Pomerantz LLP

March/April 2013

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

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.

Second Circuit Hears Appeal of Citigroup Settlement Rejection

Pomerantz Monitor, March/April 2013 

In a decision heard around the world – or at least around Wall Street – in December of 2011, Federal District Judge Jed S. Rakoff famously rejected a settlement between the SEC and Citigroup. The SEC claims that, during the waning days of the housing bubble, Citi misrepresented facts when it sold investors over $1 billion of risky mortgage bonds that it allegedly knew would decline in value. Investors allegedly lost about $600 million on this deal. The same day the SEC filed its complaint, in October, 2011, it also filed a proposed “consent judgment”, a settlement agreement resolving those claims. The proposed deal called for $160 million in disgorgement (of fees and profits made by Citi on the deal), plus $30 million in interest and a civil penalty of $95 million. The settlement agreement did not require Citi to admit to any wrongdoing, allowing it to “neither admit nor deny” the charges, a staple provision of government settlement agreements. In addition to the financial penalties, the settlement would permanently restrain and enjoin Citigroup from future securities laws violations and would impose court-supervised “internal measures” designed to prevent recurrence of the type of securities fraud that (allegedly) occurred here. 

In deciding whether to approve a settlement between agencies and private parties, courts typically defer to the judgment of a federal agency, and rejections of settlements are rare. But Judge Rakoff is an exception to this rule: he is no rubber stamp for SEC settlements, and has used settlements to express his disdain for the SEC’s efforts to police the securities industry. Two years earlier, in 2009, he rejected a settlement between the SEC and Bank of America. 

In his decision in the Citi case, announced on November 28, 2011, Judge Rakoff did it again. He did not accept the “no admit, no deny” provision, and held that the settlement failed to provide the court with enough facts relating to the merits of the case “upon which to exercise even a modest degree of independent judgment.” He also noted that “there is an overriding public interest in knowing the truth,” and the reminded the SEC that it “has a duty ... to see that the truth emerges.” These comments leave the distinct impression that the judge was looking for a more or less definitive resolution of the allegations against Citi, as a price of a settlement. The opinion also rejected the $285 million in financial penalties, deriding it as mere “pocket change” for a bank Citi’s size, a penalty that would not deter future misconduct. 

The ruling has roiled the securities bar, to say the least. Any across-the-board requirement that defendants admit wrongdoing, or that the “truth” be established in order to settle a case, would make many cases almost impossible to settle. Such admissions or determinations could then be used by investors to recover even more in private lawsuits. Some have argued that, forced to try almost every case, federal agencies would be overwhelmed and the wheels of justice would come to a grinding halt. 

Others (the author included) have viewed the ruling as a long-overdue comeuppance to an agency that has not done enough to punish the miscreants who precipitated the financial crisis. The penalties imposed by the settlement would have no chance at all of reining in Citi’s bad behavior. 

Both the SEC and Citi appealed Judge Rakoff’s ruling to the Second Circuit. In his October 2011 ruling, Judge Rakoff had directed the parties to be ready for trial on July 16, 2012. On December 27, 2011, the SEC, joined by Citigroup, asked him to stay all proceedings, including the upcoming trial, pending determination of their appeals. When he denied the motions, Citi and the SEC appealed that decision as well; and in March 2012, the Second Circuit not only granted the stay, it expedited the appeals, chiding Judge Rakoff: “The district court believed it was a bad policy, which disserved the public interest, for the S.E.C. to allow Citigroup to settle on terms that did not establish its liability. It is not, however, the proper function of federal courts to dictate policy to executive administrative agencies[.]” 

In August, 2012, at the court’s direction, an attorney for Judge Rakoff filed a brief with the Second Circuit on his behalf, contending that he had never sought definitive proof of wrongdoing or an admission of Citigroup’s “liability” (as the court of appeals put it) but simply wanted to see some evidence before rendering a decision on a proposed settlement allegedly backed up by that same evidence. 

On February 8, 2013, the Second Circuit heard final argument on the merits, and comments from the judges seemed to confirm the impression that the Court intends to approve the settlement. The SEC – clearly emboldened by the first ruling in its favor – characterized the lower court’s ruling as being at odds with a century of judicial practice. Federal agencies’ decisions to settle cases, the SEC said, have historically been entitled to – and received – great deference. Citigroup agreed, arguing that, with respect to federal agencies, “the scope of a court’s authority to second-guess an agency’s discretionary and policy-based decision to settle is at best minimal.” At one point Judge Raymond Lohier “asked about deference and why an Article III judge would question the judgment of an executive agency that presumably reached its decision based on a sound review of the evidence.” When Judge Rakoff’s lawyer responded that the SEC was entitled to deference – but only to the point that they are wrong – his comment did not go over well. 

This appeal has thus largely turned into a referendum on how much deference a trial court should give to an agency proposing a settlement, and the extent to which the trial court can and should do its own review of the underlying evidence in the case, to test whether the agency has abused its discretion. 

Judge Rakoff’s ruling has spurred some federal judges elsewhere to demand more information before signing off on settlements brokered by the SEC and other government agencies, and even to question whether the “neither admit nor deny” clause is appropriate. And in the wake of Judge Rakoff’s ruling the SEC itself announced that it would no longer allow defendants to “neither admit nor deny” civil fraud or insider trading charges when, at the same time, they admit to or have been convicted of criminal violations. While this policy shift would have no impact on the Citigroup case – which lacked accompanying criminal charges – observers, including Edward Wyatt, writing in The New York Times, immediately noted a connection to Rakoff’s decision, which was then less than two months old. 

While the appeal was pending, Judge Rakoff presided over a jury trial of the agency’s claims against former Citigroup executive Brian Stoker in connection with in the same transaction that sparked the SEC’s initial complaint against Citi. After a full trial on the merits of these claims, the jury cleared Stoker of all wrongdoing. At this point, Judge Rakoff had more than enough information to evaluate the SEC’s settlement with Citigroup. By then, however, the significance of the case had moved well beyond the settlement itself to the role the courts are going to play in evaluating settlements proposed by the SEC and other agencies. 

The one silver lining here should be the existence – and persistence – of a vigorous plaintiff’s bar championing the rights of defrauded investors. Despite roadblocks like the Private Securities Litigation Reform Act of 1995 (devised as a “filter” to “screen out lawsuits”), the private shareholder class action remains investors’ – and the public’s – best hope of curtailing the financial sector’s worst excesses. The Supreme Court’s recent decision in Amgen v. Connecticut Retirement Plans bodes well for the future ability of investors to pool their limited resources to seek results the federally-designated “watchdogs” at the SEC appear either unwilling or unable to attain, a situation not likely to improve through the proposed handcuffing of the very courts meant to mete out justice.

Amgen Decision Favorable for Institutional Investors

Pomerantz Monitor, March/Apri 2013 

In order for a court to certify a case as a class action, it must usually determine that common questions “predominate” over questions that affect only individual class members. In securities fraud actions, plaintiffs must show, among other things, that investor “reliance” on defendants’ misrepresentations can be established on a class-wide basis. Otherwise, individual questions of reliance will “predominate”. 

A quarter century ago, in the landmark decision Basic v. Levinson, the Supreme Court adopted the so-called “fraud on the market” theory to address this problem. According to this theory, if the subject company’s stock trades on an “efficient market” (e.g. the NYSE), a court can presume that the market price of that company’s stock reflects all available information, including the facts misrepresented by the defendants. All investors presumably relied on the market price in buying their shares, reliance on the fraudulent statements can be established, indirectly, on a class-wide basis. The Basic decision held that the fraud on the market presumption was rebuttable by the defendant, but until recently that was interpreted to mean rebuttable at trial, not at the class certification stage. 

As the stakes have risen dramatically in securities fraud litigation, big corporations have been trying to find ways to make it more difficult for courts to certify class actions, since their settlement leverage drops precipitously once a class is certified. In the past few years they have been arguing that classes should not be certified unless plaintiffs can actually prove, and not merely allege, at the class certification stage that common questions will be established in their favor. For example, some defendants have argued that plaintiffs should have to prove, at a hearing, that the fraud actually caused investor losses on a class wide basis (“loss causation”). Such arguments would turn a class certification procedure into a “mini trial” on issues relating to the merits of the case, which would have to be re-litigated at trial. Last year, in Halliburton, the Supreme Court rejected the argument that loss causation should have to be proven at the class certification stage. 

Now, in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, the Supreme Court has rejected attempts to force a mini-trial on the fraud on the market contention at the class certification stage. Specifically, Amgen had argued that plaintiff should be required to prove, and not merely allege, that the fraudulent misrepresentations were material enough to affect the market price of its stock, and that it should be given a chance to rebut the basic presumption that the market price actually was affected by the fraud. If the fraud did not affect the market price, Amgen argued, plaintiff could never establish on a class-wide basis that the entire class relied on the fraudulent representations in buying their shares. Individual issues would predominate, so the argument went, making class certification inappropriate. 

In a victory for investors, the Supreme Court rejected Amgen’s arguments, holding that all a securities fraud plaintiff has to do -- at the class certification stage -- is plausibly allege facts showing that the fraud was material; and that defendants cannot attempt to rebut the fraud-on-the-market presumption at that stage in the case. 

Writing for a 6-3 majority that included Chief Justice Roberts and Justices Breyer, Alito, Kagan, and Sotomayor, Justice Ginsberg’s opinion holds that proof of materiality is not a class certification prerequisite. The question of whether fraudulent statements are material is provable (or not) through objective evidence common to all investors. Thus, even if defendants prevail on this issue at trial, they will do so in a manner that is common to the entire class, and as such, materiality is a common question to all class members. Moreover, if at trial the plaintiff failed to prove the common question of materiality, the result would not be a predominance of individual questions, but rather, the end of the litigation, because materiality is an essential element of each class member’s securities fraud claim. In that sense, the entire class lives or dies based on the common resolution of the question. 

In so holding, the majority rejected Amgen’s argument that materiality should be treated like certain other fraud on the market prerequisites (e.g., that the misrepresentations were public, that the market was efficient, and that the transaction at issue occurred between the misrepresentation and the time the truth was revealed), which do have to be proven at the class certification stage. The majority found these other issues relate solely to class certification and are not ultimate merits determinations for the entire class. It also rejected Amgen’s argument that barriers should be raised to class certification because the financial pressure of a certified class forces the settlement of even weak claims, finding it significant that Congress had addressed the settlement pressures of securities class actions through means other than requiring proof of materiality at the class certification stage. In so doing, Congress had rejected calls to undo the fraud on the market presumption of reliance. Finally, the majority noted that, rather than conserving judicial resources, Amgen’s position would require a time- and resource-intensive mini-trial on materiality at the class certification stage, which is not contemplated by the federal rules and which, if the class were to be certified, might then have to be replicated in full at trial. 

In separate dissents, Justice Thomas and Scalia expressed hostility toward certification of classes where the materiality of the alleged statements had not been established. Thomas and, in a separate concurrence, Alito also questioned the continued validity of the fraud-on-the-market theory, in light of more recent research questioning its premises. These remarks may only invite additional challenges to the fraud-on-the-market presumption itself in years to come.