 2015), Thomas and Donna Tesch and William Bourbonnais (“Plaintiffs”) filed a class action suit against financial advisor, Paul Renard, SII Investments, Inc., and Ameriprise Financial Services, Inc. (together, the “Defendants”), alleging securities fraud. Plaintiffs asserted that the Defendants violated Section10(b) of the Securities Exchange Act and Rule 10b-5 thereunder.  Plaintiffs also contended the Defendants violated the Wisconsin Uniform Securities Law, the Wisconsin Organized Crime Control Act, and acted with negligence.

According to the complaint, Renard was a registered broker with Ameriprise Financial Services and SII Investments from 1998 until 2013. He allegedly sold Plaintiffs non-traditional exchange-traded funds (“ETFs”).  Specifically, the complaint asserted that Renard sold multiple leveraged and inverse ETFs in approximately $100,000 increments and that that the Plaintiffs held them for anywhere between two and four years.  Ultimately, the Plaintiffs lost most of their investments in the instruments.

Non-traditional ETFs “are leveraged or inverse ETFs that seek to deliver multiples of the daily performance of the index or benchmark they track.” According to Plaintiffs, these securities generally have an investment objective period of a single day and allegedly are not suitable for retail investors “who plan to hold them for longer than one trading session, particularly in volatile markets.”   

The complaint alleged Renard had no legal justification for recommending the ETFs and that he violated Ameriprise policy by soliciting the investment. Moreover, Renard allegedly testified that Ameriprise employees directed him to solicit and then report the transaction as unsolicited. Plaintiffs also asserted that SII Investments failed to oversee Renard and knew that his customers were losing money. The plaintiff class termed themselves “ordinary people” who sought low risk accounts and that the brokers involved selected accounts that were not suitable for retail investors. Accordingly, the complaint alleged that SII failed to establish a system to properly monitor and advise the plaintiffs of the suitability of their accounts.

The Defendants moved to dismiss for failure to state a claim, to strike the class, and to arbitrate. They asserted that the plaintiffs failed to plead their claims with the particularity required for fraud charges under Rule 9(b) and the Private Securities Litigation Reform Act of 1995.

Federal rule of Civil Procedure 12(b)(6) requires the court to accept well-pleaded factual allegations.  Moreover, Rule (8)(a) requires the complaint to include a short statement showing entitlement to relief and Rule 9(b) requires claims of fraud to be pled with particularity. Under the Private Securities Litigation Reform Act, the complaint must specify each alleged misleading statement and provide an explanation of how it is misleading.  Furthermore it requires the plaintiff to “state with particularity” facts that provide strong support that the defendant purposely committed fraud.

The court granted the Defendant’s motion to dismiss with leave for Plaintiffs to file an amended complaint. The court found Plaintiffs failed to state sufficiently particularized allegations.  See Id. (“In truth, Plaintiffs do not really dispute the defendants' assertion that the complaint fails to identify individual omissions or misrepresentations with particularity.”). 

The court, however, indicated the belief that Plaintiff would be able to meet this burden with respect to at least some of the Defendants.  Id. (“It appears clear that Plaintiffs will be able to state a § 10(b) claim with the required particularity directly against at least Renard and perhaps under principles of respondeat superior or apparent authority against Ameriprise and SII.”).   

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


SEC v. Tavella: Court Grants SEC’s Motion for Default Judgment And Gives SEC Opportunity to Supplement Contested Remedies

In SEC v. Tavella, No. 13 Civ. 4609 (NRB), 2015 BL 1982 (S.D.N.Y. Jan. 06, 2015), the United States District Court for the Southern District of New York granted the motion by the Securities and Exchange Commission (SEC) for default judgment against eight Argentinians for failure to respond to an SEC action for numerous securities violations and granted the SEC the opportunity to supplement its remedial request for disgorgement of prejudgment interest.

According to the allegations in the complaint, the eight Argentinian defendants (“Defendants”) were involved in numerous violations of American securities law. The securities in question were distributed by Biozoom (formerly known as Entertainment Arts), a penny stock company traded on the OTCBB. Biozoom represented its stock was divided among 3 corporate officers and 34 outside investors. In May 2009, Medford Financial purchased all of the shares. Biozoom, however, disclosed only the corporate officers had sold and that outside investors maintained their investment in Biozoom. In October 2012, Medford Financial announced the sale of 39,600,000 to Le Mond Capital, but actually sold 59,730,000 shares. 

Between January and May 2013, according to the SEC, Defendants opened accounts at U.S. broker-dealers making combined deposits totaling 15,685,000 shares. Defendants represented that the shares were purchased from the original 34 outside investors or persons who had acquired shares from these investors when in fact those shares had been conveyed to Medford Financial years earlier. Eventually, “Biozoom and other entities began to tout that Biozoom had ‘created the world's first portable, handheld consumer device' to instantly and non-invasively measure certain biomarkers’” and as a result of the campaign, shares underwent a “dramatic increase” and eventually “peaked at over $4 per share.” 

In May 2013, Defendants allegedly began selling shares of Biozoom in the public market. In June 2013, a number of the Defendants sought to wire proceeds to foreign accounts. Shortly thereafter, the SEC issued an order to suspend trading of Biozoom securities.

On July 3, 2013, the SEC commenced this action, seeking a temporary restraining order and a freeze on Defendants’ Biozoom shares and sales proceeds. Defendants retained two separate American attorneys, both of whom withdrew before the filing of the motion for default judgment. Defendants failed to respond to the complaint despite multiple extensions. The clerk of the court then certified Defendants’ default under FRCP 55(a), citing prolonged inaction.   

The SEC submitted a request for four separate remedies: permanent injunction, disgorgement of illegal proceeds, civil penalties, and disgorgement of prejudgment interest. The court approved a permanent injunction finding Defendants possessed a “substantial likelihood of future violations of illegal securities conduct.” The court agreed Defendants’ misrepresentations demonstrated scienter and that their violations demonstrated systematic wrongdoing. The court also approved the request for disgorgement of illegal proceeds. The court did, however, amend the amounts to be disgorged for four of the eight defendants due to calculation errors.

Civil penalties were also awarded, but the court reduced the amounts sought by the SEC. The court noted that, without more information, the role of each Defendant in the Biozoom scheme was left unclear. The court reduced penalties to $160,000 per Defendant, citing inadequate evidence of culpability necessary to  warrant penalties as high as the requested $2 to $6.2 million per Defendant.

The last remedy sought was disgorgement of prejudgment interest. The court had the discretion to require disgorgement of prejudgment interest in order to deprive defendants of the benefit of holding their illicit gains over time. When utilizing this remedy, courts generally use the IRS underpayment rate to calculate the applicable interest rate.

Because the funds had been subject to a freeze order, Defendants were already denied access to those assets. The SEC did not assert facts indicating Defendants had violated the freeze order in a manner that provided improper access to the proceeds.  As a result, the court deferred any decision on the imposition of prejudgment interest until after the Agency had “an opportunity to establish the actual amount of the returns, if any, that have accumulated on the frozen assets" or to show the Defendants had violated the asset freeze.  

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


Two Cases with Possible Implications for Corporate By-Laws

Two recent cases in Delaware has possible implications for corporate by-laws and the how corporations attempt to control both the type of proceedings parties must agree to and the forum in which parties must proceed.

The Delaware Supreme Court just added more ammunition to those favoring arbitration by applying for the first time the McWane doctrine (also known as the first-filed rule and articulated in McWane Cast Iron Pipe Corp. v. McDowell-Wellman Eng’g Co., 263 A.2d 281 (Del. 1970)) to dismiss an action because an arbitration proceeding had been earlier-filed.  In LG Electronics, Inc. v. InterDigital Communications, Inc., No. 475, 2014 (Del. Supr., April 14, 2015).  The McWane doctrine states that “litigation should be confined to the forum in which it is first commenced, and a defendant should not be permitted to defeat the plaintiff’s choice of forum in a pending suit by commencing litigation involving the same cause of action in another jurisdiction of its own choosing.‟

In LG Electronics, Chancellor Laster held that the Court could exercise its discretion under McWane “freely in favor of the stay when there is a prior action pending elsewhere, in a court capable of doing prompt and complete justice, involving the same parties and the same issues.”

The facts were somewhat unusual as there was no certainty as to whether the parties had actually agreed to arbitrate.  This ambiguity allowed the Court to find that the case presented “the rare instance when both the arbitral tribunal and the court have jurisdiction such that McWane could apply.”

LG argued that McWane could not apply because an arbitration proceed did not constitute a “prior action” under McWane –and in fact, no Delaware court had ever applied McWane to dismiss a lawsuit in favor of first-filed arbitration. The Court disagreed, finding that arbitral tribunal could provide “prompt and complete justice,” and noting that the interests of justice are better served if the tribunal deciding the overall matter in the first instance determines procedural disputes like the instant one. “Allowing parties to seek judicial review every time an arbitrator rules on—or, as in this case, declines to rule on—a procedural issue would frustrate the arbitral process.”

The decision in LG Electronics should be read together with the Chancery Court’s opinion in UtiliPath, LLC v. Hayes, Del. Ch., No. 9922-VCP, 4/15/15) finding that McWane does not apply if the parties agree in their contract that Delaware courts have jurisdiction over the dispute pursuant to a non-exclusive forum selection clause.  The clause at issue read


In UtiliPath there was a prior-pending action in the Eastern District of Pennsylvania when an action was filed in Delaware.  In light of above forum-selection language, Vice Chancellor Donald F. Parsons Jr. found that he was precluded from dismissing the lawsuit on McWane grounds because the parties clearly and unambiguously agreed that jurisdiction and venue would properly lie in the chancery court pursuant to a non-exclusive forum selection clause in the redemption agreement.

Consider the impact of these decisions taken together and what they may mean for corporate by-laws. Forum selection by-laws are receiving strong support in both Delaware courts and its legislature.  Corporations will likely now seek to adopt by-laws that require at least non-exclusive Delaware forum selection.  If they do, under Utilipath, first-filing in another jurisdiction will not prevent a Delaware filing.  Further, the strong support of arbitration shown by both the Delaware legislature in its passing of the Rapid Arbitration Act and the Delaware courts in LG Electronics suggests that by-laws requiring arbitration stand a strong chance of success –particularly given Boilermakers Local 154 Retirement Fund v. Chevron Corp., discussed here and here.


Special Projects Segment: The Proposed Crowdfunding Rules for Non-Accredited Investors and the Potential Associated Costs for Small Issuers

We are discussing possible rulemaking for equity crowdfunding under the JOBS Act.

One of the overall issues with the Proposed Crowdfunding Rules before the Securities and Exchange Commission (“SEC”) is the potential cost to those small issuers who might seek to take advantage of raising money through this type of offering. In particular, the proposed financial statement disclosures required pursuant to § 227.201(t) may cause such an offering to be cost prohibitive to many small issuers.

Under § 227.201(t), if the issuer’s aggregated offerings pursuant to § 4(a)(6) of the Securities Act of 1933 during the preceding 12 month period: (i) are less than or equal to $100,000, then the issuer’s principal executive officer must certify that the financial statements are true and complete in all material respects; (ii) exceed $100,000 but are $500,000 or less, then the issuer’s financial statements must be reviewed by an independent public accountant; and (iii) exceed $500,000, then the issuer’s financial statements must be audited by an independent public accountant. Under all three scenarios, the issuer must provide four financial statements: balance sheet, income statement, statement of cash flows, and statement of changes in stockholder’s equity. The issuer must provide those financial statements for the two most recent fiscal years or since the issuer’s inception. Additionally, the financial statements must include related footnotes and be prepared in accordance with Generally Accepted Accounting Principles (“GAAP”).

For an issuer that plans to raise $100,000 or less, the requirement that the principal executive officer certifies the financial statements as true and correct does not create an added expense. However, once an issuer decides to raise more than $100,000, additional costs are imminent. According to a 2014 survey by the Financial Executives Research Foundation, the average audit cost for a private company was $174,858 in 2013, an increase of 3.7% from 2012. Crowdfund, CPA, a company that specializes in helping issuers find a CPA firm that specializes in crowdfunding offerings and can provide the required “review” or “audit” service, estimates that a large public accounting firm charges a minimum of $15,000 for an audit, but the audit fee range for a mid-sized company is $50,000-$150,000. Crowfund, CPA, also estimates that the minimum cost for a financial statement review is $5,000.

While it is difficult to pinpoint the actual cost of a financial statement review or audit because each issuer, its business, and financial condition is unique, what is abundantly clear is that requiring an issuer to undertake a review or an audit under the Proposed Crowdfunding Rules could be quite cost prohibitive. Requiring a small issuer to spend a minimum of $5,000 for a financial statement review before it can seek to raise a minimum of $100,001 and up to a maximum of $500,000 is a significant upfront investment. Even more concerning is the potential up front cost of an audit for an issuer seeking to raise more than $500,000. These potential costs may well prevent many small issuers from taking advantage of the crowdfunding rules – rules that were proposed to grant such issuers easier access to the capital markets.