US Supreme Court Maintains Securities Fraud Status Quo

The US Supreme Court has essentially maintained the status quo in corporate securities fraud litigation.

The Court had taken up for consideration a lower court case which overturned the 25 year precedent, set in Basic v Levinson that aids plaintiff’s counsel in obtaining class certification. (Click here for background on the issue and the case.)

Statistics show that once a class is certified, a high percentage of corporate defendants settle rather than go to trial.

Hopes were high among corporate executives and their legal advisers (potential “defendants”) that the Court would even the playing field by raising the bar which plaintiff’s counsel must meet to obtain class certification.

The defendants’ small victory is that the Court made uniform among the lower courts the procedure that defendants can challenge, at the class certification stage, a key assumption that fraudulent information provided by the defendants impacted the defendant’s stock price.

Click here for ReedSmith’s summary on this case.

Proxy Season Recap 2014

There are valuable lessons to be learned from the 2014 proxy season.

Georgeson, the proxy solicitor, and Latham & Watkins, the law firm, have produced a valuable webinar to efficiently inform us of “takeaways” and trends from the proxy season.

LogoGeoLatham

Click here to go to the webcast

Topics

• Executive Compensation Developments, including updates on this year’s Say on Pay votes, proxy injunction and other executive compensation lawsuits, ISS and Glass Lewis practices and SEC rules

• Evolving Trends in Shareholder-Investor Engagement, including newly recommended protocols and differing investor approaches for making a difference over the long term

• Issues of Increasing Concern to Investors, including director qualifications, tenure and board structure; environment and social issues; and the hottest shareholder proposals

• Activist Investors, including preparing for and responding to their latest playbooks

Speakers
Jim Barrall, Partner, Latham & Watkins LLP
Rhonda Brauer, Senior Managing Director – Corporate Governance, Georgeson
Steven Stokdyk, Partner, Latham & Watkins LLP

Sponsors

Latham & Watkins LLP is a leading global law firm dedicated to working with clients to help them achieve their business goals and overcome legal challenges anywhere in the world. The firm has earned considerable market recognition based on a record of landmark matters and a unified culture of innovation and collaboration. From a global platform of offices covering the world’s major financial, business and regulatory centers, the firm’s lawyers help clients succeed. For more information, visit www.lw.com.

Georgeson is the world’s leading provider of strategic proxy and corporate governance advisory services to corporations and shareholder groups working to influence corporate strategy. For over half a century, Georgeson has specialized in complex solicitations such as hostile and friendly acquisitions, proxy contests and takeover defenses. The firm also provides issuers with expertise in corporate events solutions such as post-merger unexchanged holder programs and information agent services. For more information, visit www.georgeson.com.

 

Questions
michele.bravo@lw.com |
+1.213.892.3054

SEC Trends for Public Companies

This webinar will include practical tips to help your company avoid SEC trouble.

Latham & Watkins, the law firm, has produced valuable webinars which are well worth the time (which is not universal with webinars, in my opinion).

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Please join Latham & Watkins for a complimentary webcast discussing SEC trends for public companies in the areas of accounting and financial fraud.

Click here to go to the webinar.

Topics

• The Re-Tooled SEC – A smarter SEC takes on big data analytics

• The New Era of Creative and Aggressive Enforcement – The “broken windows” approach to enforcement and the lower bar for SEC actions

• Hitting and Avoiding the SEC’s Radar Screen – Practical tips for avoiding compliance issues and enforcement action

Speaker
John Sikora, Partner, Latham & Watkins LLP (Chicago), former SEC Assistant Director in Enforcement and the Asset Management Unit

Sponsor
Latham & Watkins LLP is a leading global law firm dedicated to working with clients to help them achieve their business goals and overcome legal challenges anywhere in the world. The firm has earned considerable market recognition based on a record of landmark matters and a unified culture of innovation and collaboration. From a global platform of offices covering the world’s major financial, business and regulatory centers, the firm’s lawyers help clients succeed. For more information, visit www.lw.com.

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Questions
michele.bravo@lw.com
+1.213.891.3054

M&A Deal Term Study by Practical Law

CvrImgPractical Law, the Thomson Reuters online resource for corporate legal information, produced its yearly study of M&A deal terms.

Practical Law also produced a valuable webinar describing a portion of its survey results.

This material is most useful for M&A professionals but may also be helpful to corporate executives active in M&A.

Click here to go to the webinar at Practical Law.

Click here to go to Practical Law to review their service offerings.

 

D&O Coverage for Subpeona Response Costs

I found this article both interesting and an easy read of a important topic.  It’s something that corporate executives and board members should know.

In summary, insurers may challenge whether the cost of responding to a subpoena is a covered cost under a company’s D&O policy.  This article (click here) by Benjamin Tievsky on Law360 describes the risk and how to reduce it by careful drafting of your policy.

Activist’s Big Ally

BlackrockLogoActivists have an ally in Blackrock Inc., which reportedly manages $4 trillion in assets.

An excerpt from Blackrock’s recent Annual Report,

Better Governance Means Better Performance

Our fiduciary duty to our clients leads us to use the ownership position we hold in companies around the world to protect their interests by advocating for good corporate
governance. Through direct engagement with management teams and effective use of our proxy voting power, we work to ensure the strong leadership and prudent management that we believe ensures sustained performance and better returns on our clients’ investments.”

Blackrock has been using its position as a large corporate shareholder to influence change.  As reported in the New York Times “Dealbook”, Chairman and CEO, Laurence Fink, sent a letter to the heads of the S&P 500 companies recommending that the companies focus on actions to promote sustainable growth vs short-term fixes.

Click here to read the NYTimes “Dealbook” article which includes a link to the Blackrock Annual Report.

Court Finds Conflicts in Rural/Metro Sale

WarningSignThe Delaware Court of Chancery has found the Board of Directors of Rural/Metro Corporation breached its fiduciary duties to its shareholders in its 2011 sale.  The Court also found the company’s lead adviser liable for aiding and abetting the breach.

The Rural Board was subject to undisclosed conflicts and failed to probe the company’s lead adviser for additional potential conflicts.

This case and prior high profile cases of conflict, such as the Del Monte and El Paso cases, should alert boards to be vigilant.

Click here to go to an article by White & Case, the law firm on JDSupra, the online legal magazine or click on the download button below.

Love Letters, They’re Not

CorpDuelTwo well-regarded participants in the corporate governance debate have issued letters to the public recently, defending their views.

In one letter, Carl Icahn, perhaps one of the best known corporate activists, defends his view that corporate management, if left unsupervised by a corporation’s shareholders, would make sub-optimal or perhaps deleterious decisions for the corporation.  Naturally, he sites his current targets, Lions Gate and eBay, as examples.

Excerpt:

“I have made a great deal of money by understanding some simple facts.  Very often assets of significant value are mismanaged by highly-compensated, but less than highly-competent, managers and boards of directors, all whom are protected by highly-compensated lawyers and bankers – with stockholders not only paying the fees of these advisors but also losing out on the returns that they otherwise could be enjoying if they took on their proper role as business owners.   In such situations, if investors can install good managers and elect directors that will hold those managers accountable, then the true value of those assets can be realized.”

Click here or past the link to read the Carl Icahn Letter on the website shareholdersquaretable.com – http://www.shareholderssquaretable.com/a-watershed-moment-for-stockholder-participation/

In the next letter, Leo Strine, Jr., Chancellor of the Delaware Chancery Court and legal scholar affiliated with several universities, addresses and counters a pro-activist essay by Professor Lucian Bebchuck, Professor of Law, Economics and Finance at Harvard Law School (Click here for Prof Bebchuck’s bibliography and links to additional information.)

Excerpt:

“Bebchuk has spent his entire career obsessed with ensuring that stockholders are not harmed by corporate managers, whether intentionally or because those managers have incentives that do not align exactly with those of the stockholders. He has been remarkably successful in seeing his agenda to make corporate managers more directly responsible to
stockholders become the predominant market reality. Fidelity to his own insights would seem to suggest a new agenda, which is ensuring that the entities of which most ordinary Americans are in fact equity investors—money managers in the form of mutual funds and pension funds—are as accountable as the managers of the productive enterprises on which our nation’s economic future is largely dependent. Until he broadens his lens to make sure that all who wield power using the funds of American investors are accountable, Bebchuk is himself fairly labeled an insulation advocate.”

Click here or paste the link to read Chancellor Leo Strine’s letter in the Columbia Law Review –  http://columbialawreview.org/can-we-do-better-by-ordinary-investors-a-pragmatic-reaction-to-the-dueling-ideological-mythologysts-of-corporate-law/

Unintended Consequences for Bond Market Liquidity

Regulatory changes under the Dodd-Frank Act designed to reduce the risk of another financial market downturn may have the reverse effect so suggests an article in “FierceCFO”, the online magazine.

My takeaway from the article is that new regulations forcing large banks out of proprietary bond trading and concentrating it in the hands of hedge funds will increase the risk of illiquidity in the event of another period of instability.

The article suggests that in the event of another period of economic uncertainty, hedge funds will quickly step away from the market accelerating illiquidity.  Regulators have much less leverage over hedge funds to maintain some level of liquidity than they have over the banks.

Click here to read the article on “FierceCFO”.

“FierceCFO” article summary

Liquidity: How regulators are fueling the next crash

We’re not fans of deregulation, but the opposite does have unintended consequences. And TABB Group just released a report that suggests the changes brought about by Dodd-Frank and other regulatory moves made in response to the last financial crisis may set the stage for the next one. How so? By shifting bond trading from banks to hedge funds, which have more freedom to pull in their horns just when the market needs the opposite. In other words, liquidity could dry up at just the wrong time. The money quote comes from Colin Teichholtz, co-head of fixed income trading at Pine River Capital Management: “These new liquidity providers can just turn off the machine in bad times,” Teichholtz said. “Illiquidity can beget illiquidity and there is no obligation on these players to make market. The danger is that the dealers won’t be around to pick up the slack. The optimum business model won’t be to warehouse risk.”

In an interesting development on this topic, Liquidnet, an equity trading “dark pool” is expanding into bond trading to provide an additional trading venue for the bond market.  As the article above stresses, the trading activity conducted by hedge funds through “dark pools” can dry up at any time if parties step to the sidelines.

Click here to read the article on FierceFinanceIT about Liquidnet entering bond trading.

 

Take Privates with Control Shareholder Rules Clarified

Taking a public company private when this involves a control shareholder has always been fraught with potential conflicts and litigation risk.

Recently, the Delaware Supreme Court upheld a Chancery Court decision setting the conditions under which a board of directors’ decision on a take private transaction with a control shareholder would be evaluated using the business judgement rule.

Katten Muchin Rosenman, the law firm, posted an article on JDSupra, the online legal magazine on this case.  Article excerpt:

In upholding the Chancery Court’s decision, the Delaware Supreme Court held that the business judgment standard of review would apply to a going private acquisition by a controlling stockholder if, but only if, the following facts were established: (1) the controlling stockholder conditioned the transaction on the approval of both a special committee, and a majority-of-the-minority stockholders; (2) the special committee was independent; (3) the special committee was empowered to freely select its own advisors and to say no definitively; (4) the special committee acted with care; (5) the minority vote was informed; and (6) there was no coercion of the minority.

Click here to read the article on JDSupra, by attorneys at Katten Muchin Rosenman LLP.

Click here to read an article on JDSupra by attorneys at Perkins Coie.

Click here to read an article on JDSupra by attorneys at Fenwick & West.

Also, another recent case in the Delaware Chancery Court spells out procedural rules and implications for the parties if there are any defects in the process.

Lathm & Watkins, the law firm, offers the following helpful analysis and recap of the case.  Additional articles from Latham & Watkins are available on its website, www.lw.com.

 

March 2014

 

 

In re Orchard Enterprises, Inc. Stockholder Litigation,
C.A. No. 7840 (Del. Ch. Feb. 28, 2014)

 

 

 

Delaware Court of Chancery applies entire fairness review to a take-private merger with a controlling stockholder, despite approval by a special committee and a majority-of-the-minority, and holds that disclosure claims may give rise to post-closing money damages where the duty of loyalty is at issue.

 

Summary

The Delaware Court of Chancery largely denied summary judgment, thereby paving the way for trial on the merits of a take-private merger in which the common stockholders of The Orchard Enterprises Inc. were cashed out by Orchard’s controlling stockholder. In a 90-page opinion, Vice Chancellor Laster found “evidence of substantive and procedural” unfairness in the process and price negotiated by a five-member special committee of directors and approved by holders of a majority-of-the-minority of the stock. The Court declined to apply business judgment review — or even shift the burden of persuasion under entire fairness review — in light of evidence that the structural protections outlined in In re MFW and CNX Gas may have failed to operate effectively to protect the interests of the minority stockholders.

The controlling stockholder, Dimensional Associates, LLC, held 53 percent of the voting power of Orchard through ownership of 42 percent of the common stock and 99 percent of the Series A convertible preferred stock. In October 2009, Dimensional made a proposal to buy out Orchard’s minority stockholders for $1.68 per share in cash. Orchard’s Board formed a five-member Special Committee, which was fully authorized to negotiate with Dimensional and potential third-party bidders and to hire independent legal and financial advisors. The Court of Chancery found evidence that the lead Special Committee director was neither independent nor disinterested in light of his long-standing relationships with family members of Dimensional’s founder and his solicitation of a post-closing consulting engagement with Dimensional.

Valuation of Dimensional’s Series A was a pivotal fact in the Court’s analysis. The Special Committee’s financial advisor preliminarily valued the common stock at $4.84, based on total equity value divided by the outstanding common stock — and assuming that the Series A would be converted to common stock and participate on a pro rata basis. This assumption effectively valued the Series A at about $7 million. Allegedly at the direction of the Special Committee, the financial advisor later changed its approach and valued the Series A based on a $25 million liquidation preference. The Court of Chancery found that, although Orchard’s charter entitled the Series A to a $25 million liquidation preference in a dissolution, asset sale or sale to third-party, none of these circumstances applied to a take-private transaction with Dimensional. Nonetheless, the price negotiation reflected Dimensional’s bargaining leverage given the unlikely scenario that any third party would value Orchard high enough to pay the $25 million Series A preference and pay a price for the common stock that would be undiminished by the preference payment.

Orchard’s public announcement of Dimensional’s initial proposal of $1.68 per share led to third party interest and generated a higher offer by a third party. Dimensional assured the Special Committee that Dimensional would be willing to support a sale to a third party if it received the full liquidation preference. The Special Committee allowed Dimensional to negotiate directly with the third party and at least one other bidder — but no deal was reached. The Court of Chancery found evidence that Dimensional may have misled the Special Committee by negotiating with the third parties for a premium above the Series A liquidation preference.

Meanwhile, in the negotiations between the Special Committee and Dimensional, Dimensional offered $2.10 per share without a majority-of-the-minority approval condition, but eventually agreed on a price of $2.05 per share with a go-shop and a majority-of-the-minority condition. The Special Committee’s financial advisor issued an opinion that the price was fair from a financial point of view to Orchard’s common stockholders — but the advisor assumed that the Series A should be allocated $25 million of the equity value of Orchard with the rest allocated to the common stock.

Orchard’s proxy statement recommended approval of the merger and of an amendment to the Series A Certificate to enable the merger (which otherwise would have prohibited a change of control via a take-private transaction with Dimensional). In July 2010, holders of a majority of the common stock not controlled by Dimensional approved the merger and the transaction closed. After closing, certain stockholders brought an appraisal action. In 2012, then-Chancellor Strine of the Court of Chancery (now Chief Justice of the Delaware Supreme Court) ruled that the merger did not trigger the Series A liquidation preference and appraised the common stock at $4.67 based on an assumed pro rata participation by the Series A on an as-converted basis. Two months later, other stockholders brought a class action challenging the process and price of the transaction.

Vice Chancellor Laster issued a 90-page opinion analyzing issues presented in dueling motions for summary judgment brought by plaintiffs and defendants.

The Court granted summary judgment to the plaintiffs on their claim that the proxy statement contained materially misleading disclosures regarding whether the merger triggered the Series A liquidation preference. The Court found that the proxy statement incorrectly stated in two places that the liquidation preference would be triggered unless the amendment was approved. One of those incorrect disclosures was material as a matter of law because the inaccuracy appeared in the description of the amendment to the Series A Certificate, which is a statutorily required disclosure under Section 242(b)(1) of the Delaware General Corporation Law (DGCL).

The Court also granted summary judgment to the plaintiffs on their arguments that the entire fairness standard of review should apply at trial, finding that Dimensional’s failure to agree at the outset to approval by both the Special Committee and a majority-of-the-minority precluded review under the business judgment rule. Furthermore, the Court held that neither of those protective measures, even though ultimately deployed, warranted shifting the burden of persuasion from defendants to plaintiffs because (a) the stockholder vote was tainted by the disclosure violation and (b) plaintiffs had raised triable issues of fact as to the integrity of the Special Committee process, including the issues with the chairman described above.

The Court of Chancery rejected the Special Committee members’ argument that they were automatically shielded from liability by the DGCL § 102(b)(7) exculpation clause in Orchard’s certificate of incorporation. That provision only immunizes directors for breach of the duty of care. Given the context of a controlling stockholder transaction subject to entire fairness review, where there was evidence of both procedural and substantive unfairness, the Court was unable to conclude, as a matter of law, that the evidence did not also implicate the duty of loyalty for all directors. Therefore, the four members of the Special Committee whose independence and disinterestedness had not been challenged by the plaintiffs were also required to prove at trial that they did not breach their duty of loyalty and were entitled to exculpation.

Finally, the Court of Chancery denied defendants’ argument that rescissory damages and quasi-appraisal damages were unavailable, finding that both measurements were possible given the failure to fully inform the stockholder electorate. (Rescissory damages is the monetary equivalent of rescission; quasi-appraisal damages is essentially monetary damages tied to the difference in equity value resulting from the non-disclosure.) The Court also rejected the defendants’ argument that In re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008) barred any post-closing claim for money damages for a disclosure violation, finding that a money damages claim is possible where the disclosure violation implicates the duty of loyalty, or where plaintiffs can otherwise prove reliance, causation, and calculable damages.

 

Implications for our Clients

 

·         To obtain business judgment review of a transaction with a controlling stockholder, it is critically important that procedural safeguards be established before substantive negotiations begin.

o    The controlling stockholder must agree at the outset to condition any transaction on approval by an independent special committee and the affirmative vote of a majority-of-the-minority of stockholders (these cannot be “deal points” to be negotiated).

o    Unless both of these procedural safeguards are implemented at the outset (even if both are implemented ultimately), the most the parties can obtain is entire fairness review with a shift in the burden of persuasion to the plaintiffs (business judgment review will not be available).

·         Where entire fairness review applies, if there is “evidence of procedural and substantive unfairness,” the exculpatory provision in a company’s charter does not automatically protect even facially independent and disinterested special committee directors from potential liability for breach of the duty of loyalty; rather, each director must establish at trial that he or she is entitled to exculpation.

·         Evidence that the special committee chairman was not independent and acted in self-interest may require other facially independent and disinterested special committee members to defend their own conduct.

o    Special committee membership must be vetted carefully for potential conflicts of interest and lack of independence; if warranted, the special committee should be re-constituted.

o    Directors considering special committee service should pay careful attention to the conflicts and independence of other possible committee members when considering whether to accept the committee appointment.

·         Under entire fairness review, post-closing damages may be awarded if disclosures to stockholders in the solicitation of majority-of-the-minority approval contain material inaccuracies.

o    Further, even in arms-length third-party merger cases, post-closing damages may be available for materially misleading disclosures, subject to plaintiff’s proof of reliance, causation and quantifiable damages.

o    This may lead to a reduction in pre-closing settlement of merger cases based on disclosures, or an increase in the cost of those settlements.

·         The decision may be appealed eventually, and it is possible that certain of the holdings, particularly those concerning the availability of exculpation for facially conflict-free and independent directors and of money damages for disclosure claims post-closing, may be considered further.

 

Discussion

Delaware Court of Chancery precedent has established that the business judgment rule can apply to squeeze-out mergers by controlling stockholders where certain procedural safeguards are adopted. In re CNX Gas Corporation Shareholders Litigation, 4 A.3d 397 (Del. Ch. 2010), established that a transaction with a controlling stockholder may be subject to deferential business judgment review if the transaction is conditioned on approval by an independent special committee and by a majority of the minority stockholder vote. In re MFW Shareholders Litigation, 67 A.3d 496, 502 (Del. Ch. 2013), clarified that, to obtain business judgment review, the special committee must have authorization to negotiate and the controlling stockholder must agree to the dual independent approval process up front, before beginning negotiations.

 

In re Orchard reiterates this timing requirement when attempting to secure business judgment protection for a transaction with a controlling stockholder. Although the transaction ultimately was approved by a special committee vested with the authority to negotiate, and by a majority–of-the-minority stockholder vote, the Court of Chancery declined to apply the business judgment rule because the controller did not agree up-front to both of those protections (and, indeed, used the majority–of-the-minority approval as a deal point to reduce the purchase price). In re Orchard confirms (resolving a question left open by CNX Gas and In re MFW), however, that the burden of persuasion may be shifted from the defendants to the plaintiff under the entire fairness standard if a controller agrees to one but not both protections. While a shift in the burden of persuasion is commonly viewed as an inferior procedural benefit because it does not obviate a potentially costly and time-consuming post-closing trial on the merits, a shift in the burden still may be valuable to defendants by incentivizing plaintiffs to settle before trial.

 

The decision also concludes that, in a controlling stockholder transaction subject to entire fairness review, an exculpatory clause in the company’s charter under DGCL § 102(b)(7) does not automatically shield even facially independent and disinterested directors from potential liability where there is evidence of procedural and substantive unfairness indicating a breach of the duty of loyalty. A trial is required to determine whether the transaction was entirely fair, and, if it was not, then an analysis on a director-by-director basis at trial is required to determine whether they committed any breach of loyalty. In re Orchard thus diminishes the opportunity for dismissal of facially independent and disinterested directors at an early stage in merger litigation (and increases the potential cost and hassle of service on a special committee). While DGCL § 102(b)(7) remains a strong substantive protection for directors who can reap the benefits of its protection at trial—even when the transaction was not entirely fair — In re Orchard meaningfully increases the risk that otherwise “clean” Special Committee members may need to bear the burden of preparation for and participation in a trial, as well as the associated reputational risks.

 

Finally, the Court held that monetary damages for alleged disclosure deficiencies in soliciting stockholder approval may continue to be available even after a merger closes. Although injunctive relief to correct disclosure deficiencies may be granted before a merger vote in order to prevent “irreparable harm” the Court rejected defendants’ inference that there can be no post-closing “remedy” in the form of monetary damages. However, plaintiffs who assert post-closing disclosure-based claims must still prove reliance, causation and quantifiable damages.

 

If you have any questions about this M&A Client Alert, please contact one of the authors listed below
or the Latham attorney with whom you normally consult:

 

Stephen B. Amdur

Mark G. Gerstein

Rachel J. Rodriguez

Blair Connelly

Pamela S. Palmer

Bradley C. Faris

Sarah M. Lightdale

 

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