I have no idea where summer went, but with the passage of Labor Day weekend there’s no denying that summer is over and that it is time to get back to work. For those of you who were fortunate enough to take some time off this summer or who maybe just found it a little harder to keep up during the warmer months, here’s a brief survey of what you missed while you were out.
The biggest development this summer was the U.S. Supreme Court’s June 2014 decision in the Halliburton case, although it was not nearly as big of a deal as it would have been if the Supreme Court had dumped the “fraud on the market” theory. Because I suspect that at this point most readers are well aware of the Halliburton decision and because the Court’s decision has been thoroughly reviewed and discussed (on this blog and elsewhere), I won’t dwell on Halliburton here. Besides, there were a lot of other important things that also happened this summer. Here’s a quick summary of the other important developments, in no particular order.
U.S Supreme Court Rejects “Presumption of Prudence” for ESOP Fiduciaries: The U.S Supreme Court’s Halliburton decision may not have been the game changer that it might have been, but the Court did still stir things up quite a bit in its decision in another case. On June 25, 2014, the U.S. Supreme Court held in Fifth Third Bank v. Dudenhoeffer that ESOP fiduciaries are not entitled to a “presumption of prudence” in connection with their decision to invest in or maintain investments in employer stock. In a unanimous opinion written by Justice Stephen Breyer, the Court held that ESOP fiduciaries are subject to the same duty of prudence that applies to ERISA fiduciaries in general, other than the duty to diversify plan assets. The court’s opinion can be found here.
In recent years, several of the Circuit courts had recognized the existence of a presumption of prudence for ESOP plan fiduciaries. Many ESOP plan fiduciaries had successfully relied on the presumption as the basis for a motion to dismiss claims filed against them under ERISA. The Supreme Court’s opinion could make it more difficult for ESOP fiduciaries to obtain dismissal in ERISA stock drop cases. However, the Court did recognize the importance of motions to dismiss in helping to weed out meritless suits. The Court laid out several guidelines for the lower courts to use in considering motions to dismiss in ERISA stock drop suits. The net effect of the Court’s opinion is that the environment for ERISA stock drop litigation has been substantially changed, as discussed here.
Delaware Legislature Tables Measure to Address Fee-Shifting ByLaws: The Delaware Supreme Court stirred up quite a bit of controversy earlier this year in the ATP Tours, Inc. v. Deutscher Tennis Bund case when it upheld the facial validity of a fee-shifting by law. The bylaw provided that an unsuccessful shareholder claimant in intra-corporate litigation would have to pay his or her adversaries’ cost of litigation. The controversy seemed headed for a swift resolution when the Delaware General Assembly quickly moved to act on a measure that would have limited the Supreme Court’s ruling to non-stock corporations (meaning that it wouldn’t apply to Delaware stock corporations). However, in late June, the legislature tabled the measure and now it will not be acted upon until at least January 2015.
In the meantime, interested parties and observers are busy debating whether or not under Delaware law stock corporations should (or should not) be allowed to adopt fee-shifting bylaws. For example, an August 27, 2014 Wall Street Journal op-ed piece (here) argued that companies should be allowed to adopt “loser pays” bylaws as a way to try to control costly shareholder litigation. In addition, even though it remain unclear whether or not fee-the Delaware legislature will ultimately pass legislation barring fee-shifting bylaws for stock corporations, some companies are going ahead and revising their bylaws to incorporate a fee-shifting provision, as discussed here.
SEC Commissioner Aguilar Addresses Cybersecurity Oversight Responsibilities of Corporate Boards: At least one SEC commissioner has made it clear that as far as the SEC is concerned cybersecurity is an important issue on which corporate boards should be engaged. In a June 10, 2014 speech entitled “Boards of Directors, Corporate Governance and Cyber-Risks: Sharpening the Focus” delivered at the New York Stock Exchange, SEC Commissioner Luis A. Aguilar stressed that “ensuring the adequacy of a company’s cybersecurity measures needs to be a part of a board of director’s risk oversight responsibilities.” He added the warning that “boards that choose to ignore, or minimize the importance of cybersecurity oversight responsibility, do so at their own peril.” A copy of Aguilar’s speech can be found here.
While Aguilar’s speech referred only to the efforts of shareholders to hold board members accountable through litigation, the fact is that – as his speech itself underscores – cybersecurity is an increasingly important issue to the SEC itself. A message implicit in his speech is that the Commission may hold boards accountable for their responsibilities as well. At a minimum, Aguilar’s speech underscores that cybersecurity is an issue on which the Commission is focused and about which the Commission is concerned.
Georgia Supreme Court Affirms, Elucidates Business Judgment Rule – and Its Limitations: A recurring issue in FDIC litigation against the former directors and officers of failed banks has been whether the business judgment rule insulates the defendants from claims of ordinary negligence. This question has been particularly important in Georgia, where there were more bank failures than any in other state and consequently more failed bank litigation. Several federal district courts, applying Georgia law, have ruled that individual defendants are entitled to have the FDIC’s negligence claims against them dismissed based on the business judgment rule (as discussed, for example, here).
On July 11, 2014, the Georgia Supreme Court ruled in Federal Deposit Insurance Corporation v Loudermilk (here) that the common law of Georgia recognizes the business judgment rule and that the rule has not been superseded by Georgia statutory law. But while the Court found that the rule insulates directors ad officers from claims of negligence concerning the wisdom of their judgment, it does not foreclose negligence claims against them alleging that their decision making was made without deliberation or the requisite diligence, or in bad faith.
The Georgia Supreme Court’s decision will have an immediate impact on the many FDIC lawsuits involving failed Georgia banks, as it will substantially affect the ability of the individual defendants to have the claims against them dismissed. The practical implication of the Georgia Supreme Court’s ruling is that many – perhaps even most — of the FDIC negligence claims against former directors and officers of Georgia banks will survive motions to dismiss.
The precedential authority of the Georgia Supreme Court’s decision is limited to cases to which the law of Georgia applies. However, the decision may have persuasive effect in cases to which other jurisdictions’ law applies. It is rare for any state’s Supreme Court to address these kinds of issues, and as the Georgia Supreme Court’s opinion is both a scholarly, thoughtful ruling and the rare pronouncement by a court of highest authority, it undoubtedly will be invoked by parties in other courts and considered by courts in other jurisdictions, as discussed in greater detail here.
Inversion Transactions and Corporate Liability: Among the developments dominating the business headlines in recent weeks has been the rising wave of so-called “inversion” transactions in which U.S. companies acquire foreign firms to avoid U.S. tax laws As discussed in a July 15, 2014 Wall Street Journal article (here), the Obama administration is calling for Congress to pass legislation to restrict U.S. companies’ ability to participate in inversion transactions. U.S. Treasury Secretary Jacob Lew sent a letter to Congressional leaders calling on them to “enact legislation immediately…to shut down this abuse of our tax system.”
While it is hardly surprising that inversion transactions are controversial in Washington, it would seem given the tax benefits that they would be popular with shareholders, and that the last thing that would happen would be for a company announcing an inversion transaction to get hit with a shareholder suit. However, in this country’s litigious environment, even a transaction seemingly as beneficial for a company as an inversion apparently can generate a shareholder suit.
According to a July 17, 2014 St. Paul Pioneer Press article (here), on July 2, 2014, a shareholder of Minnesota-based Medtronic has filed a class action lawsuit in Hennepin County District Court challenging the company’s planned $42.9 billion acquisition of Ireland-based Covidien, which will result in a new company to be called Medtronic PLC. The shareholder plaintiff contends that the transaction, in which Medtronic shareholders will receive shares in the new company in exchange for their existing Medtronic shares, will result in a “substantial loss” for Medtronic shareholders. The plaintiff alleges that the shareholders will have to pay taxes on any gains on their shares, but the transaction will not generate cash out of which to pay the taxes. According to the article, the lawsuit alleges that “Medtronic shareholders will be forced to pay taxes on any gains in Medtronic stock.”
India’s Securities Regulator Imposes Massive Penalties on Satyam’s Founder and Other Executives: As discussed here, Satyam was quickly dubbed the “Indian Enron” in early 2009 after the company’s founder, Ramalinga Raju, sent an extraordinary letter to the company’s board in which he admitted, among other things, that ”the company’s financial position had been massively inflated during the company’s expansion” from a handful of employees into an outsourcing giant with 53,000 employees and operations in 66 countries.
On July 16, 2014, India’s securities regulator, the Securities and Exchange Board of India (SEBI), entered an order (here) against the founder and former executives of Satyam Computer Services to disgorge over $306 million in allegedly ill-gotten gains from their role in the scheme to falsify the company’s financial statements, as well as at least $201 million in interest.
The size of the penalty against the individuals is clearly meant to make a statement. According to the Wall Street Journal, SEBI “has faced criticism from investors for a perceived lack of vigor” but “lately has seemed more assertive.” A commentator is quoted in the Journal article as stating that “this order by itself is driving a message that SEBI is going to be aggressive in dealing with fraud in the Indian Capital Markets.”
Outside the U.S., the aggressiveness of U.S. regulators is a frequent source of complaint. As this SEBI order demonstrates, U.S. regulators are not the only ones primed to impose large fines. Regulators everywhere, under pressure from the recent global financial crisis as well as because of the periodic outbreak of massive scandals like Satyam, increasingly are taking a more aggressive approach and increasingly are seeking to use regulatory tools to enforce their own laws and to impose penalties. These regulatory initiatives, which are emerging in countries around the world, have significant implications for companies, their executives, and their insurers.
Dodd-Frank Anti-Retaliation Provisions Do Not Protect Overseas Whistleblowers: In the latest fiscal year report of the SEC Office of the Whistleblower, the agency reported that as of the end of the 2013 fiscal year it had received a total of 6,573 whistleblower reports since the Dodd-Frank whistleblower program’s inception. These figures include not only domestic U.S. whistleblower reports but also reports from a total of sixty-eight different countries. During fiscal year 2013, there were 404 whistleblower reports from outside the U.S. representing nearly 12% of all reports during the year. Clearly, whistleblower reports from non-U.S. countries have represented a significant part of the whistleblower program, and foreign whistleblowers have been drawn to the program.
However, based on a recent Second Circuit decision, prospective foreign whistleblowers thinking about making a whistleblower report had better be prepared to watch out for themselves, as according to the appellate court’s August 14, 2014 decision in Liu Meng-Lin v. Siemens AG (here), the Dodd-Frank Act’s whistleblower anti-retaliation protections do not apply extraterritorially — that is, they do not protect whistleblowers outside the U.S. This ruling obviously could dampen the interest of prospective foreign tipsters from making whistleblower reports.
The Second Circuit’s decision clearly will have an impact on prospective whistleblowers outside the United States. Many may hesitate to make reports out of fear of retaliation. Just the same, the Second Circuit’s decision left many questions unanswered. The Second Circuit’s ruling gives no indication of what the impact on its ruling might have been if the whistleblower were a U.S. citizen or if the whistleblower report had involved a U.S. company operating overseas, or if any of the alleged misconduct had taken place inside the U.S. These issues will have to be addressed in future cases. In the meantime, it seems probable that the seeming enthusiasm for whistleblower reports from outside the U.S. will be dampened.
Securities Suits Hit Firms Allegedly Using Stock Promoters to Boost Share Price: On July 30, 2014, when a plaintiff shareholder filed a securities class action lawsuit against the firm and certain of its directors and officers, Galectin Therapeutics became the latest company to be hit with a securities suit following press reports that the company had used a stock promotion firm to try to boost its share price. There have already been several other companies against whom securities lawsuit have been filed this year that are similarly alleged to have used stock promotion firms.
As discussed here, the lawsuit against Galectin is merely the latest in series of suits that have been filed so far this year against companies alleged to have used stock promotion firms to try to boost their share price. Several of the firms that have been sued are alleged to have used a stock promotion firm known as The DreamTeam Group. Lawsuits involving allegations that the defendant companies have been filed earlier this year against Galena Biopharama (here); CytRx Corporation (here); InterCloud Systems (here); and Provectus Biopharmaceuticals (here).
Whatever companies’ thought process is for using these kinds of services to promote their companies, it is clear that news about the companies’ use of the firms can have a negative impact on the company’s stock (which obviously is counter to the idea of using the promotional firms in the first place). As the lawsuits above underscore, the alleged use of these firms can also result in securities class action litigation.
The Pre-IPO Company and “Failure to Launch” Claims: Due to a combination of favorable circumstances, the number of companies completing initial public offerings is currently at the highest level in years. According to a recent study from Cornerstone Research (here), with the 112 IPOs in the first half of 2014, IPO activity is on pace to increase for the third consecutive year. IPO activity just in the first six months of 2014 equaled 71 percent of total IPO activity in 2013 and exceeded the full years 2009, 2010, 2011 and 2012. The favorable IPO environment has encouraged even more companies move toward an IPO. However, for a company starting down the road toward an IPO, there are a number of risks. Among other things, pre-IPO companies face increased risks of liability and claims, particularly when the planed IPO fails to launch.
A recent case filed in New York (New York County) Supreme Court illustrates the kinds of “failure to launch” claims that pre-IPO companies can face. According to the plaintiff’s August 1, 2014 complaint (which can be found here), defendant Westergaard.com is a Delaware corporation with its principal place of business in Fujian, China. In 2011, Westergaard completed a private placement that provided for “automatic redemption” of the units sold in the placement if the company failed to complete an IPO at an offering price of $3.00 or greater within two years of the private offering’s closing date. The redemption amount was specified as $3.00 per share. The complaint alleges that private placement transaction closed on October 24, 2011, but that the company did not complete an IPO within two years of that date nor has it yet completed an IPO. The plaintiff is assignee of investors who had purchased units in the private placement. The plaintiff filed the action as assignee to enforce the redemption provisions in the private placement agreement, as well as to recover its costs of collection.
While the particulars of this claim may reflect the specific circumstances of the company involved, the situation nevertheless does illustrate how a pre-IPO company’s failure to launch can lead to claims from disappointed investors. This case shows how pre-IPO activities can give rise to claims, and therefore underscores the importance of taking these kinds of risks into account when structuring the D&O insurance coverage for a Pre-IPO company. If IPO activity continues to pick up, that will not only increase the possibility of IPO-related claims, but it also increases the possibility of pre-IPO claims as well.
Second Circuit Says Domestic Securities Transaction Necessary But Not Sufficient to Invoke U.S. Securities Laws: In its 2010 decision in Morrison v National Australia Bank, the U.S. Supreme Court had, based on its determination Congress had not intended for the U.S. securities laws to apply extraterritorially, attempted to establish a bright line test to determine the applicability of U.S. securities laws. The Supreme Court said that the U.S. securities laws apply only to shares traded on the domestic securities exchanges and to “domestic transactions in other securities.”
On August 16, 2014, in a long-awaited decision that could fuel disputes in future cases, the Second Circuit affirmed the dismissal of the securities suits swap agreement purchasers had filed against Porsche and its executives. In an unsigned per curiam opinion (which can be found here), the Second Circuit — concerned the application of Morrison as the plaintiffs urged would result in the very kind of extraterritorial extension of U.S. securities laws Morrison had sought to avoid — said that while it is necessary for the U.S. securities laws to apply that a domestic transaction is involved, it is not sufficient. The court went on to say that the claims in this case are so “predominately foreign as to be impermissibly extraterritorial,” even though the swap transactions at issue allegedly had been completed in the U.S.
The difficulty with the Second Circuit’s extension is that it invites further disputes, particularly given the lengths to which the Court went to avoid any suggestion that it was laying down a bright-line rule. The Second Circuit provided little guidance about what may be “sufficient,” except to say that the U.S. securities laws are implicated when a domestic transaction is involved and the defendants “are alleged to have sufficiently subjected themselves to the statute.” The groundwork seems to be set for future disputes about whether a plaintiff’s allegations have established the elements that are both “necessary” and “sufficient” to warrant the application of the U.S. securities laws.
Foreign Affairs: I hope interested readers will take the time to read the summaries I recently published of my August visits to Singapore (here) and Mumbai (here).
Coming Attractions: If all goes according to plan, tomorrow, September 3, 2014, I will be publishing my annual “What to Watch in the World of D&O” post, in which I survey the hottest topics affecting the world of directors’ and officers’ liability.