Delaware Supreme Court Wastes No Words: Summarily Affirms In re Volcano Corp. Stockholder Litigation, Upholding Business Judgment Rule and Dismissing Remaining Waste Claim

On February 9, 2017, the Supreme Court of Delaware summarily affirmed the Court of Chancery’s decision in In re Volcano Corp. Stockholder Litigation which had dismissed plaintiffs’ complaint on defendants’ 12(b)(6) motion to dismiss.

Plaintiffs, former stockholders of Volcano Corporation, had brought an action against defendants for breaches of fiduciary duty arising from the all-cash merger between Volcano and Philips Holding USA Inc. The parties had disputed what standard of review the Court of Chancery should apply: the Revlon test, as plaintiffs claimed, because Volcano’s stockholders received cash for their shares, or the irrebuttable business judgment rule, as defendants argued, because Volcano’s stockholders were “fully informed, uncoerced, and disinterested” when they approved the merger by tendering a majority of Volacano’s shares into a tender offer.  As the Court of Chancery explained, if a business judgment rule is irrebuttable, plaintiffs could only challenge the transaction on the basis of waste.  Thus, plaintiffs also argued in the alternative that if the business judgment rule did apply, it should only be a rebuttable presumption.

The Court of Chancery recognized that recent Delaware Supreme Court decisions have confirmed that the approval of a merger by a majority of a corporation’s outstanding shares pursuant to a statutorily required vote of the corporation’s fully informed, uncoerced, disinterested stockholders renders the business judgment rule irrebuttable. Moreover, it found that the stockholder approval under the merger via acceptance of the tender offer, under Section 251(h), had the same cleansing effect as a vote in favor of said transaction.  Thus, because Volcano’s stockholders were fully informed, disinterested and uncoerced, the business judgment rule irrebuttably applied to the merger.

Since the irrebuttable business judgment rule applied, the only viable claim left was plaintiffs’ claim for waste. However, the Court of Chancery was quick to dismiss this claim as well, finding that the complaint failed to plead how the merger constituted waste and noting that it was “logically difficult” to even “conceptualize how a plaintiff can ultimately prove a waste or gift claim in the face of a decision by fully informed, uncoerced, independent stockholders to ratify the transaction” when “the test for waste is whether any person of ordinary sound business judgment could view the transaction as fair.”

The Delaware Supreme Court’s affirmance of the Court of Chancery’s decision decisively put to rest the question of whether a fully informed, uncoerced, disinterested approval of a merger by a majority of a corporation’s outstanding shares pursuant to a statutorily required vote renders the business judgment rule irrebuttable. It does, and subjects a post-closing damages action challenging a merger to dismissal.

Gordon v. Verizon: New York Parts Company with Delaware

People at a Table

On February 2, 2017, the New York Appellate Division, First Department, issued a decision in Gordon v. Verizon Communications, Inc., No. 653084/13, 2017 WL 442871 (1st Dep’t 2017), approving the settlement of litigation over an acquisition by Verizon Communications (“Verizon”) and articulating a new test to evaluate the fairness of such settlements. The Gordon decision signals that New York will remain a friendly venue to disclosure-based M&A settlements and may see increased shareholder M&A lawsuits as a result

As we have repeatedly written about (here, here and here), Delaware Chancery Courts have spent the past year attempting to curtail, or eliminate altogether, M&A litigation settlements where the sole remedy is enhanced proxy disclosures. Chancellor Bouchard’s landmark decision in In re Trulia Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016), rejected these “disclosure-only” settlements, finding that the “enhanced” disclosures produced by such settlements were not “material or even helpful” to stockholders.  The Chancery Court bemoaned the proliferation of disclosure-only settlements in Delaware, and indicated that these types of settlements would be met by “continued disfavor” unless the supplemental disclosures are “plainly material,” i.e., they must “significantly alter the ‘total mix’ of information made available.”

In Trulia’s wake, the number of M&A suits filed in Delaware plummeted—declining by almost 75% in the first half of 2016—as plaintiffs’ counsel opted to file in federal court or states other than Delaware in the hope of finding more hospitable fora for “disclosure-only” resolutions.  READ MORE

A Fraud By Any Other Name: Seventh Circuit Holds That SLUSA Extends to Class Actions That Could Be Pursued Under Federal Securities Fraud Laws

A divided panel of the Seventh Circuit recently held that the Securities Litigation Uniform Standards Act (“SLUSA”) requires any covered class action that “could have been pursued under federal securities law” to be brought in federal court.  The plaintiff maintained an investment account at LaSalle Bank, which was later acquired by Bank of America.  Each night, LaSalle invested (“swept”) the account’s balance into a mutual fund approved by the plaintiff.  Without the plaintiff’s knowledge, LaSalle also allegedly pocketed the fees that some of the mutual funds paid each time a balance was transferred.  When the plaintiff found out, he brought a class action in state court, arguing that LaSalle had breached its contractual and fiduciary duties to its customers by secretly paying itself fees generated by their accounts.

LaSalle and Bank of America successfully argued before the district court that SLUSA required removal of the case to federal court. SLUSA authorizes defendants to demand removal of any class action with at least fifty members that alleges “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.”  Congress drafted SLUSA to force securities class actions out of state courts and into federal courts, where plaintiffs must clear higher pleading hurdles.

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New Year, Similar Priorities: SEC Announces 2017 OCIE Areas of Focus

On January 12, 2017 the SEC announced its Office of Compliance Inspections and Examinations (OCIE) priorities for the year, including areas of focus for Retail Investors, Senior Investors and Retirement Investments, Market-wide risks, FINRA oversight, and cybersecurity.  These priorities reflect an extension of previous years’ commitments, in particular with regard to focus on the retirement industry and cybersecurity.  The “Regulation Systems Compliance and Integrity” (Regulation SCI) adopted by the SEC in November 2014 will also be a continued focus.

Once again, protection of retail investors is of primary concern for the OCIE. Among the detailed areas of focus are examining risks related to electronic investment advice, “wrap fee” programs where investors are charged a single fee for bundled advisory and brokerage services, and “Never-before examined” Investment advisers, an initiative that was started in 2014 to engage with newly-registered advisers that had never-before been examined.  Examination of Exchange-Traded funds (ETFs) and continuation of the ReTIRE initiative are two carryovers from 2016 priorities .  The OCIE previously identified ETFs, which are sometimes seen as alternatives to mutual funds, for examination related to compliance with the Securities Exchange Act of 1934 and the Investment Company Act of 1940. ReTIRE, launched in June 2015, places particular focus on those SEC-registered investment advisers and broker dealers who offer retirement-oriented investment services to retail investors, including examining whether there is a reasonable basis for the recommendations made.  This year, the SEC will expand ReTIRE to include “assessing controls surrounding cross-transactions, particularly with respect to fixed income securities.”

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Not So Fast: The Tenth Circuit Creates a Split by Denying the Constitutionality of the SEC’s Administrative Law Judges

court decision

Just before the clock struck 2017, the United States Court of Appeals for the Tenth Circuit weighed in on the constitutionality of the United States Securities and Exchange Commission’s (“SEC” or “Commission”) administrative law judges. In Bandimere v. SEC, the Tenth Circuit overturned Commission sanctions against Mr. Bandimere because the SEC administrative law judge (“ALJ”) presiding over Mr. Bandimere’s case was an inferior officer who should have been constitutionally appointed to the position in violation of the Appointments Clause of the United States Constitution.

The SEC originally brought an administrative action against Mr. Bandimere in 2012, alleging he violated various securities laws. An SEC ALJ presided over the fast paced, “trial-like” hearing, and the ALJ ultimately found Mr. Bandimere liable, barred him from the securities industry, imposed civil penalties and ordered disgorgement.  The SEC reviewed that decision and reached the same result.  Mr. Bandimere, therefore, appealed the SEC’s decision to the Tenth Circuit. READ MORE

Going After the (Little) Bad Guys: SEC Announces More Actions Against Penny Stock Gatekeepers

The SEC last week announced that it has sanctioned several market participants in the penny stock industry, including attorneys who wrote offering documents as well as stock transfer agents, for their roles in various sham IPOs of microcap stocks.  These are the latest in a string of penny stock enforcement actions since outgoing SEC Chair Mary Jo White announced the implementation of the Commission’s “broken windows” policy in 2013. That policy targeted both large and small issuers and market participants.  The strategy has resulted in the SEC racking up its largest-ever volume of enforcement cases in fiscal year 2016.

In the first enforcement actions, the SEC alleged that a California-based securities lawyer wrote false and misleading registration statements in connection with five microcap IPOs, which were part of a scheme to transfer unrestricted shares to offshore market participants. The SEC also alleged that the CFO of American Energy Development Corp. (AEDC), one of the issuers in question, and the attorney who wrote opinion letters for the offerings made false and misleading statements.  The market participants were barred from any further penny stock activity, and the attorneys were permanently suspended from appearing and practicing before the SEC.  The SEC also suspended trading in shares of ADEC.

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Salman v. U.S.: Supreme Court Resolves Insider Trading Split

On December 6, 2016, the United States Supreme Court affirmed an insider trading conviction in a case where the “insider” obtained no direct pecuniary benefit from the disclosure.  Justice Samuel Alito, writing for a unanimous court, held that a recipient of insider information may still be criminally liable where the insider initially gave the information to a trading relative or friend and thereby received a “personal benefit.”  The court heard oral arguments in October.

Salman v. United States concerned the prosecution of Bassam Salman, a recipient of insider tips from Michael Kara, his brother in law, who in turn received insider information from his brother, Maher Kara.  Salman knew that Michael, who also traded on the information, was getting tips from Maher, a Citigroup banker working on various health care deals.  Maher, the “tipper,” never received any financial or other concrete benefit in the exchange, but testified that he suspected Michael was trading on the information he provided and there was evidence the brothers had a close relationship. READ MORE

Stockholders Petition the Supreme Court to Liberalize Eleventh Circuit Rules for Pleading Securities Fraud

Building

A recent petition for certiorari filed in the United States Supreme Court asks the Court to clarify what an aggrieved investor must plead to state a claim for securities fraud under the Securities and Exchange Act of 1934 (the “Exchange Act”).  The petition focuses on the “loss causation” element, which requires plaintiffs to prove a direct causal link between the alleged fraud and the loss in value for which they seek to recover.  In a typical fraud in-the-market case, plaintiffs allege loss causation by showing that they bought the defendant’s securities at prices artificially inflated by fraud, and then had those securities lose value after a “corrective disclosure” revealed the fraud to the public.  If the Supreme Court decides to grant certiorari, it will have the opportunity to lift certain barriers to pleading loss causation in some jurisdictions.

Petitioners, three New England funds (“Funds”) that own stock in Health Management Associates, Inc. (“HMA”), seek to reverse the Eleventh Circuit’s decision that they failed to establish loss causation as a matter of law. The Funds alleged that HMA’s stock price fell precipitously following two disclosures to the market: (1) an announcement that the government had begun an investigation into HMA for fraud, and (2) an analyst report publicizing a whistleblower case filed by a former employee against HMA three months earlier.  A panel for the Eleventh Circuit upheld the lower court’s decision that neither event could form the basis of a securities fraud claim.  First, the panel held that the announcement of a government investigation could not raise an inference of loss causation at the pleading stage because there had been no finding of “actual wrongdoing.”  Second, the panel held that the analyst report was not a “corrective disclosure” because it reported on a publicly-filed case that, although it hadn’t been reported on until then, was already disclosed to the market. READ MORE

Keep Looking Forward: Federal Court Holds Company’s Bad Legal Predictions Protected by PSLRA’s Safe Harbor

Gavel and Hundred-Dollar Bill

In a comprehensive tour of the Private Securities Litigation Reform Act’s (“PSLRA”) safe-harbor provisions, on November 22, 2016, a federal court in Massachusetts dismissed a shareholder class-action lawsuit against Neovasc, Inc.  In holding that Neovasc’s ultimately faulty predictions concerning the outcome of a trade secrets lawsuit fell within the PSLRA’s safe harbor, the court rejected the plaintiff’s attempts to import a scienter requirement into the safe-harbor inquiry, among other things, and dismissed the complaint without leave to amend.

This putative class-action came on the heels of a $70 million jury verdict against Neovasc in May 2016. In that case, a jury found that Neovasc misappropriated certain trade secrets from CardiAQ Valve Technologies after CardiAQ had severed its manufacturing relationship with Neovasc, and Neovasc had patented a competing product.  Neovasc’s stock price fell approximately 75 percent when the jury verdict was announced.  Shortly after the verdict and stock decline, shareholders filed the class action, alleging securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.  The plaintiff alleged, among other things, that prior to the verdict, Neovasc CEO Alexei Marko mischaracterized the lawsuit as “baseless,” and that Neovasc had misstated that the suit was “without merit” in the company’s SEC filings.

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Ninth Circuit Smells a Rat and Reinstates Claim That Pharmaceutical Company Failed to Disclose Cancers in Animal Testing

The Ninth Circuit recently revived a securities class action against Arena Pharmaceuticals, issuing a decision with important guidance to pharmaceutical companies speaking publicly about future prospects for FDA approval of their advanced drug candidates. The court’s opinion reemphasizes the dangers of volunteering incomplete information, holding that a company that touts the results of trials or tests as supportive of a pending application for FDA approval must also disclose negative test results or concerns expressed by the FDA about those studies—even if the company reasonably believes the concerns are unfounded and are the product of a good faith disagreement.

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