© 2012

WHEN SHAREHOLDERS REVOLT . . .

Association of Corporate CounselAustin ChapterOctober 31, 2012

David D. Sterling

UNHAPPY SHAREHOLDERS ORDINARILY COME IN ONE OF THREE FLAVORS

1. INSTITUTIONAL INVESTORS (FREQUENTLY ACTIVISTS)

2. GADFLIES

3. FRONTS FOR LAW FIRMS THAT SPECIALIZE IN REPRESENTING SHAREHOLDERS

GENERALLY SPEAKING, SHAREHOLDERS MAY BRING FOUR DIFFERENT TYPES OF CASES

1. Securities class actions seeking damages

2. Derivative suits

3. Breach of fiduciary duty class actions

4. Proxy claims

SECURITIES CLASS ACTIONS

Section 10(b) and Rule 10b-5

Section 11

State Blue Sky laws

ELEMENTS OF A 10b-5 CLAIM

A material misrepresentation or omission

Made with scienter

In connection with a purchase or sale of securities

Reliance

Loss causation

Damages

WHAT IS "MATERIAL" ?

In order for a misrepresentation or omission to be material, it must be such that a reasonable investor would consider it important in the context of the overall mix of information in deciding whether to buy or sell.

WHAT IS "SCIENTER" ?

A state of mind somewhat akin to an intent to deceive

• Most courts say "severe recklessness" suffices

• Far beyond simple negligence

• Key scienter issues:

"Motive and opportunity" - - insider trading, company issuing stock as currency, etc. . . . important but not dispositive

Absent motive, standard for circumstantial proof higher - - usually particularized allegations of specific contemporaneous reports contradicting the company's public disclosures

HOW DO SHAREHOLDERS SHOW "RELIANCE"?

Individual, subjective reliance often impossible, and certainly not amenable to class treatment

In 1988, Supreme Court adopted the "fraud on the market" presumption of reliance, relying largely on the efficient market hypothesis

Easy to allege, not so easy (or cheap) to prove

WHAT IS "LOSS CAUSATION"?

It is not enough for shareholders to allege that they bought stock at an inflated price

Must also allege that they sold after the truth was in some way revealed

PROCEDURAL HURDLES TO A 10b-5 CLAIM

PSLRA precludes discovery until court rules on motion to dismiss

Ordinary plaintiff-friendly rules and conventions on deciding 12(b)(6) motions generally supplanted by PSLRA's special pleading rules

Class certification requirements also tightened through amendments to FRCP 23

Favorable case law

PRACTICAL CONSIDERATIONS FOR 10b-5 CASES

D&O coverage

Disclosure implications

2-year statute of limitations, 5-year statute of repose

Unique timeline going forward

LAW OF UNINTENDED CONSEQUENCES

State court attempts to circumvent federal law - Blue Sky laws and common law

Largely swatted down by SLUSA

Plaintiffs' firms shift their focus

SECTION 11 CLAIMS

Keyed to false or misleading prospectus

Very different (and easier) standards than 10b-5

Essentially a strict liability provision

Directors, underwriters, experts all potentially on the hook unless they can establish due diligence defense

1-year statute of limitations, 3-year statute of repose

DERIVATIVE SUITS

Suits by a shareholder on behalf of the company• Any recovery goes to the company

So what's in it for the shareholder?

Almost always against directors (and sometimes officers) for allegedly breaching fiduciary duties

DERIVATIVE SUITS: GENERALLY TWO FLAVORS

1. Challenging a board decision or action• Related party transactions• Executive compensation• Mergers

2. Challenging board inaction ("Caremark claims")• FCPA issues• Catastrophic events• Regulatory fines• Copycatting 10b-5 suits

SPECIAL PLEADING REQUIREMENTS FOR A DERVIATIVE SUIT

Deciding to instigate litigation on behalf of a company is typically within the province of the board

Two paths around this:

1. Make demand, then allege demand was unreasonably denied

Very high hurdles Texas caveat

2. Allege particularized facts demonstrating that at least half of the board could not independently consider demand

"INDEPENDENCE" FACTORS IN THE DERIVATIVE CONTEXT

Being on both sides of a transaction = Not independent Being dominated or controlled by someone who is on

both sides of a transaction = Not independent Receiving some material benefit not shared by

shareholders generally = Not independent Approving the challenged transaction, being named

as a defendant ≠ Not independent Allegations must show "a substantial threat of personal

liability" Exculpatory provisions

PRACTICAL CONSIDERATIONS FOR A DERIVATIVE SUIT

Standing requirements Venue issues D&O issues What to do if your motion to dismiss is denied, or

if you don't think you can win on a motion to dismiss - the SLC

Books + records demands under DGCL § 220 Statute of limitations depends on law of state of

incorporation

SLC ISSUES

Independence - committee, counsel, advisors

Full authority

Judicial right to second guess?

BREACH OF FIDUCIARY DUTY CLASS ACTIONS

Typically in the M+A context

The "3 Ps"

Venue issues

Timing considerations

D+O issues

Two Texas caveats

PROXY CLAIMS

Institutional investor v. Gadfly v. Fronts

Materiality standard

Post-vote claim requires vote to have been "an essential link" in the transaction

PSLRA applies if damages sought