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WHEN SHAREHOLDERS REVOLT . . .

WHEN SHAREHOLDERS REVOLT . . . Association of Corporate Counsel Austin Chapter October 31, 2012 David D. Sterling. UNHAPPY SHAREHOLDERS ORDINARILY COME IN ONE OF THREE FLAVORS. 1. INSTITUTIONAL INVESTORS (FREQUENTLY ACTIVISTS) 2. GADFLIES

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WHEN SHAREHOLDERS REVOLT . . .

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

  2. 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

  3. 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

  4. SECURITIES CLASS ACTIONS • Section 10(b) and Rule 10b-5 • Section 11 • State Blue Sky laws

  5. 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

  6. 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.

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. "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

  18. 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

  19. SLC ISSUES • Independence - committee, counsel, advisors • Full authority • Judicial right to second guess?

  20. 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

  21. 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

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