On August 17, 2016, jurors in a New York federal court convicted Sean Stewart on criminal charges of conspiracy, securities fraud, and tender offer fraud after more than five days of deliberation. Stewart, a former investment banker for JPMorgan and Perella Weinberg Partners, was charged with leaking confidential information about health care mergers to his father, Robert Stewart, on at least five occasions over the course of four years. The case provides a victory to Preet Bharara, the United States Attorney for the Southern District of New York, after a series of setbacks in the form of unfavorable decisions in the aftermath of the Second Circuit’s decision in U.S. v. Newman, the repercussions of which have been covered extensively on this blog (see here, here). As the first conviction post-Newman, U.S. v. Stewart provides some insight into the kinds of facts that might support an insider trading charge in the Second Circuit going forward and is thus worthy of analysis.
In a 2-1 decision, the Seventh Circuit has joined the Delaware Court of Chancery’s call for enhanced scrutiny of “disclosure-only” M&A settlements that involve no monetary benefits to shareholders. As previously discussed here, M&A litigation, typically alleging breach of fiduciary duty by directors and insufficient disclosures, often ends in settlement, with defendants agreeing to provide supplemental disclosures in exchange for broad releases of claims, while plaintiffs’ counsel “earns” large attorneys’ fees for providing the class with the “benefit” of the agreed-upon disclosures. In In re Walgreen Company Stockholder Litigation (“In re Walgreen Co.”), the Seventh Circuit rejected such a settlement, endorsing the standard for approval of disclosure-only settlements articulated by the Delaware Court of Chancery in In re Trulia, Inc. Shareholder Litigation (“In re Trulia”). In In re Trulia, the Court of Chancery held that disclosure-only settlements in M&A litigation will meet with disfavor unless they involve supplemental disclosures that address a “plainly material misrepresentation or omission” and any proposed release of claims accompanying the settlement encompasses only disclosure claims and/or fiduciary duty claims regarding the sale process.
In several recent decisions we have covered (here and here), Federal Circuit Courts have unanimously ruled that respondents in an SEC enforcement action cannot bypass the Exchange Act’s review scheme by filing a collateral lawsuit in federal district court challenging the administrative proceeding on constitutional grounds. However, those prior opinions all were based on the narrow ground that district courts did not have jurisdiction to hear collateral challenges, and did not reach the merits of the constitutional challenge. In Raymond James Lucia Cos. Inc. v. SEC, No. 15-1345 (D.C. Cir. Aug. 9, 2016), the D.C. Circuit became the first federal appellate court to consider the merits and ruled in favor of the SEC. The court held that SEC administrative law judges are merely employees, rather than officers of the United States, and thus need not be appointed pursuant to the Appointments Clause of the Constitution. Their appointment satisfied constitutional scrutiny and could not provide grounds to throw out the results of the proceedings before them.
On August 2, 2016, U.S. District Judge Edward Chen dismissed a shareholder lawsuit brought against children’s educational toymaker LeapFrog Enterprises, Inc. (“LeapFrog”) for failure to adequately plead statements were false or misleading, or made with requisite intent. Plaintiffs’ suit, which was consolidated in 2015, alleged that LeapFrog and its executives hid demand and inventory problems from investors. The judge disagreed, finding that the investors had been sufficiently warned of problems with LeapFrog’s product lines and that the allegedly misleading statements were forward-looking and cautionary, and therefore fell within the PSLRA’s safe harbor. Defendants’ public statements about many of the allegedly misleading topics helped drive home that Plaintiffs’ theory amounted to classic “fraud by hindsight.”
On July 28, 2016, the Delaware Chancery Court allowed claims of unfair dealing against the Board of property management company Riverstone National Inc. to survive where the directors facilitated a merger that forestalled a derivative suit against them. The court held that by orchestrating a merger that extinguished a possible derivative action, the director defendants obtained a special benefit for themselves. As a result, the directors were interested in the transaction, thereby rebutting the presumption of the business judgment rule, and triggering application of the “entire fairness” doctrine.
Last week, several securities industry groups filed critical responses to the SEC’s plan for an audit trail. While most groups that commented on the SEC’s proposed regulation supported implementing the proposal, several had concerns regarding the cost for investors and firms, and the protection of private data.
In a move that will make Securities and Exchange Commission administrative proceedings look more like civil litigation in federal court, on July 13, 2016, the SEC announced that it had adopted amendments to its rules of practice. These rules appear similar to those the Commission proposed last September. For critics of the amendments, they may not go far enough, but the expanded discovery and clarifications regarding dispositive motion practice may address some of the issues previously raised regarding the Commission’s perceived home-court advantage.
On July 7, 2016, Judge Paul A. Magnuson of the United States District Court for the District of Minnesota granted Defendants’ Motions to Dismiss a shareholder class action that had been initiated following a 2013 holiday season data breach involving customers of Target Corporation (“Target,” or “the Company”). The data breach, which resulted in the release of information of approximately 70 million consumer credit and debit cards, made headlines as one of the biggest privacy hacks at the time. Initially disclosed to the public in December 2013, with an estimated 40 million credit and debit cards affected, Target subsequently revealed a little less than a month later that additional consumer data, including customers’ names, mailing addresses, phone numbers and email addresses, were also stolen, and increased its initial estimate to 110 million.
On June 27, 2016, SEC Administrative Law Judge Carol Fox Foelak dismissed the Division of Enforcement’s charges against IRA custodian Equity Trust Company in connection with the company’s processing of investments marketed by two convicted fraudsters. Judge Foelak’s decision—a complete defense victory for Equity Trust—shows that while the Division of Enforcement may still win most of its cases in administrative proceedings, it doesn’t win them all.
On June 30, 2016, the Delaware Chancery Court extended the Supreme Court’s holding in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), to two-step mergers under DGCL § 251(h). The Chancery Court concluded that acceptance of a first-step tender offer by a fully informed and uncoerced majority of disinterested stockholders insulates a two-step merger from challenge except on the ground of waste, even if a majority of directors were not disinterested and independent. See In re Volcano Corp. S’holder Litig., C.A. No. 10485-VCMR. In this situation, the business judgment rule is “irrebutable” and dismissal is typically appropriate given the high bar for proving “waste” and the unlikelihood that a majority of informed stockholders would approve such a transaction. In re Volcano is the latest decision underscoring the critical importance of securing an uncoerced and fully informed majority vote of disinterested stockholders if boards wish to benefit from this extremely deferential standard of review.