Threat to Shareholder Protections in Transactions with Controlling Parties

ATTORNEY: GUSTAVO F. BRUCKNER
POMERANTZ MONITOR, JANUARY/FEBRUARY 2014 

A recent Delaware Chancery Court decision, now on appeal before the Delaware Supreme Court, may dramatically lessen the customary safeguards for minority shareholders in controlling party transactions, such as going private mergers. 

In M&F Worldwide(“MFW”), Chairman Ronald Perelman offered to acquire the remaining 57% of MFW common stock he did not already own. As part of his proposal, Perelman indicated that he expected that the “board of Directors will appoint a special committee of independent directors to consider [the] proposal and make a recommendation to the Board of Directors,” and also noted that the “transaction will be subject to a non-waivable condition requiring the approval of a majority of the shares of the Company not owned by M&F or its affiliates.” 

Controlling shareholder transactions normally trigger the enhanced “entire fairness” standard of judicial review. This enhanced standard places a burden on the corporate board, and the controlling shareholder, to demonstrate that the transaction is inherently fair to the shareholders, by both demonstrating fair dealing and fair price. This is a very difficult standard for the company to meet. 

However, Delaware courts have held that the burden of proof on the issue of “entire fairness” can be shifted to the plaintiff challenger if the transaction has been approved either by an independent special committee of directors or by a positive vote of a majority of the minority shareholders. Independent committee and “majority of the minority” provisions are an attempt to assure that the company and its shareholders can exercise independent judgment in deciding to accept or reject the transaction. Although shifting of the burden of proof creates a higher hurdle for minority shareholders to surmount, it is not an impossible one, because the ultimate inquiry remains the same: the “entire fairness” of the transaction. 

Critically, even if these devices are used, Delaware courts have consistently held, up to now, that the business judgment rule does not protect the transaction. That rule, which protects most ordinary business decisions from shareholder challenge, is almost impossible for shareholders to overcome, because it provides that in making a business decision the directors of a corporation are presumed to have “acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” 

In his decision, Chancellor Strine (who was just nominated to become the next Chief Justice of the Delaware Supreme Court), ruled that where a transaction with a controlling person is conditioned on both negotiation and approval by an independent, special committee and a fully-informed, un-coerced vote of the majority of the minority, the proper standard of review is that of business judgment. According to Chancellor Strine, because Perelman conditioned the deal on implementation of procedural protections that essentially neutralized his controlling influence, the transaction is no different from routine corporate transactions in which the deferential business judgment standard is applicable. 

At oral argument, the Supreme Court seemed interested in the policy arguments both for accepting and rejecting the Chancellor’s reasoning. Chancellor Strine’s ruling, if adopted by the Supreme Court, could provide a roadmap for corporate boards to forestall litigation on even the most one-sided controlling shareholder transactions. Though too early to predict fully the repercussions of such a ruling, there is fear that institutional investors will use the power of the purse to reduce their holdings in controlled corporations over time, if their assets lose the valuable protections they are currently afforded.

Supremes About to Hear Historic Challenge to Fraud on the Market Theory

ATTORNEY: LOUIS C. LUDWIG
POMERANTZ MONITOR, JANUARY/FEBRUARY 2014

Twenty five years ago, in Basic Inc. v. Levinson, the Supreme Court adopted the so-called “fraud on the market” (“FOTM”) theory in securities fraud class actions. That theory holds that a security traded on an “efficient” market presumably reflects all public “material” information about that security, including any public misrepresentations by the defendants; and that in such cases investors rely on the market price as a fair reflection of the totality of information available. Because investors purchase their shares at the market price, assuming that that price reflects all available material information, it is fair to presume that all investors relied, indirectly, on defendants’ misrepresentations when they purchased their shares. 

Reliance is an essential element of securities fraud claims. The FOTM presumption allows investors to establish reliance on a class-wide basis, without having to show that each member of the class personally relied on defendants’ misrepresentations. If reliance had to be shown separately for each of the hundreds of thousands, or even millions, of investors, individual questions of reliance would overwhelm the case. In legalese, individual questions would “predominate” over common questions in the action, and it would be next to impossible to certify a class. The FOTM theory adopted in Basic is therefore a foundation of securities fraud class actions. The importance of class-wide reliance was apparent to the courts from the outset of the modern class action era in 1966. Just two years later, the Second Circuit rejected a defendant’s argument “that each person injured must show that he personally relied on the misrepresentations” because, the court concluded, “[c]arried to its logical end, it would negate any attempted class action under Rule 10b-5 ….” Because most investors do not suffer large enough losses from securities fraud to support prosecution of an individual action, class actions are often the only way for most investors to obtain redress for securities fraud. In recent years, some members of the Supreme Court have become more critical of securities fraud class actions, echoing Chamber of Commerce arguments that the mere act of certifying a class in a securities fraud action puts enormous financial pressure on defendants, forcing them to settle claims regardless of their merit. Before Halliburton, defendants had mounted a series of efforts to get the courts to make it harder to certify a class, arguing that plaintiffs should be forced to prove, at the class certification stage, that the misrepresentations were material (the Amgen case), or that they caused plaintiffs’ losses (an earlier Halliburton case). Both of those efforts failed. 

Those were merely the preliminary bouts; the main event is now here. For years, corporate interests have been mounting attacks on the FOTM theory, arguing that markets are not as efficient as economists previously thought. With the Supreme Court agreeing to revisit its decision in Basic, these well-funded efforts have finally paid off. On November 15, 2013, the Court granted certiorari in Halliburton Co. v. Erica P. John Fund. In Halliburton, the Supreme Court will decide two issues: 

 (1) Whether it should overrule or substantially modify the holding of Basic to the extent that it recognizes a presumption of class-wide reliance derived from the fraud-on-the market theory; and

(2) Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock. 

For everyone involved in litigating securities fraud class actions, the answers to these questions could be game-changers; and Pomerantz’s clients are among the potentially affected. If Basic is overruled and FOTM is jettisoned, securities fraud class actions as we have known them for a quarter century will be a thing of the past. 

Another possibility is that the Court will modify, rather than reject, Basic and FOTM. This possibility exists because FOTM theory actually consists of two distinct, but related, parts: first, “informational efficiency,” the idea that the market is capable of efficiently and speedily processing material information; and second, “price distortion,” whether fraudulent statements injected into the informationally-efficient market in a particular case actually distort a given security’s market price. After Basic was decided, courts weighing class certification in securities fraud cases focused primarily on informational efficiency, allowing the FOTM presumption of reliance to attach where that test was satisfied. By contrast, inquiries into price distortion were rare, if they occurred at all, on class certification motions. The Court could keep FOTM while requiring that plaintiffs establish both an informationally-efficient market, and some price distortion, perhaps using event studies of a type already much in use in securities fraud litigation. 

Defendants are arguing that the issue of price distortion is closely related to another element of a securities fraud claim, “loss causation,” proof that defendants’ misstatements, once corrected, caused the price of the stock to drop, causing plaintiff’s losses. A court that simply assumes price distortion also, to some extent, assumes loss causation. Second, the FOTM presumption is essentially predicated on another independent element of a securities fraud claim, “materiality.” By presuming reliance, courts presume the materiality of the alleged misstatement, and on the class certification motion defendants cannot offer rebuttal evidence negating materiality. Defendants argue that plaintiffs should not be entitled to such presumptions in their favor on a class certification motion. 

At the end of the day, at summary judgment or at trial, defendants will have their opportunity to rebut all these presumptions. But, the argument goes, that is too late, as a practical matter. Once a class is certified, defendants have a strong incentive to settle. Very few defendants have the chutzpah to take a “bet the company” securities fraud class action to trial. 

Even if the Court abrogates Basic and the FOTM theory completely, class actions will still be possible in cases involving failures to disclose (rather than misrepresentations), or involving violations of the Securities Act, which relates primarily to initial public offerings. In other cases, however, investors will be left to pursue individual actions, mostly on behalf of large institutional investors, and possibly in state court. Pomerantz’s current BP litigation, which alleges common law fraud and negligence claims stemming from over two dozen clients’ losses associated with BP common stock investments, provides a glimpse into what this post-Basic world might look like. In such cases, institutions with significant losses can pursue individual actions even without the FOTM presumption, if their advisors actually relied on defendants’ misrepresentations. 

Oral arguments in Halliburton are set for March 5, 2014. In the meantime, Pomerantz attorneys continue to work with economists, Supreme Court consultants, and the law firm that will argue the case, to craft an amicus brief that will support the continued viability of FOTM. Barring the outright affirmance of Basic, we will urge the Court to adopt an approach that leaves FOTM in place – as securities fraud class actions are untenable without some version of it – while adopting a limited inquiry into price distortion.

Whistleblower Program Picks Up Steam

POMERANTZ MONITOR, NOVEMBER/DECEMBER 2013 

The Whistleblower Bounty Program created by the Dodd-Frank Act mandates that the Securities and Exchange Commission (“SEC”) pay significant financial rewards to individuals who voluntarily provide the agency with original information about securities law violations. If the information provided leads to a successful enforcement action resulting in $1 million or more in sanctions, the whistleblower may receive between 10 and 30% of the sanctions collected. The SEC is required to maintain confidential treatment and anti-retaliation measures for tipsters. 

In a report issued by the SEC staff on November 15, the agency reported that it had received 3,238 tips in fiscal 2013, and had paid out $14.8 million in whistleblower awards that year, $14 million of which went to a single tipster in an award announced on October 1. In announcing the award, SEC Chair Mary Jo White stated that “Our whistleblower program already has had a big impact on our investigations by providing us with high quality, meaningful tips…. We hope an award like this encourages more individuals with information to come forward.” 

As more investigations are resolved, observers expect that more and greater awards will be granted. Currently, the SEC has over $400 million available for the program. 

While this program is new, it may ultimately supplement securities class actions in two important ways. The fundamental purpose of the Whistleblower program is to detect fraud. Unlike the basic purpose of securities class actions – to deter and hopefully monetarily punish fraud – the Whistleblower program incentivizes tipsters to come forward with information to the SEC – thus improving fraud detection. Generally, both corporate insiders (those with independent knowledge of misconduct from non-public sources) and corporate outsiders (those who detect misconduct through independent analysis and investigation of publicly available data) are incentivized to tip information to the SEC. 

Opponents of the program insist that, because the monetary incentives are so high, whistleblowers will turn first to the SEC before disclosing problems internally to obtain corrective action. However, SEC rules seek to preserve the attractiveness of internal reporting, and the SEC reports that most whistleblowers who have come forward since the program’s inception used internal channels of resolution before turning to the SEC. In addition, the SEC has indicated that its standard practice involves contacting the involved corporation directly upon receipt of a tip, describing the allegations, and giving the firm a chance to investigate the matter internally. On balance, the deterrent and detection benefits of the program, coupled with the SEC’s measures to encourage initial internal reporting, outweigh any incentive to simply run to the SEC first on the chance that a tip will result in a large reward.

The Purple Pill and “Pay for Delay”

ATTORNEY: JAYNE A. GOLDSTEIN
POMERANTZ MONITOR, NOVEMBER/DECEMBER 2013 

Pomerantz is serving as interim co-lead counsel in an antitrust lawsuit against various pharmaceutical companies. We allege that the brand company, AstraZeneca, paid generic drug manufacturers Ranbaxy Pharmaceuticals, Teva Pharmaceuticals and Dr. Reddy’s Laboratories (“Generic Defendants”) to keep generic versions of the blockbuster drug Nexium from coming to market for six years or more. Nexium, a prescription medication commonly advertised as “the purple pill,” is used to treat heartburn and gastric reflux disease. Pomerantz represents consumers, self-insured insurance plans and insurance companies who were forced to pay monopoly prices for Nexium because there was no generic competition. 

Generic versions of brand name drugs contain the same active ingredient, and are determined by the Food and Drug Administration (“FDA”) to be just as safe and effective as their brand name counterparts. The only significant difference between them is their price: when there is a single generic competitor, generics are usually at least 25% cheaper than their brand name counterparts; and when there are multiple generic competitors, this discount typically increases to 50% to 80% (or more). The launch of a generic drug usually brings huge cost savings for all drug purchasers. 

We allege that in order to protect the $3 billion in annual Nexium sales from the threat of generic competition, AstraZeneca agreed to pay the Generic Defendants substantial sums in exchange for their agreement to delay marketing their less expensive generic versions of Nexium for as many as six years or more, i.e., from 2008 until May 27, 2014. 

Under the Hatch Waxman Act, the law which governs how generic pharmaceuticals come to market, when a generic drug manufacturer wants to sell a generic equivalent of a patented drug, it must file an Abbreviated New Drug Application (“ANDA”) which must certify either that (1) no patent for the brand name drug has been filed with the FDA; (2) the patent for the brand name drug has expired; (3) the patent for the brand name drug will expire on a particular date and the generic company does not seek to market its generic product before that date; or (4) the patent for the brand name drug is invalid or will not be infringed by the generic manufacturer’s proposed product (a so-called “Paragraph IV certification”). 

In the case of Nexium, the generic manufacturers filed a Paragraph IV certification. This filing gave the brand manufacturer forty-five days in which to sue the generic companies for patent infringement. If the brand company initiates a patent infringement action against the generic filer, the FDA will not grant final approval of the new generic drug until the earlier of (a) the passage of thirty months, or (b) the issuance of a decision by a court that the patent is invalid or not infringed by the generic manufacturer’s ANDA. In this case, AstraZeneca sued all three of the Generic Defendants. 

As an incentive to spur generic companies to seek approval of generic alternatives to branded drugs, the Hatch Waxman law rewards the first generic manufacturer to file an ANDA containing a Paragraph IV certification by granting it a period of one hundred and eighty days in which there is no competition from other generic versions of the drug. This means that the first approved generic is the only available generic for at least six months, a large economic benefit to the generic company. Brand name manufacturers can “beat the system” by claiming a valid patent even if such patent is very weak, listing and suing any generic competitor that files an ANDA with a Paragraph IV certification (even if the competitor’s product does not actually infringe the listed patents) in order to delay final FDA approval of the generic for up to thirty months. 

In Nexium’s case, when the Generic Defendants filed their Paragraph IV certifications they alleged, among other reasons, that the Nexium patents were not valid because Nexium was not significantly different from AstraZeneca’s prior drug, Prilosec. The active ingredient in Prilosec is omeprazole, a substance consisting of equal parts of two different isomers of the same molecule. 

Nevertheless, after receiving the Paragraph IV certifications from the Generic Defendants, AstraZeneca filed patent infringement litigation. Just as the thirty months was about to expire and generic Nexium would have been able to come to market, the companies settled the patent litigation. AstraZeneca used the strength of its wallet as opposed to the strength of its patents to obtain the Generic Defendants’ agreement to postpone the launch of their generic Nexium products. In light of the substantial possibility that AstraZeneca’s Nexium patents would be invalidated, in which case AstraZeneca would have been unable to keep generic versions of Nexium from swiftly capturing the vast majority of Nexium sales, AstraZeneca agreed to share its monopoly profits with the Generic Defendants as the quid pro quo for the Generic Defendants’ agreement not to compete with AstraZeneca in the Nexium market until May 27, 2014. 

These cases are commonly called either “pay for delay” or “reverse payment” cases. Until recently, the various federal appellate courts were divided on whether these “settlements” violated the antitrust laws by improperly prolonging the monopoly granted by the patent laws. In June of 2013, the U.S. Supreme Court held that such settlements are subject to antitrust scrutiny. 

The trial of this case is scheduled to begin on March 3, 2014.

Health Insurers’ “Recoupment” Tactic Derailed

POMERANTZ MONITOR, NOVEMBER/DECEMBER 2013 

In Pennsylvania Chiropractic Ass’n v. Blue Cross Blue Shield Ass’n, Pomerantz’s Insurance Practice Group obtained summary judgment on behalf of our client health providers against Anthem and Independent Blue Cross in a recoupment case. Recoupment itself has been described as a “legal gray zone” that insurers exploited prior to Pomerantz’s challenges. Recoupment occurs when insurers such as Blue Cross Blue Shield (“BCBS”) pay claims initially and later decide that the claims should not have been paid, demanding repayment and claiming fraud. When the provider refuses to return the money, the insurer deducts the full amount from payment of future claims that are not challenged as improper. 

When these subsequent denials are made in the context of an employee health insurance plan, they are controlled by ERISA, which requires disclosure and appellate rights. In its decision, the court found that Blue Cross insurers violated ERISA by improperly denying beneficiary rights and making arbitrary and capricious benefit denials. The court also denied BCBS’s motion for summary judgment against several chiropractic associations, also represented by Pomerantz, for injunctive relief. This ruling paved the way for a December trial to modify the way Blue Cross obtains benefit recoupments from chiropractors across the country. 

This decision has national significance. As we stated to Law 360, an online legal publication: “The decision found for us on the merits of our claim that an insurer must comply with ERISA when seeking to recover previously paid health care benefits from providers. Given the hundreds of millions of dollars recouped by insurers every year, this decision will have widespread implications.” 

The decision follows Pomerantz’s successful trial verdict on behalf of other providers in another recoupment and fraud case in the District of Rhode Island, Blue Cross & Blue Shield of R.I. v. Korsen, and our win in yet another recoupment case in the Third Circuit in Tri3 Enterprises, LLC v. Aetna, Inc. We have other recoupment cases ongoing, the results of which we will report in future editions of the Monitor.

FIRREA: No, It’s Not a Disease, Unless You Are a Naughty Financial Institution

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, NOVEMBER/DECEMBER 2013 

As JPMorgan Chase struggled to put the finishing touches on its $13 billion settlement with the federal government over its misadventures in the mortgage-backed securities area, a major ingredient in the government’s success seems to have come from out of nowhere – or, more precisely, from the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"). This provision, enacted in the wake of the savings and loan meltdown of the 80’s, has been pulled out of the mothballs to punish some of the misbehaving financial institutions that brought about the financial crisis of 2008. 

Section 951 of FIRREA authorizes the Justice Department to seek civil money penalties against persons who violate one or more of 14 enumerated criminal statutes (predicate offenses) that involve or “affect” financial institutions or government agencies. On April 24, 2013, the U.S. District Court for the Southern District of New York issued the first judicial interpretation of the phrase "affecting a federally insured financial institution" as used in FIRREA. In United States v. The Bank of New York Mellon, the DOJ sued the bank and one of its employees under FIRREA. Defendants allegedly schemed to defraud the bank’s custodial clients by misrepresenting that the bank provided "best execution" when pricing foreign exchange trades. The DOJ contended that the defendants' fraudulent scheme "affected" a federally insured financial institution—namely the bank itself—as well as a number of other federally insured financial institutions. The bank, on the other hand, contended that a federally insured financial institution may be "affected" by a fraud only if it were the victim of or an innocent bystander, but not if it were the perpetrator. 

The court disagreed, concluding that a federally insured financial institution could be "affected" by a fraud committed by its own employees, even though it may actually have profited from that fraud in the short run. The court reasoned that the fraud exposed the bank to a new or increased risk of loss, as shown by the fact that BNY Mellon had been named as a defendant in numerous private lawsuits as a result of its alleged fraud, which required it to incur litigation costs, exposed it to billions of dollars in potential liability, and damaged its business by causing a loss of clients, forcing BNY Mellon to adopt a less-profitable business model, and harming its reputation. 

Every fraud committed by bank employees could lead to such consequences; and because mail and wire fraud are very broad statutes that apply to virtually all fraudulent schemes, FIRREA has wide scope and potentially devastating impact. 

Other features of FIRREA also cause bankers to lose sleep. Although the DOJ has to prove that certain criminal statutes have been violated, the burden of proof is not “beyond a reasonable doubt” but, rather, only a “preponderance of the evidence.” The statute of limitations is ten years, which is important given that the five-year limitations period applicable to securities fraud and other statutes is expiring on many cases involving the 2008 financial meltdown. 

Finally, and most spectacularly, the potential penalties under FIRREA are astronomical. The statute authorizes penalties of up to $1.1 million per violation; for continuing violations, the maximum increases up to $1.1 million per day or $5.5 million per violation, whichever is less. That’s not much; but FIRREA allows the court to increase the penalty up to the amount of the pecuniary gain that any person derives from the violation, or the amount of pecuniary loss suffered by any person as a result of the violation. 

The DOJ has invoked this special penalty rule to seek more than $5 billion in civil money penalties in a current litigation involving fraud allegedly committed by the credit ratings agency Standard & Poors. 

The U.S. Attorney in Manhattan has now filed civil fraud actions against Wells Fargo, BNY Mellon and Bank of America, among others, and in October a jury found Bank of America liable. Finally, potential FIRREA liability reportedly has played a major role in convincing JPMorgan Chase to pony up $13 billion to settle with the DOJ.

A New Way to Curtail Class Actions?

ATTORNEY: MARK B. GOLDSTEIN
THE POMERANTZ MONITOR, SEPTEMBER/OCTOBER 2013 

A recent decision by the Third Circuit has the potential to further restrain consumer and other types of class actions. Last August, in Carrera v. Bayer Corp., the Third Circuit reversed and remanded the certification of a class of Florida consumers who purchased Bayer's One–A–Day WeightSmart diet supplements. 

This was a potential class action by consumers claiming that Bayer falsely and deceptively advertised its supplement. When the District Court certified the class, Bayer appealed, arguing that class certification was improper because the class members were not “ascertainable”. This requirement means that “the class definition must be sufficiently definite so that it is administratively feasible to determine whether a particular person is a class member.” This is important because all class members have to be notified if a class has been certified or if a settlement has been reached, and because, if there is a recovery for the class, the court can determine who is entitled to share in it, and who isn’t. 

Here the class was to consist of everyone who purchased the supplement in Florida. Figuring out who these people are is no easy matter. In securities cases, for example, there are brokerage and other records identifying everyone who bought or owned a particular security at a particular time. Similarly, records are kept of everyone who purchases prescription drugs. But no one keeps a comprehensive list of everyone who buys consumer products like over the counter diet supplements. If such a list must exist in order to certify a class action, it will be a major roadblock in many cases. 

Plaintiffs here proposed that class members could be identified through retailers’ records of online sales and of sales made through store loyalty or reward cards. They also suggested that when class members file their individual proofs of claim to share in any recovery, they could submit affidavits attesting that they purchased WeightSmart and stating the amount they paid and the quantity purchased. 

The Third Circuit rejected those arguments, concluding that it could not know for certain whether retailers’ records would identify all or most of the class members. It also held that affidavits from people who claimed, without documentary proof, that they bought the product could be unreliable. 

It is too soon to know whether other Circuits will follow suit and adopt this standard for ascertainability. If they do that would be a problem. There are many products sold for which there is no comprehensive and authoritative source identifying all purchasers. In such cases, purchasers may have no feasible method for seeking recourse if defendants engage in deceptive or illegal conduct.

SEC Wrests Admissions in Settlement of Falcone Case

ATTORNEY: MURIELLE STEVEN WALSH
POMERANTZ MONITOR, SEPTEMBER/OCTOBER 2013 

The JPMorgan “London Whale” case is not the first time the SEC has insisted on admissions of wrongdoing as part of its settlement agreements. A few weeks earlier, for example, the SEC secured admissions as part of its settlement of charges against Hedge Fund manager Philip Falcone. 

The current push to insist on admissions of wrongdoing in these settlements can probably be traced to November of 2011, when Judge Rakoff of the Southern District New York famously rejected Citigroup’s $285 million settlement with the SEC, primarily because it did not contain any admission of wrongdoing by the bank. The judge found that the deal was "neither fair, nor reasonable, nor adequate, nor in the public interest." Judge Rakoff has been highly critical of settlements that allow defendants to neither “admit nor deny,” and has called them “a stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C.” 

Judge Rakoff was criticized as overstepping his bounds and challenging the authority of the SEC. Wall Street interests argued that admissions of wrongdoing in SEC settlements would encourage private investor litigation. Others pronounced that a requirement for admissions would make it difficult, if not impossible, for the SEC to settle cases. The Second Circuit is now reviewing whether, in fact, the court went too far. 

But regardless of the outcome of that appeal, Judge Rakoff’s opinion has had profound repercussions. When Mary Jo White was first appointed as the new SEC chair, she announced that henceforth the Commission would require admissions of wrongdoing as a condition to settlement in certain situations. 

Judge Rakoff’s colleague in the Southern District, Judge Marrero, recently approved a settlement between SAC Advisors and the SEC that also had no admissions of wrongdoing. However, he conditioned his approval on a finding by the Second Circuit in the Citigroup matter that district courts lack the authority to reject SEC settlements solely because of “admit or deny” policy. If the Second Circuit does not make such a finding, SAC will be back on the hook. 

The recent $18 million civil settlement between hedge-fund manager Philip Falcone and securities regulators is a case in point. Falcone and his hedge fund, Harbinger Capital Partners, had been accused of engaging in an illegal “short squeeze” to force short-sellers to sell distressed, high yield bonds at inflated prices, and favoring certain investors over others when granting redemption requests. An earlier agreement reached between Falcone and the SEC’s enforcement staff did not contain any admissions of wrongdoing. In a rare move, the SEC commissioners rejected the agreement and sent the parties back to the table. The new deal contains Falcon’s admissions of underlying facts of alleged improper behavior, specifically, that he had acted “recklessly” with regard to several market transactions. It does not, however, include admissions of specific securities law violations. Obviously, the facts can potentially be used as fodder in private litigation – in this case, an admission of reckless conduct has important ramifications for fraud claims. 

At the same time, Falcone won’t be limiting his legal options in other lawsuits that may follow on the heels of this settlement. As noted by James Cox, a law professor at Duke University School of Law, the admitted facts “may be helpful, but not perfectly helpful, to follow-on litigation."

Not So Fabulous After All

ATTORNEY: TAMAR A. WEINRIB
POMERANTZ MONITOR, SEPTEMBER/OCTOBER 2013 

In August, the SEC scored a much-needed win when a nine-member jury, after deliberating for two days, found Fabrice Tourre, a former Goldman Sachs bond trader once known as “Fabulous Fab,” liable on six of seven civil fraud charges. 

The SEC brought the action in 2010 against both Mr. Tourre and Goldman Sachs, accusing both of misleading investors about a complex mortgage-based financial product known as “Abacus 2007-AC1.” Abacus was a “collateralized debt obligation,” a financial vehicle based on a collection of underlying mortgage-related securities. Tourre played a major role in putting Abacus together; but he (and Goldman) allegedly failed to disclose to potential investors that hedge fund titan John Paulson, a key Goldman Sachs client, had also played a major role in selecting the securities underlying Abacus. Paulson’s involvement was critical because he himself made a huge bet against Abacus, selling millions of shares short, and made a killing when Abacus failed. In other words, the SEC claimed that Abacus was secretly designed to fail so that Paulson could make a killing at the expense of Goldman’s other clients. 

Goldman settled the SEC’s claims some time ago, agreeing to pay a $550 million fine, without admitting or denying wrongdoing. Abacus, and the large fine it generated, heavily damaged Goldman’s reputation, helping to earn it the sobriquet “great vampire squid.” 

Even after Goldman settled, Tourre fought on, and lost. Tellingly, his lawyers opted not to call any witnesses at trial, an interesting strategy which perhaps reflected the weakness of their case. The SEC called two witnesses, Laura Schwartz from the ACA Financial Guaranty Corporation, and Gail Kreitman, a former Goldman saleswoman, who testified that they were misled about who was investing in Abacus. Also key to Mr. Tourre’s downfall was a number of emails to his girlfriend, which he called “love letters,” in which he joked about selling toxic real estate bonds to “widows and orphans.” 

As of Monitor press time, Mr. Tourre was planning to ask the court at the end of September to either overturn his securities fraud verdict or grant a new jury trial. If the judge declines that request, the question will then become one of punishment. Mr. Tourre faces three potential remedies. First, the court can impose civil monetary penalties ranging from $5,000 to $130,000 for each violation. Second, the court can order that Mr. Tourre forfeit any profits he received from his violations, though it is unclear at this point what that would encompass. Third, Mr. Tourre could also face an administrative proceeding before the SEC, which could permanently bar him from any future association with the financial industry. One potential obstacle for the SEC in pursuing a bar, however, is that it obtained the power to do this when Congress passed the Dodd-Frank Act in 2010, three years after Mr. Tourre’s violations occurred. It is unclear whether the SEC’s authority to issue a bar applies retroactively. Given that Goldman continues to bankroll all of Mr. Tourre’s legal fees, it is likely he will appeal any bar order, challenging retroactivity, and continue to drag this case on further. 

Mr. Tourre is now enrolled in a doctoral economics program at the University of Chicago and seems to be gearing up for a future in academia. Other than damage to his reputation, which he has already incurred in spades, it is questionable whether a bar would make much of a difference. 

Meanwhile, the Tourre trial, though clearly a success for the SEC, has led many to question why the agency continues to pursue mid-level employees like Mr. Tourre while leaving the high-level executives unscathed. Mr. Tourre clearly did not commit these violations on his own.

Mergers Foreclose Derivative Litigation

ATTORNEY: SAMUEL J. ADAMS
POMERANTZ MONTITOR, SEPTEMBER/OCTOBER 2013 

In a case involving the notorious Countrywide Corporation, with implications for derivative actions filed across the country, the Delaware Supreme Court, has declined to expand the circumstances under which a derivative action, brought on behalf of the injured corporation, can survive a merger of that corporation into another. Because mergers often happen while derivative suits are pending, and in fact are sometimes motivated by the directors’ desire to eliminate derivative claims against them, this decision will make it harder in many cases to hold directors of Delaware corporations accountable for their reckless mismanagement. 

As is well known, Countrywide played a major role in the financial crash of 2008, because it was probably the most prolific perpetrator of toxic mortgage securities. When the mortgage market imploded, Countrywide nearly collapsed and was sold under the gun to Bank of America (“B of A”) – the unlucky purchaser of last resort not only of Countrywide but also of equally ill-fated Merrill Lynch. If ever there were directors who deserved to be sued for destroying their company, the directors of Countrywide fit the bill. Yet, when they were sued by Countrywide shareholders, they claimed that the sale to B of A wiped out the plaintiffs’ claims. 

The directors were invoking the so-called “continuous ownership” rule, which says that in order to assert a derivative claim a plaintiff shareholder must have owned stock in the injured corporation continuously from the time of the alleged wrong until the resolution of the litigation. Should the corporation be sold in a cash-out merger before the litigation is resolved, the shareholder plaintiff would be divested of his holdings, and therefore his chain of continuous ownership would be broken. 

Here, plaintiffs sued the former directors of Countrywide in California federal court, claiming that they were responsible for allowing Countrywide to engage in a host of reckless and fraudulent mortgage practices. The District Court dismissed the derivative claims under the “continuing ownership” rule, holding that under Delaware law plaintiffs lost standing to pursue the derivative claims upon consummation of Countrywide’s Merger with B of A. Plaintiffs had argued that there was an exception to this rule in cases where it was the alleged wrongdoing that forced the company to enter into the merger in the first place. On appeal, the United States Court of Appeals for the Ninth Circuit asked the Delaware Supreme Court to consider, as a “certified question,” whether this exception actually existed and, if so, whether it applied here. The certified question was prompted, in part, by the fact that state and federal courts had reached divergent results in previous cases applying Delaware law in this situation. 

In a famous decision decades ago in Lewis v. Anderson, the Delaware Supreme Court recognized a “fraud exception” to the continuous ownership rule, allowing plaintiffs to litigate post-merger derivative claims “where the merger itself is the subject of a claim of fraud,” meaning that the merger served “no alternative valid business purpose” other than eliminating derivative claims. Although there is a very low threshold for finding a “valid business purpose” for a merger, it is a short step from this doctrine to the proposition that the exception should apply if the very fraud that was the subject of the derivative action also drove the corporation to enter into the merger. 

Arguing before the Delaware Supreme Court, plaintiffs, in a twist, urged the court to consider resolving the certified question by creating a new cause of action, which they referred to as a “quasi-derivative” claim. Defendants argued that there is “no need and no basis” to recognize an exception to the continuous ownership rule even where the conduct in question forced the company to merge with another company. 

The Delaware Supreme Court found in favor of defendants, holding that shareholders cannot pursue derivative claims against a corporation after a merger divests them of their ownership interest, even if a board's fraud effectively forced the corporation into the merger. However, the court was careful to note that shareholders who lose derivative standing in a merger may nonetheless have post-merger standing to recover damages from a direct fraud claim, should one be properly pleaded.

The Oxford Decision: the Silver Lining?

ATTORNEY: JENNIFER BANNER SOBERS
POMERANTZ MONITOR, JULY/AUGUST 2013 

Ten days before the American Express decision, the Supreme Court, in a case involving the Oxford health insurance company, unanimously affirmed an arbitrator’s decision to authorize class arbitration. He held that because the arbitration agreement stated that “all disputes” must be submitted to arbitration -- without specifically saying whether “all disputes” includes class actions -- nonetheless the agreement means that class action disputes can be arbitrated. 

This case was filed in court by a pediatrician in the Oxford “network” who alleged that Oxford failed to fully and promptly pay him and other physicians with similar Oxford contracts. The court granted Oxford’s demand that the case be arbitrated. The parties then agreed that the arbitrator should decide whether the contract authorized class arbitration. In finding that the contract did permit class arbitrations, the arbitrator focused on the language of the arbitration clause, which stated that “all” civil actions must be submitted to arbitration. Oxford tried to vacate the arbitrator’s decision, claiming that he exceeded his powers under the Federal Arbitration Act. The District Court denied the motion, and the Third Circuit affirmed. 

In agreeing with the lower courts, the Supreme Court held that when an arbitrator interprets an arbitration agreement, that determination must be upheld so long as he was really construing the contract. Whether this interpretation is correct is beside the point, as far as the courts are concerned. Judicial review of arbitrators’ decisions is far more constrained than the review of lower court decisions. 

This case may turn out to be the silver lining to the Supreme Court’s series of rulings curtailing class actions in arbitration. This decision will specifically benefit plaintiffs, including those, like the plaintiff here, whose claims lie in the health care arena. 

Moreover, the decision seems to narrow the effect of the court’s previous decision in 2010, which held that “silence” in an arbitration agreement usually means that the parties did not agree to arbitrate on a class-wide basis. To the extent that arbitrators in future cases interpret an agreement to arbitrate “all disputes” as including class-wide disputes, plaintiffs will be more likely in the future to have a realistic chance to have their claims resolved. That is, unless there is an explicit class action waiver. 

Many consumers are subject to arbitration agreements, including physicians who often have no choice but to accept such agreements if they want to be in-network providers for insurers. As Pomerantz and co-counsel argued in an amicus brief on behalf of the American Medical Association and the Medical Society of New Jersey in support of the pediatrician, without being able to arbitrate on a class-wide basis, physicians will have no effective means by which to enforce their contracts with insurers and challenge underpayments. The typical claim by a doctor against an insurer is relatively small. Prosecuting such small claims in individual arbitration is impossible, given that the cost of bringing an arbitration will almost always exceed the amount an individual doctor could potentially recover through arbitration. Moreover, individual arbitrations could not adequately address certain pervasive wrongful practices by insurers such as underpayment or delayed payment of claims and do not provide injunctive relief to stop such practices – a critical remedy sought in many class actions.

SEC Approves Use of Facebook and Twitter for Company Disclosures

POMERANTZ MONITOR, JULY/AUGUST 2013 

The Securities and Exchange Commission has issued a report that allows companies to use social media outlets like Facebook and Twitter to disclose material information as required by with SEC regulations, provided that investors are notified beforehand about which social media outlets the company will use to make such disclosures. In supporting the use of social media, the SEC stated that "an increasing number of public companies are using social media to communicate with their shareholders and the investing public. . .[w]e appreciate the value and prevalence of social media channels in contemporary market communications, and the commission supports companies seeking new ways to communicate." The new “guidance” is likely to change dramatically the way companies communicate with investors in the future. 

The SEC’s action actually began as an investigation into whether Netflix violated Regulation FD by disclosing financial information in the CEO’s personal Facebook page. Regulation FD requires companies to distribute material information in a manner reasonably designed to get that information out to the general public broadly and non-exclusively. It was designed to curtail preferential early access to information by institutions and other well-connected industry heavyweights. 

Netflix, as you may have heard, runs a service providing subscribers with online access to television programs and movies. In July of 2012, Netflix CEO Reed Hastings announced on his personal Facebook page that Netflix’s monthly online viewing had exceeded one billion hours for the first time. Netflix did not report this information to investors through a press release or Form 8-K filing, and a subsequent company press release later that day did not include this information either. The SEC claimed that neither Hastings nor Netflix had previously used his Facebook page to announce company financial information, and they had never before told investors that information about Netflix would be disseminated in Hastings’ personal Facebook page. The Facebook disclosure was nonetheless picked up by investors, and boosted the Netflix share price. 

In responding to the SEC investigation, Hastings contended that since his Facebook page was available to over 200,000 of his followers, he was in compliance with Regulation FD. The SEC ultimately refrained from bringing an enforcement action against Hastings or Netflix, stating in a press release that the rules around using social media for company disclosures had been unclear. 

Now the SEC has concluded that companies can comply with Regulation FD by using social media and other emerging means of communication, much the same way they can by making disclosures in their websites. The SEC had previously issued guidance in 2008, clarifying that websites can serve as an effective means for disseminating information to investors if they’ve been told to look there. The same caveat now applies to the use of social media. 

The SEC’s guidance brings corporate reporting into the social media age, where over one billion users of Facebook and 250 million on Twitter are sharing information. Indeed, a recent study suggests that while over 60% of companies will interact with customers using social media, very few use the medium to communicate business developments to investors. That could well be about to change dramatically.

Supreme Court Holds that “Pay-To-Delay” Deals Can Violate Antitrust Laws

ATTORNEY: ADAM G. KURTZ
POMERANTZ MONITOR, JULY/AUGUST 2013 

Last fall, we wrote about how brand name drug manufacturers have been paying large amounts of money to generic drug makers to induce them to delay bringing low-cost generic drugs to market. For years prior to this recent U.S. Supreme Court decision, many federal courts have refused to declare these pay-to-delay payments anti-competitive, or even subject them to the antitrust laws. 

On June 17, 2013, in a case involving the testosterone supplement Androgel, the U.S. Supreme Court handed healthcare consumers and union health and welfare funds a victory. Androgel, a treatment for low testosterone, had sales of $1 billion a year. It has no competition from generic alternatives. If there were generic competition, sales of the branded version would probably drop by 75% and its manufacturer, Solvay, would lose approximately $125 million in profits a year. To postpone generic competition, Solvay paid the generic company, Actavis, as much as $42 million a year to delay their competing generic version of Androgel until 2015. 

The Supreme Court ruled, 5-3, that such pay-to-delay deals are, in fact, subject to the antitrust laws. This is truly a big win, given the amount of healthcare costs involved. There were 40 such deals this past year alone, and they cost American consumers $3.5 billion a year in higher drug costs. The Androgel decision may not end pay-for-delay deals, but they will now be subject to the antitrust scrutiny. 

The legal arguments addressed by the Supreme Court were complicated and involved a clash between the antitrust and patent laws. On the one hand, the antitrust laws state that two competing companies cannot agree that one of them will stay out of the market. That is, the branded and generic company cannot agree to keep drug prices high by delaying introduction of a generic drug into the market. 

On the other hand, the patent laws give a company with a valid patent the right to exclude a competitor with a product that violates the patent. That is, a branded company can exclude a generic drug as long as the branded company had a valid patent. Pay-to-delay deals are part of a settlement in a patent infringement lawsuit, brought by the brand name manufacturer, alleging that the generic drug maker is violating the brand name patent. Settlements are generally encouraged as a good thing. 

In the end, the Supreme Court chose antitrust law over patent law and healthcare consumers over pharmaceutical companies in holding that, settlement or not, these deals can be struck down if they violate the antitrust laws. 

For years, Pomerantz – on behalf of health care consumers – and the Federal Trade Commission (“FTC”) have been fighting against pay-to-delay deals, arguing that they are anti-competitive and violate the antitrust laws. In fact, Pomerantz is co-lead counsel, on behalf of a putative end-payor class, in the companion case to the recently decided U.S. Supreme Court case, which is currently pending in the Northern District of Georgia. Now that the Supreme Court has agreed that pay-to-delay deals are not immune from the antitrust laws, Pomerantz will continue to represent vigorously our union health and welfare fund clients who end up paying unlawful supra-competitive prices for branded drugs as a result of these deals.

Appeals Court Grants Bail to Two Convicted of Insider Trading

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, JULY/AUGUST 2013 

Although it has had mixed results, at best, in cases related to the financial crisis of 2008, the government has done quite well in pursuing claims of criminal insider trading. For example, the U.S. Attorney in Manhattan has filed criminal charges against 81 defendants since he took office in 2009, and convicted 73 of them. Among them is former Galleon hedge fund boss Raj Rajaratnam, whose conviction and lengthy sentence were upheld by the Second Circuit in June. 

Insider trading may sound simple, but it isn’t. The federal courts have been struggling for decades to decide what inside information is, who may trade on it, and who can’t. If an investor or analyst calls someone up to ask how his company is doing, that can be legitimate information gathering, or it can be a violation. It all depends. 

One well-established element of an insider trading violation is that the tippee must know that the information is being disclosed in violation of the insider’s fiduciary duty. In one famous case, for example, someone disclosed that the company had received a takeover offer that had not yet been publicly disclosed. That kind of information is vital to the company; people working for the company cannot divulge it without breaching their fiduciary duties.

More recently, though, courts have been struggling with the question of whether the tippee also has to know that the person disclosing the information (the “tipper”) is receiving a “personal benefit” for disclosing it. If the tippee does know this, the Supreme Court held 30 years ago that he is liable; but the question now is, does the tippee have to know this in order to be liable? If the tippee is not paying for this information, he or she may not be aware that the tipper will benefit from the disclosure in some other way. 

This issue is coming to a head in a case now pending in the Second Circuit, which is hearing an appeal of an insider trading conviction involving two hedge fund managers. They did not pay for the information, and maintain that they did not know that the insiders were profiting from their disclosures in other ways. The trial court did not believe that this was a required element of the crime, and refused to instruct the jury on it. Defendants appealed on that issue. Defendants asked that they be granted bail pending their appeal. The trial court denied it, but the defendants appealed that decision as well. 

In late June, the Second Circuit granted their bail request. This has sent tongues wagging, because it may mean that the court is about to overturn the convictions and impose a “personal benefit” knowledge requirement for insider trading claims. 

This is happening just as the government is zeroing in on the biggest fish in the insider trading pond, Steve Cohen of SAC Capital Advisors. Several of his underlings have already pleaded guilty to insider trading charges, and SAC recently paid more than $600 million in a “no admit, no deny” settlement of insider trading charges with the SEC. Yet somehow, Cohen authorized this hefty settlement without obtaining an agreement from the feds that they would not seek additional punishments or remedies against either himself or the company. 

Perhaps he thought that, because it may be next to impossible for the feds to prove beyond a reasonable doubt that he had personal knowledge of the tippers’ motivation for revealing insider information, the would not pursue criminal charges against him. In this respect he is probably right. With the five year statute of limitations bearing down, the feds have reportedly given up on the idea of prosecuting Cohen on criminal charges. 

But he is not exactly getting a free pass. On July 19 the SEC brought an administrative action against him, seeking to bar him from the securities industry for life. The complaint alleges that Cohen ignored “red flags” of illegal insider trading by employees and allowed it to go on, violating his duty to supervise. 

And then, just before our press time, the feds announced that SAC Capital has been indicted. When and if that happens, it is all over. On Wall Street, an indictment is a death sentence.

SEC Weighs Companies' Disclosures of Their Political Expenditures

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

In the wake of the Supreme Court’s decision in Citizens United, a gusher of so-called “independent” spending by private groups and organizations flooded into the last election cycle, with much of it coming from corporations. 

In its decision, the Court assumed that any adverse effects of corporate or union cash entering politics could be ameliorated by public disclosure of where the money came from; and in August of 2011, a petition signed by two law professors was submitted to the SEC, asking it to adopt a rule requiring such disclosures. 

The petition has been publicly supported by the AFL-CIO; Public Citizens; the Corporate Reform Coalition, and some Democratic members of Congress. It has generated over half a million comments, the most the SEC has ever received on any proposed rule, and most of them reportedly want the SEC to act. 

But opponents are pushing back. Republicans have lined up against it, to the point of submitting a House bill seeking to prevent the SEC from adopting any disclosure rule. 

So far, the two SEC commissioners appointed by Democrats have come out publicly in support of such a rule, and the two appointed by Republicans have come out against. Mary Joe White, recently confirmed as the new SEC Chairman, has not yet taken a public position. Although the issue was on the Commission’s April agenda, no decision had been made as of Monitor press time. 

The business community, by and large, wants no part of such a rule, fearing that disclosure might provoke a backlash from interest groups, customers, shareholders, or even from the politicians they are targeting. Another possible motivation is the desire to disguise the underlying agendas of those advancing particular political positions. Voters are likely to react differently to an ad that ostensibly comes from an independent group they never heard of, rather than from a group that they know is heavily financed by corporate interests with a particular axe to grind. 

It might be in a company’s interest for its involvement in political activities to remain hidden, but the public at large may have an even greater interest in knowing who is really responsible for the political speech to which they are being subjected. Perhaps the Federal Election Commission would, in theory, be the more logical place to hash this out. But that agency is moribund, permanently paralyzed by partisan gridlock. 

Currently, companies don’t have to disclose their political expenditures unless the amounts involved are “material.” But in this context, “materiality” is in the eye of the beholder. Even if the amount contributed is not that significant compared to a corporation’s overall expenditures, it could be considered important by many investors depending on what candidate, or what issue, is being targeted. Moreover, amounts that are immaterial to a giant company like Apple or Exxon might have a huge impact in a political campaign. As huge as political expenditures have become by historical standards, they are still dwarfed by the amounts spent by businesses for other things. 

Typically, corporations make political expenditures by contributing to advocacy groups. The petitioners to the SEC estimate that about $1.5 billion in corporate cash has been funneled through such groups over the last five years. Some groups, such as political action committees, are required to disclose their contributors; but others, such as so-called 501(c)(4) groups, don’t. Increasingly, that is where the corporate cash is going: these groups spent hundreds of millions of dollars in the last election cycle, without disclosing where any of it came from. 

If the SEC staff proposes a rule, yet another political donnybrook is certain to follow, after which will be the inevitable court case. The Court of Appeals for D.C., which reviews challenges to agency rules, has become increasingly aggressive in blocking agency rules it doesn’t like, often demanding “cost benefit” analyses. 

We should hear something any day now. 

Reportedly, most of the candidates and issues promoted by the heaviest “independent” expenditures did not do well last time around. But there is no guaranty that secret money won’t swing elections sooner or later.

Private Equity Firms Fail to Get Antitrust Case Dismissed

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

Five years ago, investors sued 11 of the world’s largest private equity firms, including Kohlberg Kravis, TPG, Bain Capital, Apollo Capital Management and Goldman Sachs, on the grounds that defendants violated the antitrust laws by rigging the market for more than two dozen multibillion-dollar acquisitions of public companies, depriving those companies’ shareholders of billions of dollars they might have received in a true competitive bidding process. They claim that defendants had a gentlemen’s agreement not to outbid each other to acquire these companies. Defendants had tried nearly a dozen times in four years to get the suit tossed, with no luck. 

They were only partially successful this time. A federal judge in Boston has now refused to grant summary judgment dismissing the entire action. He narrowed the case significantly, however, dismissing all claims relating to 19 of the 27 deals that were targeted in the actions; and he dismissed JPMorgan Chase completely from the case. Nevertheless, he concluded that there was enough evidence of at least some collusion on eight of the deals among the rest of the defendants to take the case to trial. 

At the center of the case are “club deals,” acquisitions made by members of this “club” of private equity firms. Plaintiffs allege that there was a secret quid pro quo arrangement: If you don’t bid on my deal, I won’t bid on yours. 

In his summary judgment decision, Judge Harrington concluded that there was no grand conspiracy across all the 27 deals, but rather “a kaleidoscope of interactions among an ever-rotating, overlapping cast of defendants as they reacted to the spontaneous events of the market.” Yet he decided that there was enough evidence to sustain claims relating to 8 of the deals. 

As happens so often in litigation in the internet era, emails played a decisive role in this decision. Among them were comments from unnamed executives at Goldman Sachs and TPG in reference to the $17.6 billion takeover of Freescale Semiconductor by a consortium led by the Blackstone Group and the Carlyle Group. The Goldman executive said that no one sought to outbid the winning group because “club etiquette” prevailed. “The term ‘club etiquette’ denotes an accepted code of conduct between the defendants,” the judge wrote. “The court holds that this evidence tends to exclude the possibility of independent action.” 

Another email, from a TPG official said, “No one in private equity ever jumps an announced deal.” The judge also pointed to an e-mail sent by the president of Blackstone to his colleagues just after the Freescale deal was announced. “Henry Kravis [the co-founder of K.K.R .] just called to say congratulations and that they were standing down because he had told me before they would not jump a signed deal of ours.” 

The court singled out the $32.1 billion buyout of the hospital chain HCA as particularly problematic. K.K.R. expressly asked its competitors to “step down on HCA” and not bid for the company, according to an e-mail written by a then partner at Carlyle who is now the CEO of General Motors. One e-mail from Neil Simpkins of Blackstone Group to colleague Joseph Baratta said, “The reason we didn’t go forward [with a rival HCA bid] was basically a decision on not jumping someone else’s deal.” Baratta said, “I think the deal represents good value and it is a shame we let KKR get away with highway robbery, but understand decision.” 

KKR’s $1.2 billion investment in HCA has nearly doubled in value to $2 billion in four years.

Doing Well While Doing Good in Delaware

ATTORNEY: GUSTAVO F. BRUCKNER
POMERANTZ MONITOR, MAY/JUNE 2013 

On April 18, 2013, Delaware Governor Jack Markell introduced legislation enabling the formation of public benefit corporations. Because Delaware is already the legal home of more than one million businesses, including many of the nation’s largest publicly traded corporations, this legislation, if adopted, has the potential to radically transform the corporate landscape. 

Public benefit corporations are socially conscious for-profit corporations. While not new, until recently most public benefit corporations were established by government, not the private sector. Social entrepreneurs, a growing sector of the economy, argue that the current system, with corporations focusing only on profits, almost assures a negative outcome for society. They have been pushing the corporate focus towards pursuit of a “triple bottom line” of people, planet and profits, with the mantra “doing well while doing good.” Shareholders who value socially responsibility seek to invest in companies that are serious about sustainability, and such companies want to differentiate themselves from competitors. While it may come as no surprise that California and Vermont allow for creation of public benefit corporations, so do Illinois, New York, and South Carolina. 

Some states have “constituency statutes” that explicitly allow corporate directors and officers to consider interests other than those strictly related to maximizing value for shareholders, including the interests of the community. Nearly a third of constituency statutes apply only in the takeover context, allowing directors to consider interests of employees, for example, in deciding how to respond to a takeover offer. On the other hand, directors of a public benefit corporation have an affirmative obligation to promote a specified public benefit. 

The proposed legislation identifies a public benefit as a positive effect, or a reduction of negative effects, on people, entities, communities or other non-stockholder interests. Such effects could include, but are not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, and scientific or technological nature. 

Directors of a public benefit corporation would have to balance the financial interests of stockholders with the best interests of those affected by the corporation’s conduct, as well as the specific public benefits identified by the corporation. 

If enacted, the legislation will take effect on August 1, 2013.

Court Hears Argument in BP Case

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

As we have previously discussed in these pages, Pomerantz is currently representing several U.S. and foreign institutional investors seeking to recover investment losses caused by BP’s fraudulent statements issued prior to, and after, the April 20, 2010 Deepwater Horizon oil spill. Although the Supreme Court’s decision in Morrison v. National Australia Bank, Ltd. prevents investors from pursuing federal securities fraud claims for their BP common stock losses (because those shares traded on the London Stock Exchange), we are arguing that Texas state common law fills this enforcement void. 

On May 10, 2013, Judge Keith Ellison of the United States District Court for the Southern District of Texas held oral argument on BP’s motion to dismiss our claims. 

As we expected, much of the argument focused on the Dormant Commerce Clause, a Supreme Court doctrine which says that state statutes or regulations may not “clearly discriminates against interstate commerce in favor of intrastate commerce”; “impose a burden on interstate commerce incommensurate with the local benefits secured;” or “have the practical effect of ‘extraterritorial’ control of commerce occurring entirely outside the boundaries of the state in question.” BP argued that this doctrine prevented Texas state common law from reaching BP’s misconduct. In response, we pointed out that the doctrine did not apply to common law claims and that those claims targeted BP’s misstatements, not the underlying securities transactions on the London Stock Exchange. We also advanced a variety of policy-based arguments in support of our position. 

Although it is impossible to predict how the Court will come out on this issue, we believe that the oral argument advanced our cause. We expect the Court to issue a decision on the motion in the next few months.

Walking Dead Directors

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

Did you know that forty-one directors who last year failed to receive the votes of 50% of the shareholders, are still serving as directors? At Cablevision, for example, three directors are still sitting there even though they lost shareholder elections twice in the past three years, and were renominated in 2013. Two directors of Chesapeake Energy in Oklahoma, V. Burns Hargis, president of Oklahoma State University, and Richard K. Davidson, the former chief executive of Union Pacific, were opposed by more than 70 percent of the shareholders in 2012. Chesapeake requires directors receiving less than majority support to tender their resignations, which they did. The company said it would “review the resignations in due course.” The company refused to accept one of the resignations but, mercifully, they both left. Other cases where this has occurred, according to Institutional Shareholder Services, include Loral Space and Communications, Mentor Graphics, Boston Beer Company and Vornado Realty Trust. 

Our favorite story, though, involves Iris International, a medical diagnostics company based in Chatsworth, Calif. There, shareholders rejected all nine directors in May 2011. They all submitted their resignations, but then voted not to accept their own resignations. The nine stayed on the board until the company was acquired the following year. 

Many of these cases involve companies that do not require directors to receive a 50% majority vote to win election to the board.

Delaware Takes On “Don’t Ask, Don’t Waive” Provisions

ATTORNEY: OFER GANOT
POMERANTZ MONITOR, MARCH/APRIL 2013 

In a previous issue of the Monitor, we discussed the relatively new concept in mergers and acquisitions of “don’t ask, don’t waive” provisions in standstill agreements between companies and potential acquirers. Under the law of Delaware and other states, the acceptance of a merger proposal by the target does not end the bidding process: directors must be free to consider better proposals that may come in after the merger agreement is signed, but before it is approved by shareholders. Bidders try to limit this risk by demanding “no solicitation” provisions in the merger agreement, preventing the target company from actively soliciting “topping” bids. 

However, coupling the no solicitation provisions with the don’t ask, don’t waive provisions essentially locks up the deal from all angles. Don’t ask, don’t waive provisions, set in advance of the actual bidding process, prevent bidders from increasing their bid for the target company – unless specifically invited to do so by the target’s board of directors – and from asking the target board to waive the prohibition. If losing bidders can’t make a topping bid for the target, nor ask its board to allow them to do so, and if the target can’t solicit or even consider post-merger-agreement bids, the deal is effectively locked up once the merger agreement is signed. In such a case, even if the merger agreement provides a grossly inadequate price, a court will be reluctant to enjoin its consummation for fear of killing the only offer that is actually on the table. 

Although in don’t ask, don’t waive situations the target can still consider unsolicited bids from bidders that were not part of the original bidding process and therefore never signed such standstill agreements, that doesn’t happen often. As we noted in our previous article, in the Delaware Court of Chancery’s recent ruling in the Celera Corporation litigation, Vice Chancellor Parson cast doubt on the legality of the combination of no solicitation and don’t ask, don’t waive provisions. “Taken together,” he said, these devices “are more problematic,” and that “[p]laintiffs have at least a colorable argument that these constraints collectively operate to ensure an informational vacuum” as to the best price reasonably available for the company, and that “[c]ontracting into such a state conceivably could constitute a breach of fiduciary duty.” 

In two more recent decisions, the Delaware Court of Chancery revisited this issue and reached different conclusions. In Complete Genomics, Vice Chancellor Laster echoed Judge Parsons, explaining that “by agreeing to this [“don’t ask, don’t waive”] provision, the Genomics board impermissibly limited its ongoing statutory and fiduciary obligations to properly evaluate a competing offer, disclose material information and make a meaningful merger recommendation to its stockholders.” The Court then enjoined the merger pending certain corrective disclosures and prevented the company from enforcing the standstill agreement with a certain bidder that contained this “don't ask, don't waive” provision, allowing it, if it chooses to do so, to make a topping bid. 

Three weeks later, in Ancestry.com, Chancellor Strine expressed a different view, holding that “don't ask, don't waive” provisions may actually be consistent with directors’ fiduciary duties to maximize shareholder value. Chancellor Strine stated that he was not “prepared to rule out that [the “don't ask, don't waive” provisions] can't be used for value-maximizing purposes” as long as the purpose allows the “well-motivated seller to use it as a gavel” as part of a meaningful sale process. According to the Court, if the “don’t ask, don’t waive” provisions are assigned to the winner of an auction process, allowing the winner to decide whether to let the losing bidders make a topping bid (highly unlikely), rather than left in the hands of target’s board, the Court was “willing to indulge that could be a way to make it as real an auction as you can.” 

If, on the other hand, the target’s board has the power to waive these provisions, and chooses not to waive them after signing a merger agreement with a buyer, there is “no reason to give any bid-raising credit” to this mechanism, “it has to be used with great care,” and the board has to disclose to its shareholders the fact that it continues to preclude certain potential bidders from making a superior bid for the company. Chancellor Strine cautioned board members employing don't ask, don't waive provisions to remain informed about the provisions’ potency, suggesting that a “nanosecond” after a definitive acquisition agreement was signed, he would have notified all parties subject to the provisions that they are waived, allowing them to make a superior offer. 

The court ultimately enjoined the deal at issue because the board did not disclose that certain bidders were foreclosed by a “don't ask, don't waive” provision, emphasizing that shareholders must be made aware of these provisions' effect if the provisions are to be used. 

The facts in Ancestry.com differed from those in Complete Genome, among other things, because the “don’t ask, don’t waive” provisions were already waived by the time Chancellor Strine had to rule on the issue. Would he, too, have enjoined such standstill agreements following the announcement of a merger -- as was the case in Complete Genome? That remains to be seen.