Friday, May 3, 2013
Vice Chancellor Laster issued an opinion for In re Wayport Shareholder Litig on Wednesday. This post-trial opinion deals with a number of interesting issues, but it does one thing that is really helpful for people like me who are always looking for cases that students can look at that distill the differences in doctrine and approach. In this case, the Vice Chancellor does a nice summary of the four strains of doctrinal thought that define the Delaware duty of disclosure. I'm reproducing a heavily edited version of that section below (read the opinion for all the internal cites):
The “duty of disclosure is not an independent duty, but derives from the duties of care and loyalty.” The duty of disclosure arises because of “the application in a specific context of the board’s fiduciary duties . . . .” Its scope and requirements depend on context; the duty “does not exist in a vacuum.” When confronting a disclosure claim, a court therefore must engage in a contextual specific analysis to determine the source of the duty, its requirements, and any remedies for breach. Governing principles have been developed for recurring scenarios, four of which are prominent.
The first recurring scenario is classic common law ratification, in which directors seek approval for a transaction that does not otherwise require a stockholder vote under the DGCL. If a director or officer has a personal interest in a transaction that conflicts with the interests of the corporation or its stockholders generally, and if the board of directors asks stockholders to ratify the transaction, then the directors have a duty “to disclose all facts that are material to the stockholders’ consideration of the transaction and that are or can reasonably be obtained through their position as directors.” The failure to disclose material information in this context will eliminate any effect that a favorable stockholder vote otherwise might have for the validity of the transaction or for the applicable standard of review. (“With one exception, the ‘cleansing’ effect of such a ratifying shareholder vote is to subject the challenged director action to business judgment review, as opposed to ‘extinguishing’ the claim altogether (i.e., obviating all judicial review of the challenged action).
A second and quite different scenario involves a request for stockholder action. When directors submit to the stockholders a transaction that requires stockholder approval (such as a merger, sale of assets, or charter amendment) or which requires a stockholder investment decision (such as tendering shares or making an appraisal election), but which is not otherwise an interested transaction, the directors have a duty to “exercise reasonable care to disclose all facts that are material to the stockholders’ consideration of the transaction or matter and that are or can reasonably be obtained through their position as directors.” A failure to disclose material information in this context may warrant an injunction against, or rescission of, the transaction, but will not provide a basis for damages from defendant directors absent proof of (i) a culpable state of mind or nonexculpated gross negligence, (ii) reliance by the stockholders on the information that was not disclosed, and (iii) damages proximately caused by that failure.
A third scenario involves a corporate fiduciary who speaks outside of the context of soliciting or recommending stockholder action, such as through “public statements made to the market,” “statements informing shareholders about the affairs of the corporation,” or public filings required by the federal securities laws. In that context, directors owe a duty to stockholders not to speak falsely:
Whenever directors communicate publicly or directly with shareholders about the corporation’s affairs, with or without a request for shareholder action, directors have a fiduciary duty to shareholders to exercise due care, good faith and loyalty. It follows a fortiori that when directors communicate publicly or directly with shareholders about corporate matters the sine qua non of directors’ fiduciary duty to shareholders is honesty.
“[D]irectors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violate their fiduciary duty, and may be held accountable in a manner appropriate to the circumstances.” (“When the directors are not seeking shareholder action, but are deliberately misinforming shareholders about the business of the corporation, either directly or by a public statement, there is a violation of fiduciary duty.”). Breach “may result in a derivative claim on behalf of the corporation,” “a cause of action for damages,” or “equitable relief . . . .”
The fourth scenario arises when a corporate fiduciary buys shares directly from or sells shares directly to an existing outside stockholder. Under the “special facts doctrine” adopted by the Delaware Supreme Court in Lank v. Steiner, a director has a fiduciary duty to disclose information in the context of a private stock sale “only when a director is possessed of special knowledge of future plans or secret resources and deliberately misleads a stockholder who is ignorant of them.” If this standard is met, a duty to speak exists, and the director’s failure to disclose material information is evaluated within the framework of common law fraud. If the standard is not met, then the director does not have a duty to speak and is liable only to the same degree as a non-fiduciary would be. It bears emphasizing that the duties that exist in this context do not apply to purchases or sales in impersonal secondary markets.
Thursday, May 2, 2013
...or the lack of it. In a live-chat with Warren Buffet at the University of Nebraska, Omaha, Buffet dropped this bit of golden Buffet wisdom. How to get directors to do a good job? Well...don't give them D&O insurance. They'll pay attention for sure.
Swimming against the tide has worked for him.
Ghosol and Sokol have recently posted a paper, Compliance, Detection and Mergers & Acquisitions. They argue that buyers and sellers use regulatory compliance as a signal for quality in the market for corporate control. Because regulatory compiance is costly, firms with unobserveable high quality will separate from lemons by demonstrating third party compliance, while low quality firms will not. Here's the abstract:
Abstract: Firms operate under a wide range of rules and regulations. These include, for example, environmental regulations (in which some industries have increased regulatory exposure) and finance and accounting (where all industries have reporting requirements). In other areas, such as antitrust cartels, enforcement is unregulated and antitrust leaves the market as the default tool to police against anti-competitive behavior. In all of these areas, detection of non-compliance by a firm can result in significant penalties. This issue of non-compliance has implications in the merger and acquisitions (M&A) context. In a transaction between an acquiring firm (buyer) and a target firm (seller), there is asymmetric information about the target’s quality. In our framework, we link a target’s quality directly to the strength of its regulatory compliance. In an M&A transaction, an acquirer seeks information about the target’s compliance, as a compliance failure may result in substantial penalties and sanctions, post-acquisition. In the presence of quality (compliance) uncertainty about target firms, low quality targets can masquerade as high quality. This would tend to give rise to a M&A market with Lemons-like characteristics, resulting in low transactions prices and dampening of M&A activity. We examine how M&A transactions in such regulatory areas – environmental, finance and accounting, and antitrust compliance problems – might function to alleviate quality uncertainty.
Penny Pritzker was just nominated to be Secretary of Commerce. I post this for the corporate geeks amongst my readers (Smith v van Gorkom; Pritzker family tree; 2006 Marmon Group breakup; ). The rest of you can move along.
Tuesday, April 30, 2013
Shareholder Representative Services has just released a new report, its 2013 M&A Post-Closing Claims Study. The report is based on a review of claim activity in 420 private company transactions over the past year. Two thirds of deals had post-closing issues to report. Some of the study's key findings:
- Earn-out milestones for tech and other deals outside of life sciences were achieved 50% of the time
- 18% of deals had at least one claim made in the final week of the escrow period.
- Final escrow releases were delayed due to claims in 30% of deals.
- 73% of deals with post-closing purchase price adjustment mechanisms saw adjustments, which were more often buyer-favorable than seller-favorable. 27% of adjustments were ultimately modified from the initial amount claimed.
- 10% of earn-out milestones that were initially claimed as missed eventually resulted in a payout for shareholders.
- Tax claims became more frequent due to the average target being a more mature taxpayer. In addition, state and local governments have become more aggressive about revenue collection, especially for sales and use taxes.
Give it a download.
Thinking about it now, it turns out that the 2011 settlement approval of In re Sauer Danfoss Shareholder Litig is an important case. Why? Did it set out any special new points in the law? No. But it did one thing of real value for the courts. In Appendix A to the opinion, it set out a chart of recent settlements with identification of the work accomplished by plaintiffs counsel, the benefit achieved, and the fee approved by the court. It's a price list. And, like a price list, the Delaware courts are now regularly referring to it when they are reviewing requests for attorneys fees in disclosure only cases. I suppose that's a good thing. The downside? Well, now Vice Chancellor Laster has to remember to update the appendix every now and again!
Monday, April 29, 2013
I'll be the first the first to admit that the whole reverse merger situation with Chinese corporations really reveals the most cynical aspects of our capital markets. For those of you who haven't been paying attention to this issue, towards the end of the credit bubble and early on during the financial crisis there were a large of number of reverse mergers in the US involving Chinese corporations. The reverse merger is a back door way to take a company public. A privately held foreign company, in this case Chinese, acquires a publicly listed, but thinly traded, US corporation, usually a Delaware corporation through a reverse merger (the acquirer is the disappearing corporation and the target is the surviving corporation). The suriving corporation then changes its name to the Chinese corporation and presto, you have a publicy traded Chinese corporation incorporated in Delaware.
OK, so far so good. The next step is where things start to get 'hinky'. The newly public Chinese corporation then raises additional equity on US markets through a public offering. The money is transfered back to China and then ... it disappears. Surprised? There are lots of people who you might point a finger at in this exercise. The lawyers and investment bankers who arrange the reverse merger, the lawyers, investment bankers, and accountants who sign off on the public offering, the analysts who recommend shareholders buy shares in these companies. The list is very long. Now add to that list, the independent directors, usually US persons, who are required to sit on the boards of these companies (pursuant to the listing rules).
[Fuqi] listed its shares on Nasdaq through a reverse merger and in 2009 it raised $120 million through a public stock offering. Less than a year later, the company said it found accounting errors and uncovered transfers of cash out of the company totaling more than $130 million to entities that Fuqi has yet to verify were legitimate businesses. Fuqi has said the cash was recovered.
Fuqi's audit committee started to investigate, but its work stalled when management stopped paying the lawyers and accountants hired by the audit committee. The company said the lack of payment stemmed from a dispute with its insurer.
In protest, [independent directors] Brody and Hollander resigned from the board.
Shareholders sued the directors of Fuqi, including Brody and Hollander, who resigned in protest. Prior to suing, the shareholders had made demand, but the corporation sat on the shareholders' demand for over two years. The shareholders argued that notwithstanding the fact that they had previously made demand, it was futile because of the two year delay in responding. The essence of the shareholders claim was a Caremark oversight claim - that directors failed in the duty to monitor the corporation's activities and permitted more than $130 million to disappear. Glasscock sided with shareholders.
... lead me to believe that Fuqi had no meaningful controls in place. The board of directors
may have had regular meetings, and an Audit Committee may have existed, but there
does not seem to have been any regulation of the company’s operations in China.
The Vice Chancellor noted that independent directors had ignored several 'red flags' with respect to problems with internal controls and that directors did nothing to ensure that reporting mechanisms were accurate. The lack of internal controls was so bad that $130 million was transferred out of the company in Novermber 2010, but it wasn't found out by the directors until March 2011.
Also, and this is critically important for independent directors, a strategy of "noisy withdrawal" will not immunize independent directors from liability for bad acts that took place on their watch. Glasscock's ruling in Fuqi and Chancellor Strine's earlier in re Puda decision make two things clear: first, Caremark is alive - although it's a difficult standard to meet, there are facts that will meet that standard; and second, if you are an independent director, remember that it is serious business. Resigning in protest won't help. Better stick around and clean up the mess you created by your own inattentiveness.