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Continued Erosion of the Blasius Standard: Keyser v. Curtis (Part 1)

Shareholders get few meaningful protections under Delaware common law.  One of them has been the Blasius standard.  Blasius has held that actions taken in order to prevent the proper exercise of the franchise by shareholders must be supported by a "compelling justification."  The court in Blasius came to the conclusion that these matters were not appropriately reviewed as a matter of business judgment but deserved a higher standard of review. 

Blasius has been applied in cases where directors filled board vacancies or changed the date of a shareholder meeting.  In other words, it applies to what otherwise would be routine functions of the board.  It is the motive of the board that takes the actions out of the routine.  The standard is sufficiently high that, once the courts have found the Blasius standard to be applicable, boards have had a difficult time showing the requisite compelling justification.  Only one case so far has held that the board met this standard.  See Mercier v. Inter-Tel, 2007 Del. Ch. Lexis 119 (Del. Ch. 2007).  

There is, however, growing opposition to the Blasius standard in the Chancery Court.  In Mercier, the court argued that the applicable analysis should be the reasonableness standard from Unocal.  Since the "reasonableness" standard in Unocal is an easy one to meet, the effect of the change would be to reduce the protections afforded shareholders and give management greater latitude to interfere with the franchise.

In Keyser v. Curtis, 2012 Del. Ch. Lexis 175 (Del. Ch. July 31, 2012), the erosion of the Blasius standard in the Court of Chancery continued.  The case involved allegations that the sole director of the company created a class of Series B shares, each with 1000 votes and each redeemable (at the demand of the holder) for $1.00.  The director purchased 25,000 shares for $0.01 per share.  As the court reasoned, the shares were issued "in order to prevent [the insurgent] and his allies from electing a new Board, which is the quintessential Blasius trigger." 

Given that the case implicated Blasius, the applicable standard of review ought to have been the compelling justification standard.  The court, however, decided otherwise.  It first noted that the "main role" of the Blasius standard, "to the extent it has one," was "as a specific iteration of the intermediate standard of review laid out in Unocal Corp. v. Mesa Petroleum Co."  The court went on to conclude that in cases involving self interested transactions, such as the one at issue, "[a] standard of review that was established to review selfless conduct is, by definition, ill-suited to serve as a standard of review for self-dealing conduct."  As a result, the court opted to apply the entire fairness doctrine.  

We will discuss the implications of this decision in the next post.  

Primary materials in this case are posted on the DU Corporate Governance web site.


A Delaware Update

This week (and maybe some of next), we will be reviewing a series of Delaware cases.  The decisions are varied. 

There are a handful that push the law in an interesting direction.  The decisions by VC Laster that seek to affect the race to the courthouse fall into this category.  There are a host of additional decisions that reflect the management friendly nature of the Delaware courts.  Decisions on inspections right and the application of the Blasius standard fall into this category.


Is this what states created corporations for?

You may have heard the stories making the rounds this week about employers pressuring their employees to vote for particular candidates.  Much of this activity apparently traces back to Mitt Romney expressly encouraging business owners to do this.  As reported (here):

The candidate himself suggested that business owners adopt this practice during a virtual town hall meeting with the National Federation of Independent Businesses back in June.  “I hope you make it very clear to your employees what you believe is in the best interest of your enterprise and therefore their job and their future in the upcoming elections," he said, telling the audience, "Nothing illegal about you talking to your employees about what you believe is best for the business, because I believe that will figure into their election decision, their voting decision."

Personally, I think a number of the reported tactics rise to the level of an abuse of power.  At least to the extent these are corporate employers, my rationale is:

1.  The leverage used on these employees is at least partly attributable to the corporate form.  That is to say, without the capital accumulation benefits of corporate status, the owners of these businesses would likely not have nearly as much power to exert over this captive audience of employees.

2.  These business owners were not granted the right to operate in the corporate form so they could pressure employees to vote for particular candidates.  Rather, they were granted the right to operate in the corporate form because of legislative judgments that making incorporation widely available would benefit society as a whole.  (If you believe that it is possible to create a corporation solely via private contracting, then this point will be unconvincing to you.  However, please let me know if you ever actually manage to pull off that feat.)

3.  Given this public aspect of corporate status, it is improper to divert the power of this corporate form to force the business owner’s personal political views on employees.

However, as Paul Secunda explains (here), as a result of Citizens United such abuses of power are now legal.

Citizens United has wrought widespread changes in the election law landscape. Yet, a lesser-known consequence of this watershed case might have a significant impact in the workplace: it may permit employers to hold political captive audience workplace meetings with their employees. Under Citizens United’s robust conception of corporate political speech, employers may now be able to compel their employees to listen to their political views at such meetings on pain of termination….

Prior to Citizens United, the 1971 Federal Election Campaign Act (FECA), as amended in 1976, provided that corporations were permitted unlimited communication with and solicitation of shareholders and executive and administrative personnel (the corporation’s “restricted class”). Rank-and-file employees, on the other hand, could be solicited for corporate Political Action Committees (PACs) only twice a year (originally pegged to primary and general election seasons), only by mail sent to their home addresses, and only through an accounting system that made it impossible for management to know which employees did or did not contribute. Partisan political communication to rank-and-file employees, moreover, was completely prohibited.

Now, post-Citizens United, express advocacy outside a corporation’s restricted class is no longer restricted….

Although federal law does still prevent employers from issuing explicit or implicit threats against employees who vote for the “wrong” candidate, short of that, nothing prohibits employers from requiring employees to participate in one-sided political propaganda events.


S.E.C. v. Stoker: Court Denies Citigroup Director’s Motion to Dismiss Claims under Sections 17(a)(2) and (3) of the Securities Act of 1933  

In S.E.C. v. Stoker, No. 11 Civ. 7388(JSR), 2012 WL 2017736 (S.D.N.Y. June 6, 2012), the Southern District of New York reaffirmed its earlier order denying defendant Brian Stoker’s motion to dismiss after concluding that the Securities and Exchange Commission (“SEC”) adequately stated claims for relief under the Securities Act of 1933.  The SEC alleged that Stoker, in his capacity as director in a division of Citigroup, negligently violated §§ 17(a)(2) and (3) of the Securities Act of 1933. 

Citigroup Inc.’s primary broker-dealer is Citigroup Global Markets Inc. (“Citigroup”). Brian Stoker was a Citigroup director responsible for constructing and marketing securities known as collaterized debt obligations (“CDOs”), and, specifically, the Class V Funding III (the “Fund”).  Section 17(a)(2) prohibits “obtain[ing] money or property by means of any untrue statement [or omission] of a material fact [in connection with the sale of securities].”  Furthermore, subsection (3) prohibits “engag[ing] in a course of business which operates … as a fraud or deceit upon the purchaser [in connection with the sale of securities].”  The SEC alleged that Stoker negligently violated both subsections because he was responsible for ensuring the accuracy of the marketing materials that were sent out to potential CDO investors.

Stoker made two arguments as to why the SEC’s claim that he violated § 17(a)(2) should be dismissed.  First, Stoker conceded that his bonus increased “around the time of the fraud,” but he argued that the two occurrences were not sufficiently linked to qualify under § 17(a)(2).  The court reasoned that under a plain reading of the statute, § 17(a)(2) imposes liability where the benefit is obtained either “directly or indirectly.”  Therefore, it was sufficient that Stoker, acting as an agent of Citigroup, facilitated a fraud, which made Citigroup millions of dollars by means of  “…untrue statement[s] of a material fact or any omission[s].”  The court then concluded that the SEC’s allegations were enough to impose liability regardless of whether Stoker obtained compensation for his employer, or if Stoker himself financially benefited indirectly from the fraud.

Next, Stoker argued the SEC failed to allege that he be held solely responsible for “making” the omissions and false statements contained within the marketing materials.  Stoker analogized the “by means of” language of § 17 to the “to make” language in Rule 10-b5 of the Securities and Exchange Act of 1934.  The court reasoned that § 17(a)(2), unlike Rule 10-b5, imposes liability where money or property is obtained “by use of a false statement,” regardless of the source.  Alternatively, Stoker argued that the court should apply the KPMG standard, which requires plaintiffs to argue that the actor was “sufficiently responsible for the statement … and knew or had reason to know that the statement would be disseminated to investors.”  The court found that even this more stringent KPMG standard was met; Stoker made “substantial edits” to the marketing materials given to investors, and he knew the statements included in the marketing materials would be given to investors.

Lastly, Stoker argued that the SEC’s § 17(a)(3) claim is duplicative of the § 17(a)(2) claim. A defendant may be held liable under both subsections, so long as the plaintiff alleges that the defendant “undertook a deceptive scheme or course of conduct that went beyond the misrepresentations.”  The court found that the misrepresentations and omissions within the marketing materials constituted a portion of the alleged misconduct, but not the entirety of it.  Stoker and Citigroup were on notice that certain CDOs were going to perform poorly, but they sought to include as many of these assets in the Fund as possible.  Furthermore, the two engaged Credit Suisse Alternative Capital as their collateral manager, knowing investors would not be interested in the Fund unless they thought a reputable third party would choose the assets.  Finally, they represented to one particular investor that the Fund was a “top-of-the-line CDO squared.”  The court found this more than sufficient to state a claim under § 17(a)(3). 

After this decision, the case went to trial on July 31, 2012 and the jury acquitted Stoker.  The SEC was unsuccessful in proving that Stoker was primarily responsible for the perpetrated fraud, primarily because Stoker’s lawyer, John Keker, successfully questioned why Stoker, a relatively low-level executive was targeted by the SEC instead of the CEOs in decision-making levels above him.

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


Turtles All the Way Down: Rulemaking, the DC Courts, and the Lack of Judicial Deference

The latest legal challenge to an SEC rule is underway.  The Chamber of Commerce and the American Petroleum Institute have challenged the SEC's rule governing payments by mineral extraction companies.  The complaint in the district court and the petition in the court of appeals contains a first amendment challenge.  (The action has been filed in the district court and in the court of appeals, with an emergency motion pending in the court of appeals that seeks to resolve jurisdiction). The complaint also alleges that the SEC exceeded its rulemaking authority. 

The complaint asserted that the SEC's "principal defense" of the "onerous rule" was "that it was required by law to issue the rule it adopted, under Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act."  The complaint characterized the defense as "mistaken" and argued that the SEC lacked the rulemaking authority to adopt the rule.

Section 1504 requires only that a “compilation” or aggregation of payment information made by all U.S. companies to each foreign government and the federal government be made publicly available. The Commission, however, grossly misinterpreted its statutory mandate to require that each U.S. company publicly file a report on the Commission’s online electronic database (EDGAR) detailing each payment made to each and every foreign government, for each and every “project” relating to extractive industries. And the Commission adopted this approach despite the fact that publication of a “compilation” would have served the purposes of the statute without further burdening U.S. companies or revealing trade secrets or pricing strategies to competitors.

Mostly, though, the complaint and the petition repeated the basis used by the DC courts to justify their interventionist approach with respect to agency rulemaking.  The SEC, as usual, failed to conduct an adequate cost benefit analysis. 

the Commission failed to properly consider the Rule’s effects on competition, or whether the Rule was likely to achieve its desired benefits in light of its enormous costs. Indeed, the best the Commission could muster as to the Rule’s purported benefits was that it “may result in social benefits” that “cannot be readily quantified with any precision.” 77 Fed. Reg. at 56, 398 (emphasis added).

The actual cost benefit analysis applied by the Commission was little more than "lip service." 

While the Commission paid lip service to the requirement for cost-benefit analysis and tabulated (erroneously) some of the direct costs of the Rule, it repeatedly failed to resolve critical questions that directly relate to the Rule’s effect on competition; made regulatory choices that exacerbated the competitive harm to U.S. companies and increased the burden on First Amendment rights; and flatly refused to allow any exemption from the Rule’s requirements to protect U.S. companies from the billions of dollars in competitive harm it projected.

Part of the "arbitrary" beavior was the decision not adopt certain exemptions. 

In the final Rule, the Commission arbitrarily rejected any exemption from the Rule’s disclosure requirements for projects in countries that forbid such disclosures by law. 77 Fed. Reg. at 56,368. That refusal flies in the face of principles of comity and the Restatement (Third) of Foreign Relations Law, both of which counsel against implementing a statute in a manner that causes a direct conflict with foreign law.

In the past, this would have been viewed as a long shot.  There are two things that make it a more viable challenge.  First, it was filed by Eugene Scalia.  He has an enviable track record in the DC courts with respect to challenging agency rulemaking. 

The other is a decidedly interventionist set of courts in the DC Circuit (although Scalia pointedly disagrees with this approach).  Its true that SEC rules have been invalidated by panels that include judges appointed by presidents of both parties.  But the decision in the shareholder access case was, as we have noted on this blog, not well reasoned and explained more by a dislike for shareholder access than an analysis of administrative law.  It reflected an utter lack of deference to agency process, something traditionally required under the arbitrary and capricious standard of review.  See Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC

The same is risk is present in this case.  To the extent the judges do not like the rule (despite the congressional mandate that it be adopted), they will strike it down on the basis of an inadequate cost benefit analysis.  Since this type of analysis is not subject to definitive standards, a court can always find that it was inadequate. 

The approach has long term costs.  In addition to the consequences with respect to the particular rule, the interventionist approach of the courts discourages rulemaking in the first instance and discourages anything but the most conservative approach to rulemaking in the second. 

In many cases, this does not obviate regulation.  It merely shifts regulation from rulemaking to informal positions of the staff.  Informal positions, as we have noted, are subject to far greater swings as the political makeup of the Commission changes.  See Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.  One set of costs simply replaces another. In short, turtles all the way down

We will follow the case.  The complaint is posted on the DU Corporate Governance web site. 


Going the Way of the Dodo: CFOs on the Board of Directors

The WSJ recently discussed the disappearance of the CFO from the board of directors of large public companies.  In fact, the disappearance was nothing new.  As the article noted, the number of CFOs on the board of Fortune 500 companies had declined from 37 in 2005 to 19 in 2012.  While this represented a 50% decline, it also represented a fall from a meager 8% to an even more meager 4%.  In other words, CFOs have been a rare presence on the board for a significant period of time. 

In fact, the trend has been less about the CFO and more about the general decline of all non-independent directors.  According to a study of the 100 largest public companies by the law firm Shearman & Sterling, 93 of the companies  have a board with at least 75% independent directors and on 56 of the companies, the CEO is the only non-independent director.  In other words, the trend in board composition of the largest companies is to have all independent directors except for the CEO.

The WSJ article further noted that "[g]overnance advocates, of course, back the idea of fewer CFOs serving on their respective company's board."  But in fact it is not that simple.  The article left out another critical fact.  As the Shearman & Sterling Report determined, 71 of the 100 largest companies combine chair of the board and CEO.  Only 12 companies have an independent director serving as chair. 

In other words, the largest boards consist of independent directors with the CEO serving as chair.  Independent directors are for the most part directors with no significant relationship with the company.  As a result, the CEO is the only director on the board with detailed knowledge about the internal activities of the company.  This provides a certain degree of control over information.  By serving as the chair, the CEO also determines the agenda of the board meeting and the information that will be provided to directors. 

The presence of the CFO or any other executive officer on the board provides an additional source of information for independent directors.  In other words, there is a benefit that can flow from the presence of executive officers inside the boardroom.  Moreover, the benefit is likely to be greater where the CEO serves as chair.   


In re Fannie Mae 2008 Securities Litigation: CIS, Smith, and Liberty Pursue FNMA Alone Despite a Parallel Class Action

In In re Fannie Mae 2008 Securities Litigation, 2012 WL 3758537 (S.D.N.Y. Aug. 30, 2012), the U.S. District Court for the Southern District of New York addressed fourteen motions to dismiss by various defendants in response to amended complaints by Comprehensive Investments Services, Inc. (“CIS”), Edward Smith (“Smith”), and multiple entities related to Liberty Mutual Insurance Company (“Liberty”) (collectively, the “Plaintiffs”).

This matter is ancillary to a securities class action brought against the Federal National Mortgage Association (“FNMA”), its executives (collectively, the “Defendants”), and certain underwriters. The class action is premised on alleged material misstatements in regard to security offerings by FNMA concerning “(1) subprime and Alt A exposure; (2) risk management controls; and (3) core capital financials.”

CIS, Smith, and Liberty declined to join the class action and, instead, alleged individual claims against the Defendants. In 2008, CIS purchased 600,000 shares of Series T Preferred Stock in FNMA, and CIS now asserts claims under Section 10(b), Rule 10b-5, Section 20(a), and various state laws. In 2007, Smith purchased FNMA’s Series S Preferred Stock and also asserts Section 10(b), Rule 10b-5, Section 20(a), and state law claims against the Defendants. Finally, Liberty purchased FNMA’s Series P and S Preferred Stock and asserts Section 10(b), Rule 10b-5, and state law claims against only Goldman Sachs & Co. (“Goldman”), an alleged underwriter for the offering. 

Before addressing the substantive motions to dismiss, the court declined to find merit in the Defendants’ motion to strike parts of the complaints that repeated allegations set forth in both a parallel action by the Securities and Exchange Commission (“SEC”) and a Non-Prosecution Agreement with the SEC. The court found that factual allegations supported the Plaintiffs’ claims, and further, that the issue would not prejudice the Defendants.

In addressing the motions, the court first denied the Defendants’ efforts to dismiss the Section 10(b) and Rule 10b-5 claims of CIS and Smith premised on FNMA’s subprime and Alt A exposure. The court explained that the claims were identical to those made in an SEC action, which were upheld in a prior opinion.

Moreover, Chief Risk Officer (“CRO”) Enrico Dallavecchia’s claim that he did not “make” statements consistent with the Janus standard failed. The court found that the plaintiffs alleged the CRO made misstatements during conference calls with investors. In addition, the court found that plaintiffs had sufficiently alleged that the CRO had “ultimate authority” over company statements even though he had not signed the documents.  As the opinion described:

Given Dallavecchia's position as Chief Risk Officer, his knowledge of FNMA's subprime and Alt-A exposure, his participation in drafting relevant disclosures, his position on the disclosure committee, his review of draft filings, the fact that he had individual discussions with Mudd about the SEC filings, and his sub-certification (and, thus, approval) of the SEC filings, a question of fact exists as to whether Dallavecchia had ultimate authority over the misstatements, or ratified and approved the misstatements, contained in FNMA's SEC filings.

Second, the court granted the Defendants’ motion to dismiss CIS’s Section 10(b) and Rule 10b-5 claims premised on FNMA’s core capital financials. The court had previously dismissed a similar claim in the parallel class action; however, in amending their complaint, CIS and Smith produced additional information, including an email from a White House economist that referenced accounting “shenanigans” and a report by Morgan Stanley that concluded FNMA “overvalued its deferred tax assets.” The court, however, found that these allegations were insufficient. With respect to the reference to accounting shenanigans, the court concluded that the allegations did not “plausibly explain why FNMA's core capital financials were incorrect.” Nor did the contents of the Morgan Report warrant an inference of fraud. 

Third, the court denied the Defendants’ motion to dismiss CIS’s and Smith’s Section 10(b) and Rule 10b-5 claims based on FNMA’s risk management disclosures. The court held that the complaint contained sufficient allegations to plead that Defendants had made material misstatements with the requisite scienter. The court noted that “[p]roceeding headlong into an unfamiliar market and telling investors that risk controls are in place . . . without the internal ability to analyze the risks associated with that market is certainly enough of ‘an extreme departure from the standards of ordinary care.’” Furthermore, the Defendants’ warning to investors about future risk and losses did not, in the view of the court, overcome the allegations of inadequate risk control disclosure.   

Fourth, the court held that CIS and Smith satisfactorily pled all of the required elements of their Section 20(a) claims. CIS and Smith adequately alleged material misstatements as to FNMA’s subprime and Alt A exposure and risk management controls. The court explained that both the CEO and CRO could be viewed as having control since the CEO signed the 10-K and 10-Q reports and the CRO was responsible for internal control systems.

Fifth, the Defendants sought dismissal of all state law claims under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). As to FNMA, CEO Daniel Mudd, and Dallavecchia, the court found the claims preempted by SLUSA. State claims against executives Robert Levin, Stephen Swad, and related underwriters, however, did not trigger SLUSA because they did not involve more than fifty persons seeking damages, a required element of SLUSA preemption.

Sixth, Swad, and Levin moved to dismiss the Texas state law claims previously asserted by CIS. In its original complaint, CIS alleged both federal and state law claims against Swad and Levin. CIS, however, amended the complaint and voluntarily dismissed the federal claims. Because the federal claims were voluntarily dismissed, the court lacked pendent personal jurisdiction, which predicated the federal court’s jurisdiction over the state claims. The court held there was no other independent basis for personal jurisdiction; therefore, Levin and Swad’s motion to dismiss for lack of personal jurisdiction was granted.

Seventh, Goldman moved to dismiss Liberty’s Section 10(b), Rule 10b-5, and state law claims. Liberty asserted that Goldman violated subparts (a), (b), and (c) of Rule 10b-5. The court held that: (i) Liberty failed to allege facts showing misstatement of the offering material; (ii) Goldman had no “freestanding duty to disclose” the omitting of FNMA’s quantitative subprime and Alt A exposure; and (iii) Goldman did not defraud Liberty through market manipulation or any other avenue. Therefore, Liberty’s Rule 10b-5 (a) and (c) claims were invalid. As to Liberty’s state law claims, they also failed. “Liberty failed to allege an actionable misstatement contained in the offering circular [and] it cannot show that Goldman made or supplied false statements to Liberty.”          

Eighth, the Smith underwriters, which include many of the largest investment advisory firms on Wall Street, moved to dismiss Smith’s state law claim of negligent misrepresentation. The court held that Smith failed to plead necessary facts to show that the underwriters had “made a misrepresentation.”

Finally, the CIS underwriters, including Wachovia Capital Markets, LLC and Citigroup Global Markets, Inc., moved to dismiss multiple state claims under Texas law. The court concluded that each claim—statutory fraud, negligent misrepresentation, and violation of the Texas Security Act—was invalid for failure to correlate any material misrepresentation to the underwriters. 

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


Phillips v. Scientific-Atlanta, Inc.: Proving Loss Causation in 10b-5 Violations

In Phillips v. Scientific-Atlanta, Inc., No. 10–15910, 2012 WL 3854795 (11th Cir. Sept. 6, 2012), the Eleventh Circuit affirmed the grant of the defendants’ motion for summary judgment because the plaintiffs failed to present sufficient evidence of loss causation as required in an alleged Rule 10b–5 violation. 

Defendant Scientific–Atlanta, Inc. (“S–A”) manufactures and sells devices used in the cable television industry. Together with the company’s CFO and CEO (collectively with S–A, “the Defendants”), S-A was named in a class action by shareholders alleging violations of Rule 10b-5 based on loss of investments which occurred in the fourth fiscal quarter of 2001. The Defendants allegedly attempted to cover up decreasing demand for company products, issued materially false and misleading statements, and later issued “corrective disclosures” which caused the price of S–A securities to fall. The Complaint alleged that in 2001, S–A management became aware that sales were declining and the Defendants used various mechanisms to hide evidence of lower sales, including “discounts, warehousing credits, unusually liberal return policies, and extended repayment terms” thereby misleading investors.

The S-A shareholders also alleged the Defendants issued a series of materially false and misleading statements including: a press release of “record financial results” for the second fiscal quarter of 2001; a press release announcing an increase in manufacturing capacity “in response to the continuing acceleration in customer demand”; statements forecasting continued growth in several sectors; a press release noting a large year-over-year increase in third quarter sales; and interviews with the media describing rising demand and performance in the fourth fiscal quarter. The alleged fraud was revealed to the public in the fourth quarter of 2001 when corrective statements were made and S–A filed its Form 10-K with the SEC. S–A stock prices fell several times after issuance of the corrective statements.

To show a Rule 10b-5 violation, a plaintiff must show “(1) a material misrepresentation (or omission); (2) scienter, i.e., a wrongful state of mind; (3) a connection with the purchase or sale of a security; (4) reliance…; (5) economic loss; (6) and ‘loss causation’ i.e., a causal connection between the material misrepresentation and the loss.” The district court granted the Defendants’ motion for summary judgment, holding “the record evidence provide[d] no method by which a jury can determine how much, if any, of Plaintiffs' loss is attributable to Defendants' failure to disclose its [sic] alleged channel stuffing activities.”

The Eleventh Circuit upheld the finding that the plaintiffs had not sufficiently established loss causation.

According to the appellate court, a plaintiff attempting to use “corrective disclosure” and a “showing that the stock price dropped soon after the corrective disclosure,” to prove a 10b-5 violation, must also “eliminat[e] other possible explanations for this price drop…” in order to show loss causation. The Plaintiffs submitted an expert report in an attempt to eliminate other explanations for the drop in price. The Eleventh Circuit held the expert appropriately separated the statements made by management from general industry factors that could affect stock price. The expert, however, made no attempt to separate the impact of Defendants' truthful statements on the price of stock. The court pointed out that the negative statements regarding the industry-wide trends and the slowing of the economy specifically affected the fourth fiscal quarter performance. This truthful information confounded a finding that any false statement was the direct cause of a fall in stock price. The plaintiffs, therefore, failed to eliminate other possible explanations for the price drop.  Without eliminating these other possibilities, no genuine issue of material fact exists regarding the loss causation element, which is a required element of the 10b-5 claim.

The Eleventh Circuit upheld the grant of summary judgment to the Defendants.

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


In the Matter of New York Stock Exchange LLC, and NYSE Euronext: SEC Sanctions NYSE for Discriminatory Data Distribution

In the administrative proceeding In the Matter of New York Stock Exchange LLC, and NYSE Euronext, the respondents, the New York Stock Exchange LLC and NYSE Euronext, (collectively, “NYSE”) consented to an Order Instituting Administrative and Cease-and-Desist Proceedings (the “Order”) issued by the Securities and Exchange Commission (“SEC”) for violations of Rule 603(a) of Regulation NMS (“Rule 603(a)”), the record retention provisions of Section 17(a)(1) of the Securities Exchange Act (“Section 17(a)(1)”) and Rule 17a-1.  Securities Exchange Act Release No. 67857 (Admin. Proc. 3-15023, Sept. 14, 2012).  The Order required the NYSE to pay a $5 million civil penalty and hire a consultant to provide recommendations on how to avoid future violations. 

Stock exchanges subject to SEC regulation, such as the NYSE, are required to send computerized quotes and trade reports (“market data”) to be included in publicly available consolidated data feeds.  Stock exchanges are permitted to distribute customized market data directly to customers via proprietary feeds, but Rule 603(a) requires exchanges to distribute market data on terms that are “fair and reasonable” and “not unreasonably discriminatory.” 

According to the Order, from June 2008 to July 2011, the NYSE consistently released market data to its subscribing customers before it sent the same market data for inclusion in the public consolidated feed, creating time disparities between the two feeds.  The time disparities “ranged from single-digit milliseconds to, on occasion, multiple seconds.”  There were several reasons given for the time disparities.  First, the data path for one NYSE proprietary feed involved fewer steps and was thus faster than the data path to the consolidated feed.  Second, another NYSE proprietary feed bypassed the system that processed market data into the required format for the consolidated feed.  As a result, intermittent delays in the data processing system affected the data being sent to the consolidated feed, but not the proprietary feed.  Third, a software problem caused delays in the release of market data to the consolidated feed during periods of high trading volume.

The SEC, citing its own adopting release for Rule 603(a), explained that under the standards of “fair and reasonable” and “not unreasonably discriminatory,” the rule prohibited the release of market data via proprietary feeds “any sooner” than the data had been sent for inclusion in the consolidated feeds.  Therefore, the SEC found that NYSE had violated Rule 603(a). 

The SEC also found that NYSE had violated Section 17(a)(1) of the Exchange Act and Rule 17a-1 thereunder.  Section 17(a)(1) required every exchange to “make and keep for prescribed periods such records as the [SEC] may require by rule.”  Rule 17a-1 specified that exchanges had to keep “all records as shall be made or received by it in the course of its business.”  NYSE regularly retained trade-related timestamps and processing speed data for three days before deletion to make room for more recent data.  The SEC found that the deleted timestamps and processing speed data “fell within the scope of [Section 17(a)(1)] because they related to NYSE’s compliance with Rule 603(a).”  

NYSE reached a settlement with the SEC, consenting to a $5 million civil penalty, a cease and desist order, and a censure.  NYSE also consented to a series of undertakings, including hiring an independent consultant to analyze NYSE’s market data distribution systems and make recommendations of how to prevent and detect future violations of Rule 603(a). 

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



Yosifon on “The Law of Corporate Purpose”

David Yosifon recently posted “The Law of Corporate Purpose” on SSRN (HT: Bainbridge).  Here is the abstract:

Delaware corporate law requires directors to manage firms for the benefit of the firm’s shareholders, and not for any other constituency. Delaware jurists have been clear about this in their case law, and they are not coy about it in extra-judicial settings, such as in speeches directed at law students and practicing members of the corporate bar. Nevertheless, the reader of leading corporate law scholarship is continually exposed to the scholarly assertion that the law is ambiguous or ambivalent on this point, or even that case law affirmatively empowers directors to pursue non-shareholder interests. It is shocking, and troubling, for corporate law scholarship to evince such confusion about the most important black letter matter in the field. While I am a critic of the “shareholder primacy norm” in corporate governance, I am nevertheless convinced that shareholder primacy is the law. In fact, the critical vantage and reformative program that I have pursued in other writing presupposes that shareholder primacy is currently the law. This article is therefore dedicated both to providing doctrinal clarification on the law of corporate purpose, and to vindicating a key presumption in a broader normative agenda.

While I have not had a chance to read the paper, my initial reaction to the abstract is that there is an important distinction between nominal and actual requirements.  It is certainly fair to say that, “Delaware corporate law [nominally] requires directors to manage firms for the benefit of the firm’s shareholders, and not for any other constituency.”  It is quite another thing to assert that Delaware jurists actually enforce this requirement in a way that seriously impinges on the ability of directors to manage the firm for the benefit of other constituents.  While the latter pronouncement may be subject to vigorous debate, I certainly don’t find it troubling or shocking that a number of esteemed scholars have concluded that Delaware jurists do not in fact require directors to manage firms for the benefit of the firm’s shareholders in any meaningful sense—and thus there is actually no such requirement in practice.  Of course, this is merely my initial reaction to the abstract and Yosifon may well deal with this objection deftly in the body of his paper.  To that point, I note that Stephen Bainbridge commented (here) that Yosifon delivers “a very effective critique of arguments made by scholars like Einer Elhauge and Lynn Stout that, as the latter put it, ‘The notion that corporate law requires directors . . . to maximize shareholder wealth simply isn’t true.’”  Thus, I encourage you to go read the entire paper if you have the time.


Delgado v. Ctr. on Children, Inc: Notes as Securities under State and Federal Law  

In Delgado v. Ctr. on Children, Inc., No. 10-2753 (E.D. La. July 13, 2012), the court granted the defendants’ motion for summary judgment, finding that the two notes issued by one of the defendants, Center on Children (“the Center”), were securities and that the plaintiffs’ claims were time-barred under both federal and state securities law.

The plaintiffs, LaDonna and Rich Delgado (“Plaintiffs”) held two notes (“Notes”) issued by the Center. The Center issued the first note in April of 2004 for $20,000.00 at 8.5 percent interest compounded annually, and it issued the second note in May of 2006 for $25,000.00 at 8.5 percent interest compounded annually. The defendants were the Center, its former president Donald Allison, former board member Kenneth Mills, and the Mid-Atlantic District Church of the Nazarene (“the Church”) of which Mr. Mills is the superintendent (“collectively Defendants”). As the Center is no longer in existence, Plaintiffs claimed that Mr. Mills and the Church were responsible for the Center’s debts.

To address the issue of Plaintiffs’ claims in relation to the relevant statutes of limitations, the court first determined whether or not the Notes were securities. The court applied the test delineated by the United States Supreme Court in Reves v. Ernst & Young, which differentiated “notes based on whether the notes are issued in an investment context (which are ‘securities’) from notes issued in a commercial or consumer context.” This test presumes that all notes are securities, but allows this presumption to be rebutted when the note in question can be shown to resemble a “family” of instruments that are not considered securities. If the note does not closely resemble one of these listed instruments, the fact finder must then “evaluate four factors to determine whether the note is in a class that should be added to the list” of instruments that are not considered securities.

These four factors are: “(1) the motivations that would prompt a reasonable buyer and seller to enter into [the transaction]; (2) the ‘plan of distribution’ of the note to determine whether it is a note for which ‘common trading for speculation or investment’ exists; (3) the reasonable expectations of the investing public; and (4) the existence of another regulatory scheme which would reduce risks related to the note and make application of securities law unnecessary.” The court determined that the Notes did not fit into any of the enumerated exceptions and proceeded to apply the test.

The court found that factors 1, 3, and 4 weighed in favor of the Notes being classified as securities, while factor 2 did not. As the Reves test is a balancing test, the court ruled that the Notes were considered to be securities under federal law. Since both Maryland and Louisiana utilize the Reves test, the court determined that the Notes were securities under state law as well. Defendants argued that the Notes were unregistered, and Plaintiffs did not contest this fact. After checking the Security and Exchange Commission’s online database and finding no filings by the Center, the court held that the Notes were unregistered securities.

The court then addressed the federal and state statutes of limitations.  Section 13 of the 1933 Act reads, “an action based upon the sale of an unregistered security must be filed ‘[w]ithin one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence’… In no event, however, may suit be filed more than three years after the sale or public offering of the security.” Maryland’s blue sky laws contain the same time restrictions as the federal statute, and Louisiana’s, while similar, actually shorten the period to two years. The Center issued one note in 2004 and the other in 2006, and Plaintiffs did not commence the action until 2010; therefore, the court ruled that the claims were barred under federal securities law, Maryland’s securities law, and Louisiana’s securities law. The court dismissed Plaintiffs’ claims with prejudice.

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


Union Cent. Life Ins. Co. v. Ally Fin., Inc.: PSLRA Discovery Stay is Applicable to State Law Claims in Federal Securities Actions

In Union Cent. Life Ins. Co. v. Ally Fin., Inc., No. 11 Civ. 2890(GBD)(JCF), 2012 WL 3553052 (S.D.N.Y. Aug. 17, 2012), the United States District Court for the Southern District of New York denied the plaintiffs’ motion for commencement of limited discovery.  The plaintiffs’ (Union Central Life Insurance Company, Ameritas Life Insurance Corporation, and Acacia Life Insurance Company) initially alleged that the defendants violated the Securities Exchange Act of 1934 (“Exchange Act”) and committed “state common law fraud in connection with the sale of twenty-one residential mortgage-backed securities.”  Plaintiffs moved for limited discovery against three groups of defendants:  Morgan Stanley, Washington Mutual, and UBS.  The plaintiffs asserted only state law claims, and not claims under the Exchange Act, against these particular defendants. 

Under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), discovery is postponed in cases involving violations of the Exchange Act until all motions to dismiss are ruled upon.  Defendants filed motions to dismiss, halting discovery.  The plaintiffs put forth three arguments in support of their motion for limited discovery.      

First, the plaintiffs asserted that the PSLRA discovery rule is not applicable to “state law claims where no parallel Exchange Act claim is asserted.”  This argument broke down into two propositions:  (1) “the question of whether the PSLRA stay applies should be resolved independently with respect to each defendant”; and (2) “[assuming the first proposition is true,] the stay does not apply with respect to those defendants against whom the plaintiffs have raised solely state law claims.”  

The court accepted neither proposition.  With respect to the first proposition, the court noted that the cited cases involved the commencement of discovery after the denial of a motion to dismiss.  Because the motions were pending, the cases were inapposite. 

The court resolved the second proposition by looking at the plain language of the PSLRA.  The statute applied to “federal securities actions” [emphasis in original] and did not specify the need for a federal security claim against each particular defendant.  The court reasoned that this language was broad enough to encompass these state law claims because they were within the federal securities action.  

The plaintiffs’ second argument for limited discovery was that “the presence of Exchange Act claims against other defendants is not a valid basis for extending the stay to include defendants against whom they assert only state law claims.”  The court concluded that a discovery stay was inapplicable to state law claims that were unrelated to fraud.  The actions in the instant case were related to fraud and therefore inseparable from the Exchange Act claims.  Furthermore, the court explained that extending the PSLRA to state law claims was essential in cases such as this where coordination among the defendants is required. 

The plaintiffs’ final argument was “that the PSLRA’s stay provision was not intended to apply to individual, rather than class action, securities claims.”  The court again looked to the language of the statute and found no limitation on the scope, holding that the PSLRA applies to individual actions. 

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


New York Supreme Court Dismisses All but One Claim in Suit Brought by Facebook Purchaser

In Facie Libre Assocs. I, LLC v. Secondmarket Holdings, Inc., No. 651696-2011E (N.Y Sup. Ct. August 10, 2012), the New York Supreme Court granted defendant SecondMarket Holding’s (“SecondMarket”) motion to dismiss on all but one claim.  Plaintiffs, Facie Libre Associates I, LLC and Facie Libre Associates II, LLC (collectively “Facie Libre”), which is coincidentally Latin for “Facebook,” were Delaware LLCs organized for the purpose of buying shares of Facebook before it went public.  SecondMarket created an online marketplace and brought together buyers and sellers of shares in privately held companies.  Facie Libre brought claims against SecondMarket for breach of contract as a third party beneficiary, negligence, breach of fiduciary duty, intentional misrepresentation, professional malpractice and unjust enrichment.

According to the complaint, the dispute arose when a Facebook employee sought and was granted permission from Facebook to sell 75,000 Class B common shares.  The employee entered into a Stock Transfer Agreement (“STA”) with Facie Libre that valued the shares at $33 per share for a total purchase price of $2,475,000.  SecondMarket entered into an Intermediary Services Agreement (“ISA”) with the Facebook employee whereby SecondMarket would design, implement, and facilitate the entire transaction in exchange for $75,000. 

Facie Libre alleged that SecondMarket had a duty under the ISA to deliver a legal opinion and obtain Facebook’s signature to authorize the transaction.  This task needed to be completed by a deadline of March 26, 2010.  Facie Libre’s expectations were based on twenty previous transactions with SecondMarket in the past. 

Three months after SecondMarket represented to Facie Libre that the transaction had closed, SecondMarket recanted and revealed that it had failed to present Facebook with the legal opinion by the deadline and that the transaction never closed.  Shortly after the missed deadline, Facebook instituted an insider trading policy that prevented employees from selling shares to company outsiders.

SecondMarket initially sought dismissal of  the claims based on a one-year limitation of liability provision in its User Agreement and the argument that the User Agreement barred liability on the claims in this case.  The court rejected both arguments because the User Agreement governed use of SecondMarket’s website, while the STA governed the transaction.

Facie Libre’s breach of contract claim was dismissed because the agreement at issue was not breached.  To succeed as a third-party beneficiary of a contract, the plaintiff must establish that (1) a contract existed between other parties; (2) the contract was intended for the plaintiff’s  benefit; and (3) that benefit was direct rather than incidental.  The ISA, however, was not breached.  It did not require SecondMarket to obtain and deliver the legal opinion; that duty was the Facebook employee’s under the STA.  Accordingly, the claim was dismissed.

The court dismissed the claim for negligence because no duty existed.  The court held that the only potential duty was contractual and that a breach of contract claim may be appropriate, but a negligence claim is “improperly duplicative.”

Similarly, Facie Libre’s breach of fiduciary duty claim failed because a fiduciary relationship was never created.  Facie Libre alleged that because it relied on SecondMarket’s expertise, a special relationship of trust, confidence, and responsibility arose that created a fiduciary duty.  The court reasoned that “‘[p]laintiff’s alleged reliance on defendant’s knowledge and expertise . . . ignores the reality that the parties engaged in arm’s-length transactions pursuant to contracts between sophisticated entities that do not give rise to fiduciary duties.’”

The plaintiffs sufficiently pled the elements of an intentional misrepresentation claim.  The elements of an intentional misrepresentation claim are (1) a material misrepresentation; (2) falsity; (3) scienter; (4) reliance; and (5) injury.  SecondMarket allegedly made a “clearly false” statement when it told Facie Libre that the deal had closed, and Facie Libre’s reliance on SecondMarket was reliable because SecondMarket was in the best position to know whether the deal closed.  Finally, Facie Libre properly pled that its injury was proximately caused by SecondMarket’s misrepresentation because if SecondMarket had been truthful, Facie Libre could have obtained the legal opinion, closed the deal, and realized the gain in Facebook’s stock price.

Facie Libre withdrew its professional malpractice claim during oral argument.

Facie Libre’s claim for unjust enrichment was also dismissed.  A successful claim of unjust enrichment alleges a benefit conferred upon the defendant that the defendant obtained without adequately compensating the plaintiff.  Facie Libre’s claim failed because the benefit conferred on SecondMarket came from the Facebook employee, not Facie Libre. 

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


Americas Mining Corp. v. Theriault: Delaware Supreme Court Upholds Court of Chancery’s Award for $2 Billion in Damages and $304 Million in Attorneys’ Fees

In Americas Mining Corp. v. Theriault, Nos. 29, 2012, 30, 3012, 2012 LEXIS 459 (Del. Aug. 27, 2012), the Supreme Court of Delaware upheld the Court of Chancery’s judgment in favor of minority shareholders, affirming an award of more than $2 billion in damages and more than $304 million in attorneys’ fees.

Michael Theriault, trustee for Theriault Trust, brought a derivative suit on behalf of minority shareholders in Southern Copper Corporation (“Southern Peru”) against American Mining Corporation (“AMC”), a subsidiary of Southern Peru, and Southern Peru’s affiliate directors for breach of the duty of loyalty. Theriault alleged that AMC, a subsidiary of Grupo Mexico, the controlling shareholder of Southern Peru, caused Southern Peru to acquire a 99.15% equity interest in Minera Mexico (“Minera”), a Mexican mining company owned by Grupo Mexico. Plaintiff alleged that Southern Peru overpaid for the acquisition.

The Court of Chancery held that evidence presented at trial demonstrated that because of the Special Committee’s ineffective operation, AMC, through its controlling shareholder Grupo Mexico, “extracted a deal that was far better than market” price, constituting a breach of the duty of loyalty to Southern Peru. The defendants appealed the decision based on five distinct arguments, and the Delaware Supreme Court found each contention to be without merit.

Defendants argued that the Court of Chancery unfairly prejudiced them when it denied their request to allow one of their financial advisors from Goldman Sachs to testify at trial as a replacement for a previously identified witness. The advisor would explain the internal processes used at Goldman Sachs to issue fairness opinions to clients. The witness was proposed a week before the trial, was not available to be deposed before the trial and was not available to testify during the scheduled trial dates. Defendants requested that he be deposed after every other trial witness had testified, and sought a modification of the trial schedule so that the court could reconvene several weeks after the trial was scheduled to conclude to hear the testimony of the witness.

The Court of Chancery found that other Goldman Sachs witnesses had been deposed about the same topic. Moreover, the trial judge was willing to “watch the video” of the previously identified witness. Finally, the “eleventh-hour request” to change the trial dates “would have been unfair to the Plaintiff.” The Delaware Supreme Court found that the Chancery Court’s decision was “supported by the record and the product of a logical deductive reasoning process” and was, as a result, a proper exercise of discretion.

Defendants also asserted as error the decision of the Court of Chancery to fail to decide before trial which party had the burden of proof. The defendants asserted that their use of a Special Committee resulted in plaintiffs having the burden. The Delaware Supreme Court, however, noted that the shift in the burden depended upon the effectiveness of the Special Committee, something that could only be determined after the presentation of affirmative evidence at the trial. Moreover, the practical effect of the shift in the burden was “slight” and did not, in the opinion of the Court, alter the outcome of the decision. See Id. (“Nothing in the record reflects that a different outcome would have resulted if either the burden of proof had been shifted to the Plaintiff, or the Defendants had been advised prior to trial that the burden had not shifted.”).

The defendants also challenged the lower court’s finding that there had not been fair dealing or fair price. In particular, defendants argued that the Chancery Court incorrectly rejected Goldman Sachs’ valuation procedure without a sufficient evidentiary basis. The Delaware Supreme Court held that “the Court of Chancery did understand the [d]efendants’ argument and that its rejection of the [d]efendants’ ‘relative valuation’ . . . was the result of an orderly and logical deductive reasoning process that is supported by the record.”

The Delaware Supreme Court also reviewed the calculation of damages. In determining the amount of the overpayment, the Court of Chancery looked to three different alternate valuation techniques for Minera, concluding that the average “difference” was $1.347 billion. The court awarded that amount plus the statutory interest rate. Because the Court of Chancery had “explained the reasons for its calculation of damages with meticulous detail” and shared with the defendants “complete transparency of its actual deliberative process,” it properly exercised its discretion in calculating and awarding damages.

Finally, the defendants contended that the $304 million award for attorneys’ fees was unreasonable as it would pay the plaintiffs’ counsel at a rate of more than $35,000 per hour, an amount 66 times more than the value of the attorneys’ time and expenses. The Delaware Supreme Court affirmed the use of the “percentage of the fund” method when setting common fund fee awards. See Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del. 1980) (fees based on (1) the benefit achieved; (2) counsel’s time and effort; (3) the difficulty and complexity of litigating the case; (4) whether counsel’s representation was contingent; and (5) the standing and ability of counsel working on the case).

The Delaware Supreme Court explained that the “benefit achieved” factor was the most important in determining the amount of fees and that counsel, when it secures an extraordinary benefit for its clients, is “entitled to a fair percentage of the benefit” [emphasis in original]. Again, the Court of Chancery described in thorough detail its reasoning for awarding the amount of attorneys’ fees that it did, even declining the percentage based in part upon the size of the judgment, and in part upon plaintiffs’ counsels’ delay in litigating the case.

In an unusual move, Justice Berger filed a separate opinion concurring in the merits of the case, but dissenting with regard to the legal standard applied by the trial court to the award of attorneys’ fees. Justice Berger found that instead of applying the Sugarland factors, the trial court’s analysis was based upon its views of whether the fees available to plaintiffs’ lawyers were high enough to incentivize them to try “mega” cases.

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


UBS Financial Services Inc. v. Carilion Clinic: FINRA Arbitration Ordered in ARS Case

In UBS Financial Services Inc. v. Carilion Clinic, Civil Action No. 3:12cv424–JAG, 2012 WL 3112010 (E.D. Va. July 30, 2012), the United States District Court for the Eastern District of Virginia denied plaintiffs’ motion for a preliminary injunction prohibiting arbitration with the Financial Industries Regulation Authority (“FINRA”).

Defendant Carilion Clinic (“Carilion”) is a non-profit healthcare organization operating eight hospitals in Virginia. It entered into a business relationship with UBS Financial Services (“UBS”) and CitiGroup Global Markets, Inc. (“Citi”) (collectively, “Plaintiffs”) through two sets of documents: the Underwriter Agreements and the Broker-Dealer Agreements. Carilion then issued about $234 million in auction rate securities (ARS), allegedly at the recommendation of UBS and Citi, to fund expansion of its facilities. ARS “are bonds for which the variable interest rate is determined through a periodic auction.”  UBS and Citi allegedly bid in these auctions along with investors to ensure the auctions did not fail. When the ARS market crashed in 2008, UBS and Citi discontinued auction bidding; the auctions failed, resulting in a loss of millions of dollars by Carilion. Carilion initiated arbitration in FINRA in February 2012.

In order to be successful on their motion for a preliminary injunction, Plaintiffs must prove the following: “(1) they are likely to succeed on the merits; (2) they are likely to suffer irreparable harm in the absence of preliminary relief; (3) the balance of equities tips in [their] favor; and (4) an injunction is in the public interest.”

Plaintiffs first argued that Carilion is “an issuer of securities, not a customer,” and therefore, Carilion did not have a right to arbitration under FINRA. The court defined “customer” as “one that purchases some commodity or service.” The court reasoned that Carilion was a customer because it paid for financial services, such as underwriting, administrative auction fees, and financial advice. Accordingly, the court ruled that Plaintiffs were not likely to succeed on the merits of arguing Carilion was not a customer.

Next, Plaintiffs argued that Carilion waived any right to arbitration by agreeing to a forum selection clause in the Broker-Dealer Agreements. The court stated that the Federal Arbitration Act “requires any ambiguities in contract to be resolved in favor of arbitration.” The court found that the language of the forum selection clause stated that “all actions and proceedings” were to be brought in New York and it “did not directly address arbitration.” Plaintiffs were also on notice of a potential arbitration requirement because their status as FINRA members required arbitration in certain circumstances. Accordingly, the court ruled that Plaintiffs were unlikely to succeed on the merits of their claim that the forum selection clause waived arbitration.

The court also found that Plaintiffs could not show they would be irreparably harmed, the balance of equities was not in Plaintiffs’ favor, and the public interest favored arbitration.

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


Kiobel Unlikely to Turn on Corporate Personhood posted an article this past Monday with the provocative headline: In Shell Case, Will Supreme Court’s View of Corporate Personhood Mean Liability for Crimes Abroad?  The article went on to describe the case as follows:

The Supreme Court opens its 2012-2013 term today with a landmark case to decide whether survivors of human rights violations in foreign countries can bring lawsuits against corporations in U.S. courts. The case centers on a lawsuit that accuses the oil giant Shell’s parent company, Royal Dutch Petroleum, of complicity in the murder and torture of Nigerian activists. Some legal analysts are comparing this case, Kiobel v. Royal Dutch Petroleum, to the landmark campaign finance ruling in Citizens United. In 2010, the Supreme Court ruled corporations have broad rights under the First Amendment and can directly fund political campaigns. The court is now being asked to decide if corporations have the same responsibilities as individuals for violations of international law.

However, there are good reasons to believe the Court will never reach the issue of corporate theory or personhood.  To begin with, the Court ordered re-argument to address the question whether the Court should be hearing the case at all—independent of any questions of corporate status.  As the Wall Street Journal reported (here):

Initially, the Supreme Court agreed to consider whether the alien tort law applied to corporations as well as individuals, but after a first round of arguments in February, the justices ordered additional arguments over the far broader question of whether the law applies at all to events overseas.

"Why does this case belong in the courts of the United States when it has nothing to do with the United States other than the fact that a subsidiary of the defendant has a big operation here?" said Justice Samuel Alito, who both Monday and in February seemed most inclined to restrict the law's scope.

Furthermore, as I note in the latest SSRN draft of my paper, The Silent Role of Corporate Theory in the Supreme Court’s Campaign Finance Cases, 15 U. PA. J. CONST. L. __ (forthcoming), even the corporate-status issue is unlikely to involve corporate personhood/theory:

Looking ahead, in Kiobel v. Royal Dutch Petroleum Co., the Court will soon be addressing the question whether federal courts in the United States may exercise jurisdiction over corporations pursuant to the Alien Tort Statute, which gives federal courts “original jurisdiction of any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.”   The Second Circuit, in ruling on the case below, identified the relevant issue as “the treatment of corporations as a matter of customary international law.”    This may at first blush suggest corporate theory is irrelevant because the question is not why corporations are treated a particular way under international law, but rather simply how they are in fact treated.  

I did go on to note, however, that:

Nevertheless, it may again be difficult to separate a conclusion about the scope of the statute from preconceived notions about what corporations are.  For example, the Brief Amicus Curiae for the Brennan Center for Justice at NYU School of Law in Support of Petitioners  notes the following:

"In his opinion denying rehearing, a distinguished member of the panel majority below asserted that requiring multinational corporations to defend against customary international law claims in United States courts would subject them to 'extort[ed]' settlements, and unjustifiably 'beggar' them. Such a canard is deeply troubling, not only because it is so clearly legislative in nature, but because it is premised on an indefensible assumption that corporations are freestanding entities less prone to great evil than the fallible human beings who constitute them."

Thus, it is unlikely that the case will turn on corporate personhood or corporate theory, but I won’t be surprised if the attitudes of the justices toward corporations make their way into the opinion nonetheless.



SEC v. Bartek: Officer/Director Bans Barred by Statute of Limitations

In SEC v. Bartek, the Fifth Circuit Court of Appeals held that the discovery rule exception does not apply to the federal statute of limitations (codified at 28 U.S.C. § 2462), and that an injunction permanently barring defendants from serving as officers or directors at any public company is a penalty under § 2462.  2012 WL 3205446 (Fifth Cir. Aug 7, 2012).  The court held that because there was no discovery rule exception in the statute and because the remedy sought by the plaintiff was a penalty, the claims were barred by § 2462.   

Douglas Bartek was the founder and CEO of Microtune, a company that manufactured silicon tuners.  Nancy Richardson was the general counsel and CFO of Microtune.  In 2008, the Securities and Exchange Commission (“SEC”) brought suit against Bartek and Richardson for violations of the antifraud and books and records provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.

According to the SEC, Bartek and Richardson failed to properly expense backdated stock options granted to officers and employees of Microtune from 2000 to 2003.  Allegedly, Bartek retroactively selected grant dates, using the date of the lowest stock price over the previous two weeks as the supposed option grant date.  The SEC claimed that the alleged backdating scheme caused Microtune to understate over $22.5 million of compensation expenses and overstate income in filings to the SEC.  The SEC sought civil penalties and permanent injunctions barring Bartek and Richardson from serving as officers or directors at any public company. 

Bartek and Richardson filed a motion to dismiss, arguing that the claims were barred by the five-year federal statute of limitations for enforcement of civil penalties.  28 U.S.C. § 2462.  The district court granted the motion.  On appeal, the SEC argued that the discovery rule exception should apply to § 2462 and therefore that the claims did not begin to accrue until the SEC first discovered the violations in 2003.  Application of the discovery rule means that a claim begins to accrue “upon discovery of harm” instead of when the violation occurred. 

To determine whether the discovery rule applied to § 2462, the Fifth Circuit considered the text of the statute and case law.  The court found no support for a discovery rule exception in the text of § 2462.  With respect to case law, the Fifth Circuit court began its analysis by noting that it had previously held that “[i]t is abundantly clear that both the courts and Congress have construed the ‘first accrual’ language of § 2462 to mean the date of the violation.”  (citing United States v. Core Labs., Inc., 759 F.2d 480, 482 (5th Cir. 1985)).  The court also noted that the 9th, 11th, and D.C. Circuits have “similarly held that § 2462 does not incorporate a discovery rule.”  Finally, the court applied the Supreme Court’s holding that “the general meaning of when a right accrues is when that claim comes into existence.  (citing United States v. Lindsay, 346 U.S. 568, 569 (1954)).  Thus, the court ruled that the discovery rule did not apply to § 2462. 

The SEC also argued that the permanent officer and director bars it sought against Bartek and Richardson were not penalties, but were instead equitable remedies.  Equitable remedies, unlike penalties, are not subject to the time limitations of § 2462.  The court explained that “[i]n determining whether the sanction is a penalty [under § 2462], a court must objectively consider the degree and extent of the consequences to the subject of the sanction.”  The court found that the injunctions were penalties because they “would have a stigmatizing effect and long-lasting repercussions” and because they wouldn’t remedy past harm.  Therefore, the SEC’s permanent injunction claims against Bartek and Richardson were subject to the time limitations of § 2462. 

Because there was no discovery rule exception to § 2462 and because the injunctions sought by the SEC were penalties, the court affirmed the dismissal of the SEC’s claims against Bartek and Richardson.

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


Abrams v. Wainscott: Derivative Action Dismissed

In Abrams v. Wainscott, et al., Ruth Abrams (“Plaintiff”) filed a derivative action in federal district court against the board of directors of AK Steel Holding Corp. (collectively, “Defendants”).  No. 11-297-RGA, (D. Del. August 21, 2012).  

Plaintiff alleged that the proxy statement for AK Steel instructed stockholders that if they voted to reapprove the performance goals of the Long-Term Performance Plan (“LTPP”), the Stock Incentive Plan (“SIP”), and the amendment and restatement of the SIP, performance based compensation under the plans would be tax-deductible.  Plaintiff alleged that the compensation under the plans was not tax-deductible and that the disclosure was misleading.  Plaintiff brought four claims, including unjust enrichment, waste based on the payment of non-deductible compensation, breach of duties under the federal proxy rule, and breach of the duty of loyalty. 

Defendants moved to dismiss the complaint for the failure to make demand.  Plaintiffs asserted, however, that demand was excused as futile.  Under Delaware law, demand futility will be shown through allegations of particularized facts that create a reasonable doubt as to whether “(1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).

The court found that Plaintiff did not adequately allege that the Director Defendants were interested in the various plan matters submitted to shareholders for approval.  As a result, demand would be excused only if Plaintiff alleged particularized facts establishing “a reasonable doubt as to whether the protections of the business judgment rule” were available to the directors.   

Plaintiff asserted that the Compensation Committee of the Board had been responsible for the development and implemented the LTPP.  Moreover, the Committee had, “at various earlier times allegedly violated the express terms of then-existing LTPP.”  Because at least half the board sat on the Compensation Committee, according to Plaintiff, they could not claim the protection of the business judgment rule. 

 The court held that broad allegations of a violation of a compensation agreement was not sufficient to meet the second prong of the Aronson test.  Instead, shareholders had to include allegations of knowledge and intent with respect to the violations of the plan.  Plaintiff also alleged that demand was excused because the majority of the board violated public policy, the claim involved a disclosure issue, and the compensation at issue involves waste. The court summarily dismissed these arguments.

Plaintiff’s pleadings failed under both the first and second prongs of the Delaware test; thus, the court dismissed the case.  The court did so without prejudice in order to allow Plaintiff the chance to amend.

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


Securities Fraud and a Pump-and-Dump Scheme: SEC v. Curshen

In SEC v. Curshen, No.11–CV–20561–JLK, 2012 WL 3755527 (S.D. Fla. Aug. 28, 2012), the United States District Court of the Southern District of Florida granted the Security and Exchange Commission’s (“SEC”) motion for summary judgment against two defendants, Yitzchak Zigdon, an accountant, and Ariav Weinbaum, a businessman, for violations of the antifraud provisions in both the Securities Exchange Act of 1934 and Securities Act of 1933.

This case involved the sale of common stock in a limited private company incorporated in the United Kingdom called CO2 Tech (“CO2” or “the company”).  According to the SEC’s allegations, the company had a registered business address in London and purported to have a manufacturing and research development facility in Israel. The company claimed that it had experts with over a decade of experience in the pollution control industry and partnerships/alliances with leading companies and research institutions.   

In reality, according to the SEC, CO2’s London office was simply a rented mail drop, and its manufacturing and research development facility could not be located. Additionally, with respect to the officers, the CEO “had not traveled outside of Israel since November 1, 2003” and the President was the CEO’s 72-year-old mother. 

Sections 10(b) and 10b-5 of the Exchange Act and Section 17(a) of the Securities Act prohibit certain types of false statements.  They also prohibit schemes to defraud.  The latter type of violation did not necessarily require a misstatement or omission, but was aimed at a “broader fraudulent scheme.”

The court found that there were no facts in dispute and that the SEC had met its burden establishing violations of Section 17(a) and Rule 10b-5.  According to the opinion:

A pump-and-dump stock scheme is a classic violation of these provisions. The actions of Defendants . . . repeatedly violated the anti-fraud provisions of the Securities Act and Exchange Act. Defendants . . . converted C02 Tech into a public company by instructing Defendant Krome to find a public shell corporation; opened a brokerage account at Red Sea management to facilitate the stock manipulation; and directed matching buy and sell orders to artificially inflate C02 Tech's stock value. Individually, Defendant Weinbaum transferred money to Defendant Krome for the shell purchase and hired Defendant Weidenbaum to promote the stock and help organize buy and sell orders. Defendant Zigdon orchestrated the false media campaign surrounding C02 Tech.

The court also found the defendants liable for the sale of unregistered securities under section 5 of the Securities Act. According to the court, the SEC produced undisputed facts showing CO2 sold unregistered shares and that the defendants were “at the very least, necessary participants and substantial factors” in the sale of the shares.

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


BofA, Merrill Lynch and the Financial Crisis of 2008

BofA settled the law suit over the Merrill Lynch acquisition for $2.43 billion (along with some governance changes). See Bank of America Settles Suit Over Merrill for $2.43 Billion. The suit arose out of allegations that BofA did not adequately disclose a forecast of the fourth-quarter losses expected to be incurred by Merrill.  The action was described as “the largest securities class-action lawsuit settlement yet to arise from the financial crisis.” 

We have no comment on the merits of the case.  We note only this.  The acquisition of Merrill came at a critical time. Lehman had collapsed. The financial markets were hardly functioning. As evidence of the burgeoning losses at Merrill became clear, BofA had an argument that it could walk away from the acquisition (based upon a material adverse condition). There is some evidence that the government pressured BofA to complete the acquisition. Had the Bank walked away and had Merrill collapsed, the blow to the financial markets likely would have been enormous, potentially making the downward economic spiral substantially worse. 

This is one of those instances where the merits of the acquisition to shareholders can be debated (although as the Dealbook article notes, Merrill has contributed “roughly half the bank’s revenue since 2009”). But the financial system, the country, and the persons who would have suffered had the recession worsened as a result of a failure of Merrill, likely owe a debt of gratitude to BofA for completing the acquisition.