These days just about every public company merger transaction draws at least one merger objection lawsuit. These lawsuits formerly were filed in Delaware state court alleging violations of Delaware law, but since the 2016 Delaware Chancery Court decision in the Trulia case, in which the court expressed its distaste for this type of litigation, the lawsuits have been filed in federal court based on alleged violations of Section 14 of the Securities Exchange Act of 1934. These cases, through frequently filed, are rarely litigated. They typically are resolved by the defendants’ voluntary insertion of supplemental proxy disclosures and agreement to pay the plaintiff a “mootness” fee.
However, in a recent case a corporate defendant refused to update the proxy and succeeded in getting the case dismissed. As discussed in a recent law firm memo about the dismissal ruling, the “usual playbook” for these kinds of cases – making supplemental disclosures and paying a mootness fee – may not be the best approach, and the ruling itself may provide ammunition for companies that want to try an “alternative to the status quo.”
District of Connecticut Judge Michael P. Shea’s April 16, 2020 ruling on the company’s motion to dismiss in the SI Financial case can be found here. The Cleary Gottlieb Steen & Hamilton memo appeared as a July 12, 2020 post on the Harvard Law School Forum on Corporate Governance entitled “Doubt on Merger Disclosure Claims in a Rare Federal Court Decision” (here).
In December 2018, SI Financial Group, a New England financial services company, announced that it was going to merger into Berkshire Hills Bancorp. SI filed its preliminary proxy on February 4, 2019, after which a shareholder plaintiff filed a lawsuit in federal court in Connecticut alleging that material information had been omitted from the proxy.
Among other things, the plaintiff alleged that the proxy omitted information about an alternative bid the SI board had rejected; background information about SI’s financial advisors fairness opinion and analysis; and details about SI insiders’ interests in the merger. The plaintiff alleged that in making these omissions the defendants had violated Section 14 of the Securities Exchange Act of 1934.
Contrary to the usual pattern of events, SI refused to make any supplemental disclosures. The plaintiff failed to make any move to seek a preliminary injunction blocking the merger and the merger closed on May 17, 2019. Following the merger, the litigation continued in the form of a damages lawsuit. SI filed a motion to dismiss arguing that the plaintiff had failed to state a claim under Section 14.
The April 16, 2020 Ruling
In his April 16, 2020 order, Judge Shea granted the defendants’ motion to dismiss. In making this ruling, Judge Shea contrasted the pleading standard under Section 14 with the duty of disclosure under Delaware law. Delaware law, Judge Shea said, “includes a general prohibition on the omission of material facts” when a board of directors is seeking shareholder action.
By contrast, he said, an alleged omission in a proxy statement violates Section 14 (and applicable rules) only if “the SEC regulations specifically require disclosure of the omitted information in a proxy statement, or the omission makes other statements in the proxy statement materially false and misleading.” Thus, while it may be sufficient under Delaware law to plead the omission of a material fact, that is not enough to plead a claim under Section 14.
Judge Shea concluded that the plaintiff had essentially alleged that the omitted information would have been helpful to shareholders; however, this was insufficient. He said, “As helpful as this information might have been to investors, Plaintiff fails to allege any facts suggesting that its absence made any statement in the Proxy misleading. And he certainly does not specify any statement that was made misleading as a result of these omissions, let along provide ‘the reason or reasons why the statement was misleading.” He added that the plaintiff did not allege “except in a conclusory fashion” how the disclosure of the omitted information “would have changed the overall picture of the transaction presented by the Proxy.”
On the one hand, Judge Shea’s ruling in the SI Financial case suggests that many defendants who want to fight merger objection suits have substantial grounds on which to rely. As the authors of the law firm memo put it, the SI Financial case “demonstrates that it is very difficult for stockholder plaintiffs to plead a viable Section 14 claim in a strike suit merger case. The typical Section 14 case, the memo’s authors note, “does not come close to meeting the standard articulated in SI Financial” – which, the authors note, is hardly surprising as in most cases the plaintiffs have no idea what the omitted facts are, and no means of discovery or for a books and records inspection.
So does that mean more defendants will be fighting these cases rather than just paying the plaintiffs’ lawyer to go away? Unfortunately, it may not. The usual process for disposing of these cases – making a few meaningless changes to the proxy and paying the plaintiffs’ lawyers a modest sum – costs so little for most defendants that the alternative seems less than compelling. The participants to the merger deal also don’t want to risk delaying the transaction or face other litigation risks. Also, most merger transaction participants (particularly the target companies) are not likely to be repeat participants in this type of litigation, so they may feel little incentive to trouble themselves to try to address a systemic problem.
But does that mean, the memo’s authors ask, that the “proliferation” of Section 14 merger objection lawsuits is “inevitable”? The authors suggest that there are several ways that the pace of these cases might be slowed, or even ended. There are, the authors suggest, a number of considerations that “highlight the fact that defendants have options” and that “should give ammunition to companies and boards that want to consider … an alternative to the status quo.”
First, even though defendants may lack the incentives, if more defendants refused to make supplemental disclosures and pay mootness fees, these cases would quickly become both more expensive and less lucrative for the small number of plaintiffs’ firms that file most of these lawsuits – which would, in turn, “likely discourage such cases from being filed in the first place.
Second, while most merger participants are not repeat players, there are a number of other companies that are serial acquirers and that may want “to pursue a public strategy of refusing to settle these cases as a way of discouraging the plaintiffs’ bar.”
Third, there is an important case pending in the Seventh Circuit that could have a substantial impact on these cases. As I noted at the time (here), in June 2019, Northern District of Illinois Judge Thomas Durkin abrogated the settlement of a merger objection lawsuit and ordered the plaintiffs’ counsel to disgorge the $322,000 mootness fee that the defendants had agreed to pay. Judge Durkin expressly found that the additional disclosures the defendants had made were “worthless to shareholders” and concluded that the mootness fee was not justified. (He also had a lot of choice words about this type of litigation.) As discussed here, Judge Durkin’s mootness fee ruling is on appeal to the Seventh Circuit. If Judge Durkin’s ruling were to be affirmed, it could have a substantial impact on the filing of merger objection lawsuits, at least in the Seventh Circuit.
Fourth, there are other arguments defendants may raise as well; among other things, defendants could argue that the PSLRA bars attorneys’ fees when plaintiffs achieve only a non-monetary recovery. Also, in light of the fact that most Section 14 actions have little chance of surviving a motion to dismiss, courts could enforce the PSLRA’s mandatory sanctions provision for violations of Rule 11.
Finally, another defendant could try to raise the argument that there is no private right of action under 14(e) (relating to tender offers), as had been argued in the case that was before the U.S. Supreme Court in Varjabedian v. Emulex Corporation. As discussed here, in January 2019, the Court had granted a writ of certiorari in the case to take up the question about the existence of a private right of action for misrepresentations in connection with a tender offer. However, the court did not reach the merits of the case, as it dismissed the writ as having been improvidently granted before ruling on the case. Another defendant could take up this argument, but, as the memo’s authors’ note, the impact of the case would be limited to tender offer cases and “would not likely have an immediate impact on cases involving traditional mergers, in which the company issues a proxy statement governed by Section 14(a).”
Judge Shea’s ruling in the SI Financial case and the authors’ suggestions of other ways that companies might try to fight merger objection suits are heartening. I have long argued, along with numerous other observers, that the merger objection lawsuit “racket” is a curse on the system the effectively imposes a process tax (to be paid the plaintiffs’ lawyers) on the parties to merger transactions in the U.S.
Unfortunately any progress toward overcoming this litigation curse depends on defendant companies sidestepping the usual, low-friction means of getting rid of these cases, in order to fight a systemic problem. Because they are unlikely to be repeat litigants, most companies may feel there is little incentive for them to get involved in trying to fight this curse. While the memo’s authors optimistically point to the ways defendants might fight these cases, the reality is that few defendants will actually fight. That is why the plaintiffs’ lawyers continue to cynically file these kinds of cases, they know they can score a small fee without much bother or fight.
It also is important to note that while other defendants might be heartened by Judge Shea’s ruling in the SI Financial case, the plaintiff in the case has filed a notice of appeal, so there could be more of this story to be heard.
The appeal in the Seventh Circuit may have some promise, at least with respect to cases within the Seventh Circuit. However, while I find Judge Durkin’s district court opinion in the Akorn case compelling, on appeal the plaintiffs’ lawyers fighting to retain their mootness fee have raised important questions about the district court’s ability to abrogate the settlement and order the disgorgement of the fees. It remains to be seen how this case will fare on appeal.
The surest remedy could be legislative; Congress could, for example, specify that there is no private right of action at all under Section 14. That would force the plaintiffs’ back on their state court remedies. Alternatively, Congress could require court approval of the payment of mootness fees in Section 14 cases, or otherwise require Court supervision of the resolution of Section 14 cases, as was suggested in a recent guest post on this site. Unfortunately, the likelihood of this type of reform seems remote given our current divided and distracted Congress.
In the end, it does seem like the only thing that is really going to help here is for more defendants to fight these cases rather than just rolling over. The more the plaintiffs’ lawyers have to fight these kinds of cases, the fewer of them they will file. As the law firm memo’s authors note, settlement is “not inevitably the best course” for merger objection lawsuit defendants”; defendants “should seriously consider whether the usual playbook is still the best approach.”