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Despite COVID-19, corporate law marches on

Many of us, practicing at home while walking the dog and driving the kids, likely are impressed with the constant flow of court decisions notwithstanding obvious present difficulties. We are in the midst of a busy litigation season for corporate law.

Tell the truth

Class actions on behalf of shareholders compensate investors for lost share value caused by corporate failure to tell the truth. That which constitutes the truth is situational.

honig-stephenWe are in the midst of a busy litigation season for corporate law.

In July, the 2nd U.S. Circuit Court of Appeals reinstated an action against NewLink Genetics Corp. alleging material misstatement about a drug undergoing clinical trial. It is understood that opinion or mere “puffery” cannot be bases for legal liability, but the court here held that misstatements may in fact occur in expression of opinion, depending on context.

In Newlink, the stock price crashed upon disclosure that the company’s drug failed a clinical trial, when the company had previously stated that the survival rate for patients taking the candidate drug was higher than the average survival rate for the untreated general population.

The company stated as a fact (not opinion) that the untreated survival rate historically was 24.1 years based on public studies by third parties and that, further, the survival rate in Phase 3 trials of the company’s candidate drug would also be about 24 months. In stating the historical and expected survival rate against which the survival rate would be tested, the company failed to disclose that there were also major public studies that found the historical survival rate might well be higher, at least 25 months and as high as 43 months.

The company’s misstatement was based upon the quite possible understatement of the historical survival rate against which the company’s new drug was to be tested.

Further, the company statements were made at a conference for investors, not off-the-cuff, and thus should be presumed to be intended by the company to be taken as fact.

While no doubt the company defense was weakened by the unfortunate result that the control group actually out-survived patients being treated, the court took into account not only the nature of the statements but also their context and frequency.

Also in July, Signet Jewelers (parent of Kay and Jared) in New York settled its class action defense against misstatements about its harassment policy with the payment of $240 million (lawyers will get 25 percent).

Interestingly, the allegedly false representation, causing a decline in stock price, was contained within the company’s code of conduct and ethics; that code promised freedom from sexual harassment, a freedom allegedly not achieved.

The company had defined its code as a “textbook example of ‘puffery,’” citing authority in the 2nd Circuit that codes were not actionable. Since, in Signet’s case, these statements of policy appeared in context as factual and not aspirational, and were made in response to previous litigation concerning prior harassment, the court certified the class action, determining that a reasonable investor would take defendant’s code statement as fact.

The learning of this case is obvious: Codes often are drafted by non-lawyers and should be reviewed by counsel (given changing mores, likely periodically).

Finally, Apple has been defending claims that CEO Tim Cook misstated to analysts by minimizing the impact of the trade war with China on iPhone demand. The judge, in permitting that case to move forward, found it implausible that Cook would not have known that iPhone demand in China would fall, based in part on common knowledge.

The decision turns in part on the obviousness of the omitted warning made to sophisticated securities analysts. Unanswered is the degree to which this experienced cadre of listeners was reasonable in believing what they were being told. If it was patently obvious to Cook (as determined by the court), how did it escape the understanding of these analysts?

Business judgment rule

The business judgment rule creates an irrefutable presumption that directors cannot be attacked for their decisions, provided those decisions are reached on a level playing field.

Delaware courts, solicitous of directors of myriad corporations formed in that state, have been staunch supporters of that rule, upsetting it only in cases of self-interest or lack of appropriate board process.

Given this context, the June decision in Dell Technologies deserves analysis. In that case, Chancery imposed the higher review standard of “entire fairness” to board actions in a company stock redemption that cemented ownership in the founder.

Michael Dell held control of the company. Given that control, did the board approve the merger properly? Perhaps not, although the board committee and the minority stockholders both had voted approval. The court held that the case can continue, based on the following:

  • the board committee reviewing the deal was overly loyal to the company’s control person, Dell, and could not be deemed independent;
  • the board committee permitted direct negotiation between redeemed stockholders and the company, taking no active role and merely rubber-stamping the deal;
  • the expressed threat, that if this deal were not approved then the transaction could nonetheless be achieved in a different format, constituted possible coercion of the committee and the stockholders;
  • although the stockholders in fact got better terms than the committee, better does not necessarily mean “fair,” as the committee might have done better if not coerced;
  • outside advice to the board committee was either not independent or not competent.

The court held that, at the pleading stage, plaintiffs are entitled to the benefit of every inference drawn from alleged facts, which are assumed to be true.

One practice tip when constituting a board committee to review a transaction: that committee is best conceived if it can not only decline the proposed transaction as structured, but also decline the transaction if achievable by a different corporate method.

Social issues

In July, two California courts took notice of broad societal trends impacting corporate practice.

Oracle, based in California, was sued derivatively for misleading investors by claiming the company was committed to diversity while in fact having no Black directors or top managers.

These facts allegedly constitute breach of board fiduciary duty owed stockholders, citing a Department of Labor lawsuit (relating to meeting federal contract requirements) that claimed lack of minority employment.

Relief demanded includes a $700 million fund for hiring and promoting minorities, training of executives, and goals for hiring.

Current filings disclose that Oracle has four women on its board of 14, although note that a California statute requires local public companies with large boards have at least three female members at the end of 2021. The statute does not speak to any discrimination other than as to females.

Another, unusual expression of social values comes from the California federal bench, where a judge was asked to approve counsel for class claimants in a bankruptcy. While conceding that the two proposed law firms were experienced and competent, thereby allaying concerns as to adequacy of representation, the judge asked for inclusion of less experienced counsel, more able to represent the “diversity of the proposed national class … .” How the court was to determine the diversity of class claimants is unclear, although one might draw an acceptable inference from general demographics.

The case itself is fascinating, claiming customers could not access their stock trading accounts on March 2, 2020, a day of incredible volatility on which the Dow set a then-record increase of 1,294 points.

The SEC

The Supreme Court this term decided 8-1 that the SEC has the power to demand disgorgement of gains obtained in violation of securities laws.

Defendant Charlies Liu claimed that the SEC recovered funds that it could not prove were earned by illicit means. In confirming the SEC’s disgorgement power, a series of articulated limits on calculations were established, including offset of costs incurred by the defendant, creating fodder for detailed contention in the lower courts.

Finally, the SEC at the end of July dove into another longstanding battle by enacting rules limiting the operation of proxy advisory firms such as ISS and Glass Lewis, which provide institutional investors proxy voting advice on matters coming before public company directors.

Long the bane of companies when they criticize management actions and urge negative votes for management’s slate of directors, these firms are often relied on by clients that hold (as a class of investors) an estimated 72 percent of public U.S. equities, as well as by brokers voting shares owned by retail customers.

Aside from imposing requirements to disclose conflicts of interest, new rules require that proxy firms give companies a copy of their advice in enough time for the companies to provide rebuttal.

Brokers voting retail shares, beginning in December 2021, must comply with mandatory guidance reminding them of their fiduciary duty to gain all facts.

Finally, new rules codify SEC practice treating proxy advice as a solicitation as to which the anti-fraud rules apply, a contention already under litigation by ISS.

Putting aside whether these firms are overbearing (they accept speaking engagements such as from the National Association of Corporate Directors here in New England in an effort to explain their positions), the SEC has thus complicated the impact of these services to the delight of the business community. Investor advocates claim these changes impair the independence of the advisory firms upon which investors rightfully rely.

The regulatory actions affecting proxy advisors were taken by vote of the Republican-named majority of SEC commissioners, over the objection of the sole sitting Democratic member who stated that there was no evidence of proxy advisory inaccuracy nor of investor dissatisfaction.

As the Republican business agenda is to deregulate as much as possible, the imposition of these new rules, relating to the hither-to unregulated proxy advisory industry, seems anomalous.

Stephen M. Honig practices at Duane Morris in Boston. Associate Craig Shepard assisted with the above article.

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