Will shareholder litigation survive the abandonment of the fraud-on-the-market presumption of reliance? After the Supreme Court’s announcement that it will be considering the presumption in Halliburton Co. v. Erica P. John Fund, No. 13-317, there is much discussion of whether a rejection of fraud-on-the-market could mean the end of securities litigation. The fraud-on-the-market doctrine, set forth in Basic Inc. v. Levinson, 485 U.S. 224, 243-50 (1988), allows a plaintiff seeking class certification to use a rebuttable presumption to establish reliance. The presumption is that public information is reflected in the price of a stock traded on a well-developed market, and that investors rely on the integrity of the market price when deciding whether to buy or sell a security. Under the doctrine, investors do not need to show they actually relied on a misstatement in order to satisfy the “reliance” element of their claim for class certification. Though overturning the presumption would have a significant impact on shareholder class actions under Section 10(b) of the Securities Exchange Act of 1934, it would not spell the end of shareholder litigation. Read More
Richard Gallagher is a partner in Orricks Silicon Valley office. His practice focuses on litigation and pre-litigation advice involving securities and corporate governance issues, including representation of companies, directors and officers involved in class action litigation, derivative actions, internal investigations, shareholder demands, and regulatory investigations and enforcement actions brought under the federal and state securities laws.
Mr. Gallagher also has significant experience advising companies, boards of directors and special committee members in M&A litigation brought under the laws of Delaware, California and other states throughout the country. He has successfully defeated multiple cases seeking to enjoin proposed mergers, acquisitions and other business combinations involving both public and private companies.
Mr. Gallagher has also litigated numerous disputes involving founders and investors in start-up companies, as well as matters involving venture capital disputes, executive compensation issues, intellectual property rights, unfair competition, breaches of partnership and shareholder agreements, employment and fraud claims, significant real estate disputes, franchising claims, and fiduciary obligations.
He has also advised U.S., Asian and EU companies regarding securities litigation and corporate governance risks arising from cross-border activities.
Mr. Gallagher has first-chair trial and arbitration experience in both civil and criminal matters, including the prosecution of several jury trials with the San Francisco District Attorney’s office. Some of his recent representations include:
- winning dismissal of multiple shareholder challenges to one of the largest ever technology company mergers;
- winning dismissal of a fiduciary duty case challenging a spin-off transaction involving board of directors of Fortune 100 company;
- winning dismissal of multiple class actions targeting a leading mutual fund company, its board members and executives;
- winning dismissal of securities class action seeking hundreds of millions of dollars from a leading software firm, its board members and executives; and
- prevailing in an arbitration dispute between founders of an Internet start-up company.
Recently, the Delaware Court of Chancery in Pfeiffer v. Leedle declined to dismiss a shareholder derivative action against a board for breach of fiduciary duty, where the directors allegedly approved stock options exceeding the maximum number of options permissible under the corporation’s stock incentive plan. C.A. No. 7831-VCP (Del. Ch. Nov. 8, 2013).
The Stock Incentive Plan provided that no participant could receive options relating to more than 150,000 shares of stock in any calendar year. Nevertheless, the board of directors allegedly awarded the CEO nearly 450,000 stock options in 2011, and 285,000 stock options in 2012.
Defendants moved to dismiss the complaint for failure to make a demand, and for failure to state a claim. The Court of Chancery rejected both arguments. Read More
After first announcing a change on June 18 of this year to demand more admissions in SEC actions, an SEC leader recently made further comments echoing that same sentiment, as well as referencing the SEC’s intended use of stiffer monetary penalties. On October 1, at a Practising Law Institute conference, SEC Enforcement Division Co-Director Andrew Ceresney discussed the new SEC regime’s motto of strict enforcement and provided concrete, practical advice for defense lawyers on how to effectively interact with the SEC’s enforcement personnel.
Given the SEC’s ongoing commitment to deter current and future violations, Mr. Ceresney stated that the SEC will continue to increase penalties in an aggressive bid to deter misconduct. He stated that “[t]here is room for bolder actions” and monetary penalties are a deterrent that everyone understands. Mr. Ceresney also advised defense lawyers on how to handle meetings with SEC enforcement personnel. He stated that defense lawyers should focus on a case’s broad policy or legal arguments, including the circumstances surrounding the case, the client’s settlement position, and any flaws in the legal theory and policy implications of the case. Most importantly, stated Mr. Ceresney, defense lawyers must answer the SEC’s questions, must be trustworthy, and must not attempt to intimidate the SEC. Read More
“Life settlements” are financial transactions in which the original owner of a life insurance policy sells it to a third party for an up front, lump sum payment. The amount paid for the policy is less than the death benefit on the policy, yet greater than the amount the policyholder would otherwise receive from an insurance company if the policyholder were to surrender the policy for its cash value. For the life settlement investor that buys the policy, the anticipated return is the difference between the death benefit and the purchase price plus the amount paid in premiums to keep the policy in force until the death benefit is payable.
Some commentators have deemed life settlements as essentially a “bet” on the life of the insured. The longer the insured lives, the lower the rate of return on the investment. Critics of life settlements are quick to point out that investors have a financial interest in the early demise of the insured person. The life settlement industry has been subject to extensive litigation for several years.
An important and as yet unsettled question is whether life settlements are “securities” as defined under federal and state securities law. This basic question has important ramifications for how life settlement contracts will be treated by courts and regulators. Read More
In August, the Public Company Accounting Oversight Board (“PCAOB”) issued a proposal that calls for enhanced communication from Auditors—in addition to the traditional Pass/Fail opinion—in Audit Reports (PCAOB Release No. 2013-005). If this proposal is approved, it would be the first significant change to the audit report in more than 70 years, according to PCAOB Chairman James Doty. The proposed changes are based on the premise that investors and financial statement users want more information from auditors, and these changes would represent a huge landscape change for the audit profession.
Many state securities laws, known as blue sky laws, are patterned after Section 12(a)(2) of the Securities Act of 1933. The interpretation of these state blue sky laws, however, may diverge significantly from the interpretation of analogous federal securities statutes. The recent Washington Court of Appeals opinion in FutureSelect Portfolio Management, Inc. et al. v. Tremont Group Holdings, Inc. et al., No. 68130-3-1 (Wn. Ct. App. Aug. 12, 2013), highlights one such divergence in which the scope of potential primary liability for secondary actors under the Washington State Securities Act extends beyond the scope of the federal law on which it was based.
In FutureSelect, a group of Washington state investors (“FutureSelect”) lost millions of dollars after purchasing interests in the Rye Funds, a “feeder fund” that invested in Bernie Madoff’s Ponzi scheme. The investors sued Tremont Group Holdings, Inc., the general partner in the Rye Funds and its affiliates, as well as the audit firm Ernst & Young LLP. The plaintiffs’ claims against EY were based primarily on the allegation that EY misrepresented that it had conducted its audit of the Rye Funds’ financial statements in conformity with generally accepted auditing standards when issuing its unqualified audit opinion on these financial statements. The trial court dismissed the plaintiffs’ claims against EY for failure to state a claim, but the Washington State Court of Appeals reversed that decision on appeal. Read More
The Supreme Court in U.S. v. Windsor held that the federal Defense of Marriage Act’s (DOMA) section defining marriage as between a man and woman is unconstitutional because it violates the Fifth Amendment’s equal protection clause. Under Section 3 of DOMA a person could only be considered a spouse under federal law if they were married to a person of the opposite sex.
The term “spouse” appears several times in the Securities and Exchange Act Rules. Exchange Act Rule 10b5-2 provides a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the misappropriation theory of insider trading. The misappropriation theory expands the traditional view of insider trading to cases where a person misappropriates confidential information in breach of a duty owed to the source of the information.
Subsection (b)(3) of Rule 10b5-2 enumerates circumstances where this duty is presumed to exist and includes circumstances when “a person receives or obtains material nonpublic information from his or her spouse[.]” Because Rule 10b5-2’s enumerated list is non-exclusive it’s possible a duty of trust and confidence could be found between domestic partners regardless of the Windsor ruling. However, the expanded definition of spouse post-Windsor shifts the burden, creating a rebuttable presumption that such a duty exists between same-sex couples in states where they are legally married for the purposes of the misappropriation theory of insider trading.
There are other instances where the term spouse may be significant under the securities laws, including beneficial reporting requirements for Section 16 insiders and Audit Committee independence rules.
In a split vote last week, the SEC adopted new rules designed to increase protections for customers who invest money and securities with broker-dealers. Recent rulemaking and statements made by the SEC have highlighted the fact that broker-dealer regulation is becoming a growing area of SEC interest. In connection with last Wednesday’s vote, SEC Chair Mary Jo White stated that “[i]nvestors need to feel confident that their money is safe when it’s being held by their broker-dealers… [and] these rules will strengthen the audit requirements for broker-dealers and enhance [the SEC’s] oversight of the way they maintain custody over their customer’s needs.”
The new rules amend the broker-dealer reporting and notification rules codified in Section 17 and Rules 17a-5 and 17a-11 of the Exchange Act. Currently, a broker-dealer is required to file an annual report with the SEC and the SRO designated to examine that broker-dealer. The report must contain audited financial statements conducted by an independent public accountant registered with the PCAOB. Under the new requirements, a broker must file a quarterly report telling the SEC whether and how it maintains control over its client’s funds. The new rules also require that the broker-dealer let the SEC review the work-papers of the accountant, if requested. Read More
When a board of directors decides to enter the company into a change-of-control transaction, the board is charged with the duty to act reasonably to secure the best value reasonably attainable for its shareholders. As the Delaware Supreme Court put it in its seminal decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, in the change-of-control context, the directors’ role changes “from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”
But is an “auction” of the company always necessary to comply with this duty? No – there is no bright-line rule that directors must conduct a pre-agreement market check or shop the company. Delaware courts have repeatedly emphasized that there is no single “blueprint” that a board must follow to fulfill its duties in connection with a change-of-control transaction and, in fact, a board may pursue a single-bidder sales process so long as it has reliable evidence with which to evaluate the fairness of the transaction without an active survey of the market and retains flexibility to consider potential topping bids after the merger agreement is signed.
That is not say that a single-bidder approach will always pass judicial muster, as demonstrated in Koehler v. NetSpend Holdings, Inc., a recent case in which the Delaware Court of Chancery found that NetSpend’s directors acted unreasonably by not engaging in a market check before agreeing to sell the company. The court in NetSpend acknowledged that a single-bidder process is not unreasonable per se, and found that the board’s initial decision to adopt a “not-for-sale” strategy that sought to maximize value by inducing the sole bidder to bid against itself was reasonable. According to the court, however, the board’s approach to the transaction was not reasonable. In support of this finding, the court pointed to a “weak” fairness opinion, as well as acquiescence to potentially preclusive deal protection provisions, including a “No-Shop” clause and “Don’t Ask-Don’t Waive” provisions that precluded NetSpend from waiving any standstill agreement without the buyer’s consent. These factors precluded an effective post-agreement market check to assess the fairness of the deal price. Read More
The second quarter of 2013 saw the largest quarterly percentage decline in new securities actions since before the 2007/2008 financial crisis. New filings in the first quarter plummeted by 41 percent, from 352 in the first quarter to 234 in the second quarter. This drop represents a 55 percent decrease in the number of new securities actions filed as compared to same period last year (Q2 2012). It has been approximately five years since we have seen a lower number of quarterly filings.
The number of new securities fraud cases also plummeted, falling 59 percent from the prior quarter, with the number of new filings decreasing from 149 to 61. There were also quarterly declines in newly-filed shareholder derivative actions, which decreased from 43 filings in the first quarter to 37 in the second quarter, and breach of fiduciary duty cases, which fell from 99 new filings in the first quarter to 71 in the second quarter.
Not only did the number of securities actions filed drop significantly, but so too did the average settlement amounts. The average settlement for all types of securities cases in the second quarter was just over $37 million, a marked decrease from the average settlement amount of $69.3 million during the first quarter of 2013.
What’s going on? There are a number of factors that may be contributing to these downward filing trends. The stock market has been strong, so many investors have little to complain about. Moreover, the surge in suits against U.S.-listed Chinese companies appears to have run its course, and no new scandal or market development has yet become the next “big thing” that will drive increased filings. In addition, SEC enforcement activities have continued to shift into areas (such as insider trading and whistleblowing) that do not always spawn parallel private litigation. It remains to be seen whether the recent appointment of new SEC personnel or a renewed focus on accounting fraud cases by regulators, which is anticipated by some analysts, will cause a variation in these trends moving forward.
Source = Advisen D&O Claims Trends: 2013 Report (July 2013)