WHEN SHAREHOLDERS REVOLT . . .
Association of Corporate Counsel
Austin Chapter
October 31, 2012
David D. Sterling
© 2012
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