Supreme Court Update
Supreme Court Hears Oral Argument in Halliburton II
On March 5, 2014, the Supreme Court heard oral argument in Halliburton v. Erica P. John Fund, No. 13-317 (Halliburton II). As we discussed in our Year-End Review, the latest issue to be considered in this series of cases is whether or not the "fraud-on-the-market" presumption of reliance in federal securities fraud class actions continues to be valid. Based on the reaction of observers present for oral argument, the tentative consensus prediction is that the Court will not discard the fraud-on-the-market presumption in its entirety, but instead will allow defendants to take some action—often called the "middle ground" approach —to rebut the presumption at the class certification stage. Currently, the Second Circuit is the only jurisdiction that has a significant body of caselaw addressing this "middle ground" approach. See, e.g., George v. China Automotive Systems, Inc., 2013 U.S. Dist. LEXIS 93698 (S.D.N.Y. July 3, 2013). What seemed to be of interest to the Supreme Court is the fact that most securities class actions are certified without a true challenge to the applicability of the fraud-on-the-market presumption to a given case, and many have observed that the justices seemed interested in providing defendants with the opportunity to rebut the presumption by introducing evidence of a lack of "price impact."
Supreme Court Grants Certiorari in Omnicare Decision
The Supreme Court recently granted certiorari in Indiana State District Council of Laborers v. Omnicare, which held that the strict liability provisions of Section 11 of the 1933 Act apply to statements that traditionally constituted "soft" information, such as statements of opinion. The outcome should impact companies, corporate officers, directors, underwriters and auditors involved in such filings. At issue is whether or not a plaintiff may survive a motion to dismiss by alleging that a statement of opinion contained in a registration statement was "objectively false" — that is, merely inaccurate — or whether the plaintiff must go further and allege facts showing that the opinion was "subjectively false" — meaning that the defendant did not believe the statement at the time it was made.
Joe Crace and Brant Phillips co-authored a piece for InsideCounsel discussing the Omnicare case in detail, which was published on March 24, 2014. The full article is available here.
Supreme Court Issues Decision in Chadbourne & Parke, LLC v. Troice
On February 26, 2014, the Supreme Court issued its decision in Chadbourne & Parke, LLC v. Troice. The Court held that state law fraud claims against various law firms and brokerage firms were not precluded by SLUSA and, thus, could proceed even though the claims in question were based on the theory that investors had been fraudulently induced to purchase Certificates of Deposit (CDs) based on representations that the proceeds from the sale of the CDs would be invested in SLUSA-covered securities. The Court found that SLUSA did not apply because "there is not the necessary 'connection' between the materiality of the misstatement and the statutorily required 'purchase or sale of a covered security.'" The Court focused on the fact that the transaction in question—the sale of CDs—was not a transaction in covered securities and rejected what it viewed as efforts to stretch SLUSA's preclusive effect beyond Congress' clear intent in enacting the statute.
How the Supreme Court's Decision in Gabelli Might Influence the SEC's Enforcement Policies
Brant Phillips and Britt Latham co-authored an article titled, "Supreme Court Gabelli Decision Will Continue to Bring Changes to SEC Enforcement Policy," that was published by Inside Counsel on February 26, 2014. The article outlines how the decision issued in February 2013 by the U.S. Supreme Court in Gabelli v. Securities & Exchange Commission may indicate potential changes to the SEC's enforcement policies.
Sixth Circuit Update
Sixth Circuit Affirms Dismissal of Section 10(b) Claims
The Sixth Circuit recently affirmed dismissal of claims brought under the Securities Exchange Act of 1934 in two separate cases.
In Dailey v. Medlock, 2014 U.S. App. LEXIS 907 (6th Cir. Jan. 13, 2014), the Sixth Circuit analyzed Section 10(b) and Rule 10b-5 claims surrounding a bank's $10 million loss in late 2009 in which $5.9 million of the loss was attributable to a "valuation allowance" on the bank's net deferred tax assets. Later, the bank failed and was placed in receivership. The Sixth Circuit affirmed the lower court's decision to dismiss the federal security fraud claims, but it remanded the case under Michigan case law for a separate state law claim of "silent fraud." In discussing the bank's valuation allowance, the Sixth Circuit held that the plaintiffs did not allege sufficient facts to show that the "defendants knew that the [valuation] allowance would be taken but they failed to disclose that information." Id. at * 13. The Court also relied upon the bank's disclosed risks that were not "boilerplate cautionary statements" but detailed the bank's high-risk loan portfolio, loan delinquencies, credit losses, and possible changes in the bank's regulatory capitalization rating. The Court further explained that the bank’s "well capitalized" statements were not false or misleading because no allegations showed how the bank did not meet its "well capitalized" regulatory classification. Id. at *16-17. Finally, the Court found that by the bank's statements about applicable government regulations did not mislead investors because the bank did not state that it was in compliance with such laws and "a generic claim of legal compliance, absent any specifics, does not form the basis for [an actionable] misrepresentation." Id. at *20. Overall, this case gives provides added guidance to financial institutions about how to avoid securities fraud claims when disclosing specific risks.
In Kuyat v. BioMimetic Therapeutics, Inc., 2014 U.S. App. LEXIS 5738 (6th Cir. March 28, 2014), the Sixth Circuit dismissal of security fraud claims surrounding a company's disclosures about the prospects for Federal Drug Administration (FDA) approval of a new drug. The Court held that opposing inferences existed that the Company believed the statements regarding the FDA and plaintiff did not allege sufficient facts to allege an inference of scienter that was "at least as strong as any opposing inference." The Court further held that the Company timely and sufficiently disclosed results of its drug tests and noted that the market reacted when the results of the study were released. "It is doubtful that the company intended to defraud investors in light of its willingness to disclose information that harmed its share prices." Id. at *20. Overall, the Court held that the Company was justified in expressing optimism about the drug's prospects at the time it made statements to investors.
Corporate Governance Update
Delaware Supreme Court Applies Business Judgment Review to Controlling Shareholder Transaction
In mid-March, the Delaware Supreme Court issued what has been described as a landmark ruling in Kahn v. M&F Worldwide Corp., C.A. 6566 (Del. March 14, 2014). This decision affirmed then-Chancellor Leo Strine's application of the more deferential "business judgment" standard of review in granting a motion for summary judgment that dismissed a challenge to a controlling shareholder buyout. Brant Phillips has addressed this decision in depth for Inside Counsel in a May 1 article, found here.
Delaware Chancery Court Finds Investment Bank Aided and Abetted Board's Breach of Fiduciary Duty
In In re Rural Metro Corp. S’holder Litig., No. 6350-VCL, 2014 Del. Ch. LEXIS 36, at *9 (Del. Ch. Mar. 7, 2014), the Delaware Court of Chancery found RBC Capital Markets LLC liable for aiding and abetting breaches of fiduciary duty by the directors of Rural Metro Corporation in connection with Rural's 2011 acquisition by Warburg Pincus LLC. In the opinion, Chancellor Laster found that RBC, in negotiating the transaction on behalf of Rural, had succumbed to multiple conflicts of interest when it was simultaneously pitching its services to the acquirer. The court found that RBC's undisclosed desire and efforts to secure the lucrative buy-side financing work tainted its valuation materials for Rural's board, making Warburg's offer appear more favorable than it was. These actions, along with a failure to provide timely interim valuation materials to the board or its special committees, did not allow the directors to have a "reasonably adequate understanding of the alternatives available to Rural, including the value of not engaging in a transaction at all."
The court also stressed the "active and direct" role that directors must maintain in the sale process "from beginning to end." The court found that potential liability for investment banks, characterized as "gatekeepers," would create a "powerful financial reason for the banks to provide meaningful fairness opinions and to advise boards in a manner that helps ensure that the directors carry out their fiduciary duties when exploring strategic alternatives and conducting a sale process." The court ultimately held that stockholders were entitled to recover from the bank, but it declined to impose a specific remedy.
Tennessee Court of Appeals Holds That "Substantial Benefit Doctrine" Does Not Justify Award of Attorneys' Fees in a Class Action That Yields No Monetary Benefit for Shareholders
On February 11, 2014, the Tennessee Court of Appeals affirmed a Chancery Court decision denying plaintiffs' petition for an award of $850,000 in attorneys' fees under the common law "substantial benefit" doctrine. In In re: O'Charley's, Inc. S'holder Litig., No. M2012-02221-COA-R3-CV (Tenn. Ct. App., Middle Div., Feb. 11, 2004), the Court of Appeals held that, where plaintiffs had filed an action seeking to enjoin the acquisition of O'Charley’s, Inc. by Fidelity National Financial, Inc., but had obtained no monetary recovery or "common fund" for the benefit of shareholders, there was "no legal authority or basis upon which [Plaintiffs were] entitled to recover their attorneys' fees" under Tennessee law, which strictly applies the American Rule absent a recognized statutory or common law exception. Tennessee law recognizes no exception to the American Rule for shareholder class actions that do not provide shareholders with a monetary recovery.
Overton Thompson, Brant Phillips, and Joe Crace served as counsel for O'Charley's and its board of directors in this action. A copy of the Court of Appeals decision is available here.