Corporate Securities Law Blog

On August 25, 2010, the Securities and Exchange Commission voted 3-to-2 along party lines to adopt a controversial proxy access regime to facilitate shareholders’ ability to nominate a limited number of candidates for election as directors. The new rules, which are primarily contained in new Rule 14a-11 promulgated under the Securities Exchange Act of 1934, will permit a single shareholder or group of shareholders owning at least 3% of the shares entitled to vote for directors to nominate, in accordance with applicable state corporate law, a number of directors up to 25% of the number of authorized directors and have such nominees included in the company’s proxy statement.
 

In In re Aetna, Inc. Securities Litigation, No. 09-2970, 2010 WL 3156560 (3d Cir. Aug. 11, 2010), the United States Court of Appeals for the Third Circuit held that certain allegedly misleading statements regarding the pricing of insurance premiums by a large health insurance company were protected under the safe harbor provision of the Private Securities Litigation Reform Act of 1995 (“Reform Act”), 15 U.S.C. § 78u-5(c)(1). The Court reasoned that the statements warranted protection because they were not only forward-looking — despite containing both present and future elements — but also immaterial. This decision further clarifies the Court’s analysis of mixed present/future statements for purposes of protection under the Reform Act’s safe harbor for forward-looking statements.
 

In Northstar Financial Advisors, Inc. v. Schwab Investments, No. 09-16347, 2010 WL 3169400 (9th Cir. Aug. 12, 2010), the United States Court of Appeals for the Ninth Circuit held that nothing in Section 13(a) of the Investment Company Act of 1940 (“ICA”), as originally enacted or as subsequently amended, either created a private right of action or implied that such a right exists with the clarity and specificity required under United States Supreme Court precedent. In so holding, the Ninth Circuit followed the Second Circuit and the recent trend of federal courts to reject implied private rights of action under the ICA.
 

In NetCoalition v. Securities & Exchange Commission, No. 09-1042 (D.C. Cir. Aug. 6, 2010), the United States Court of Appeals for the District of Columbia Circuit held that the Securities & Exchange Commission (“SEC” or “Commission”) failed adequately to explain the basis of, and failed to provide adequate support for, its approval of a proposed fee by NYSE Arca for access by investors to its proprietary “depth-of-book” product, Arcabook.  The Court vacated the approval order and remanded the matter to the SEC for further consideration of whether the proposed fee is consistent with the requirements and purposes of the Securities Exchange Act of 1934 (“Exchange Act”).
 

In Securities & Exchange Commission v. Platforms Wireless Int’l Corp., No. 07-56542, 2010 U.S. App. LEXIS 15328 (9th Cir. July 27, 2010), the United States Court of Appeals for the Ninth Circuit held that under Section 10(b) of Securities Exchange Act of 1934 (“1934 Act”), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, a showing that a statement is so obviously misleading to a reasonable person that the defendant who made the statement must have known of its misleading nature is sufficient on summary judgment to prove defendant’s scienter. The Court held further that a defendant cannot defeat summary judgment merely by denying subjective knowledge of the risk that a statement could be misleading. This decision clarifies two points of law in the Ninth Circuit: first, that the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (“Reform Act”), did not alter the substantive requirement for pleading scienter for claims under Section 10(b) and Rule 10b-5, and second, that deliberate recklessness, for purposes of demonstrating scienter, may be proved by an objective, not subjective, evaluation of a defendant’s mental state.
 

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first six months of 2010. (Their findings and analyses are summarized in press releases here: NERA, Cornerstone.) Both report that new federal securities class action filings continued to decline from 2009, as litigation following the 2008 credit crisis winds down. (We previously reported on trends for 2009 here.) If new filings continue at the same pace through the rest of the year, we could see the lowest level of filings since 2006 and the second lowest since 1997.

For further information, please contact John Stigi at (310) 228-3717.

In Morrison v. National Australia Bank Ltd., 2010 WL 2518523 (U.S. Jun. 24, 2010), the United States Supreme Court held that domestic courts lack jurisdiction over claims brought by private citizens pursuant to Section 10(b) of Securities Exchange Act of 1934 (“Exchange Act’), 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, against corporations whose stock is traded exclusively in foreign exchanges. The decision, written by Justice Scalia on behalf of a five justice majority, departs from decades of precedent from the United States Courts of Appeals that allowed such claims to be brought when substantial aspects of the misconduct occurred in the United States or when the misconduct had a substantial effect on U.S. investors.
 

In Skilling v. United States, 2010 WL 2518587 (U.S. Jun. 24, 2010), the United States Supreme Court significantly limited the scope of a criminal statute used frequently by federal prosecutors to criminalize a wide range of behavior by business executives and public officials. The Court held that 18 U.S.C. § 1346, which makes it a federal crime to deprive another of the “intangible right of honest services,” may only be used by prosecutors in cases where the defendant has participated in conduct involving bribery or kickbacks. The justices agreed unanimously that the statute does not apply to cases where the defendant’s conduct merely entails a conflict of interest, self-dealing, breaches of fiduciary duty or unwise business decisions, and that does not include bribery or kickbacks. The Skilling case ends the long running debate between those who perceived this “statute of last resort” as a necessary tool for prosecutors to use in fighting malfeasance by corporate and public officials, and those who contended ambitious and/or unwise prosecutors were abusing the statute to target persons whose behavior may be unpopular, unethical or subject to second-guessing, but was not clearly criminal.
 

In In re Cutera Securities Litigation, 2010 WL 2595281 (9th Cir. June 30, 2010), the United States Court of Appeals for the Ninth Circuit concluded that the Private Securities Litigation Reform Act’s (“Reform Act”) safe harbor provision, 15 U.S.C. § 78u-5, protects forward-looking statements accompanied by meaningful cautionary language” andforward-looking statements in the absence of meaningful cautionary language not made with “actualknowledge” that the statement was false or materially misleading when made. This decision greatly clarifies the law in the Ninth Circuit. Previously, in dicta, a Ninth Circuit court had suggested that if plaintiffs could prove a sufficiently strong inference that a forward-looking statement made with actual knowledge of its falsity, such a statement would not protected by the safe harbor provision of the Reform Act even if accompanied by meaningful cautionary language. In re Cutera puts this notion to rest. A forward-looking statement that is either accompanied by meaningful cautionary language or is made without actual knowledge of its falsity may not form the basis for a federal securities fraud claim.
 

In In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5377-VCL, 2010 WL 2291842 (Del. Ch. May 25, 2010) (Laster, V.C.), the Delaware Court of Chancery held that minority stockholders established a likelihood of success on the merits of their claim challenging the “entire fairness” of a tender offer by a controlling stockholder intended to “freeze-out” minority stockholders.  The court held that the transaction was not entitled to the less onerous “business judgment” standard of review — which would have applied only if the transaction was (1) negotiated and recommended by a special committee of independent directors and (2) conditioned on the affirmative tender of a majority of the minority shares— because, inter alia, the company’s special committee did not recommend the deal. The court nevertheless declined to enjoin the tender offer, holding that the minority stockholders did not demonstrate a risk of irreparable harm. In this decision, Vice Chancellor Laster applied a “unified standard” to controlling stockholder “freeze-out” transactions that differed from the standard applied in other Chancery Court decisions, urging the Delaware Supreme Court to resolve the conflicting approaches.
 

In United States v. Deloitte LLP, No. 09-5171, 2010 WL 2572965 (D.C. Cir. Jun. 29, 2010), the United States Court of Appeals for the District of Columbia Circuit held, among other things, that the provision of documents containing attorney work product to a company’s independent auditor does not waive the protection of the work product doctrine. This decision, on a matter of first impression, allows companies to deliver work product to outside accountants that might be relevant to their audit of the company’s financial statements without fear that the materials will automatically be discoverable in subsequent litigation.
 

In Solis v. Tennessee Commerce Bancorp, Inc., a three-judge panel of the Sixth Circuit recently reversed a lower court’s decision to enforce a preliminary order by the Department of Labor (“DOL” or “Department”) to reinstate an alleged whistleblower under the Sarbanes-Oxley Act of 2002 (“SOX”). The court avoided determining whether it had authority under SOX to enforce preliminary orders, instead deciding the case based on the “balance of harms” test that applies in all cases seeking preliminary injunctive relief.
 

In Maric Capital Master Fund, Ltd. v. PLATO Learning, Inc., C.A. No. 5402-VCS (Del. Ch. May 13, 2010), the Court of Chancery of the State of Delaware granted plaintiff Maric Capital Master Fund’s (“Maric”) motion for a preliminary injunction to halt a stockholder vote on a proposed merger in which Thoma Bravo, LLC (“Thoma Bravo”) would acquire PLATO Learning, Inc. (“PLATO”). Although the court held that Maric failed to demonstrate a likelihood of success on the merits of its assertion that the directors of PLATO failed to meet their duties under Revlon, Inc. v. McAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), the court nonetheless enjoined the vote based upon a determination that three specific disclosures in the proxy statement were materially misleading. The court ordered that corrective disclosures on those items be issued before the vote could proceed. This decision reflects the Chancery Court’s efforts to ensure that proxy disclosures in advance of stockholder votes are not materially misleading.

In MCG Capital Corporation v. Maginn, Civil Action No. 4521-CC, 2010 Del. Ch. LEXIS 87 (Del. Ch. May 5, 2010), the Delaware Court of Chancery granted in part and denied in part the defendants’ motion to dismiss plaintiff preferred stockholder’s complaint alleging both derivative and direct claims. In doing so, the court, for the first time, set forth a rule allowing preferred stockholders to bring derivative suits absent an express limitation in the company’s articles of incorporation or other appropriate document.

In Securities & Exchange Commission v. Jenkins, No. CV-09-1510-PHX-GMS, 2010 WL 2347020 (D. Ariz. Jun. 9, 2010), the United States District Court for the District of Arizona held that the responsibility of a CEO under Section 304 of the Sarbanes-Oxley Act of 2002 (the “Act”) to reimburse an issuer for bonuses, incentive compensation and stock sale proceeds he or she received in the year prior to a restatement of the issuer’s financial statements does not require a showing that CEO committed or even knew of misconduct that led to the restatement. This decision marks the first time a court has applied Section 304 of the Act in the absence of allegations that the targeted CEO personally committed any wrongdoing, enforcing strict liability of CEOs and CFOs in the event of a restatement due to corporate (as opposed to their own) misconduct.

In King v. VeriFone Holdings, Inc., C.A. No. 5045-VCS (Del. Ch. May 12, 2010), the Delaware Court of Chancery dismissed a derivative plaintiff’s Section 220 books and records action on the ground that the purpose for the request — to bolster demand futility allegations in the prematurely filed derivative complaint — was improper. The court criticized plaintiff for filing a derivative complaint before counsel was able to complete his investigation, solely to “win the race to the courthouse.” This decision reflects the Chancery Court’s willingness to impose consequences on plaintiffs who do not follow appropriate procedures in their haste to obtain lead plaintiff status.
 

In Slayton v. American Express Co., No. 08-5442, 2010 WL 1960019 (2d Cir. May 18, 2010), the United States Court of Appeals for the Second Circuit affirmed the dismissal of a securities fraud class action against American Express Company (“Amex”) on the ground that the complaint did not plead a strong inference of defendants’ scienter. While the court affirmed dismissal, it rejected Amex's argument that the alleged misrepresentation was protected by the “safe harbor” for forward-looking statements set forth in the Private Securities Litigation Reform Act of 1995 (“Reform Act”). In doing so, the Court set forth useful guidance for determining when a statement is “forward-looking” and whether cautionary warnings are sufficiently “meaningful” to trigger the protection of the statute’s safe harbor.
 

In Greb v. Diamond Int’l Corp., 2010 Cal. App. LEXIS 566 (Cal. App. 1st Dist. Apr. 26, 2010), the California Court of Appeal for the First District affirmed the trial court’s dismissal of a personal injury claim against a dissolved Delaware corporation, holding that the claim was filed more than three years after dissolution of the corporation in violation of Delaware General Corporation Law Section 278. In doing so, the Court made it clear that, for purposes of lawsuits filed in California against dissolved non-California corporations, the law of the state of incorporation controls whether claims are timely filed.
 

In Merck & Co. v. Reynolds, No. 08-905, 2010 U.S. LEXIS 3671 (Apr. 27, 2010), the Supreme Court of the United States held that a private securities fraud claim accrues for statute of limitations purposes at the earlier of when (1) the plaintiff does in fact discover, or (2) a reasonably diligent plaintiff would have discovered, “the facts constituting the violation.” The Supreme Court held further that “facts constituting the violation” include the “fact” of defendants’ scienter, i.e., “a mental state embracing intent to deceive, manipulate, or defraud.” This unanimous clarification by the Supreme Court of how lower courts should apply the statute of limitations for private securities fraud claims provides a bit more breathing room for would-be plaintiffs.
 

In Pacific Investment Management Co. LLC v. Mayer Brown LLP, No. 09-1619, 2010 WL 1659230 (2d Cir. Apr. 27, 2010), the United States Court of Appeals for the Second Circuit affirmed the dismissal of securities fraud claims asserted against outside counsel to Refco Inc. (“Refco”), holding that such secondary actors can be held liable for damages in a private securities fraud action only if the alleged false or misleading statements are attributed to that secondary actor at the time the statements were disseminated. Without a showing of this so-called “attribution requirement,” secondary actors who participate in the preparation or creation of false statements can be guilty of no more than “aiding and abetting,” which under Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), cannot form the basis of a securities fraud claim. This decision confirms the Second Circuit’s strict application of Central Bank and Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008), to limit securities fraud claims against secondary actors.
 

In Bezirdjian v. O’Reilly, Case No. A124859, 183 Cal. App. 4th 316, 2010 WL 1212437 (Cal. App. Mar. 30, 2010), the California Court of Appeal for the First Appellate District affirmed the dismissal of a shareholder derivative action against current and former board members of Chevron Corporation. The Court held that the plaintiff failed to allege facts with sufficient particularity to rebut the presumption that the company’s refusal to pursue the case in response to the shareholder demand was protected by the business judgment rule. This decision joins the growing body of California cases that follow or apply Delaware law in protecting the integrity of corporate decision-making.
 

Mutual fund companies have traditionally argued that they are exempt from the whistleblower protections of the Sarbanes-Oxley Act (“SOX”) because the funds themselves do not have any employees. Massachusetts District Court Judge Douglas P. Woodlock soundly rejected that argument in a ruling issued March 31 and, in so doing, may have opened the door to a tidal wave of whistleblower suits against mutual fund companies.
 

In In re Omnicom Group, Inc. Securities Litigation, No. 08-0612-CV, 2010 WL 774311 (2d Cir. Mar. 9, 2010), the United States Court of Appeals for the Second Circuit affirmed the district court’s grant of summary judgment dismissing a securities fraud class action for failure to proffer sufficient evidence to support a finding of loss causation.  The Second Circuit held that plaintiffs failed to show that the decline in the issuer’s stock price occurred as a result of a disclosure of new information about the alleged fraud. At most, the investor losses arose from the negative press and investor concerns about possible accounting problems. As the Second Circuit stated, however, an issuer is not responsible under the securities laws for losses arising merely from “investors’ concerns that other unknown problems [are] lurking.
 

In Securities & Exchange Commission v. Tambone, No. 07-1384, 2010 U.S. App. LEXIS 5031 (1st Cir. Mar. 10, 2010) (en banc), the United States Court of Appeals for the First Circuit, sitting en banc, vacated the three-judge panel’s prior holding and affirmed the district court’s dismissal of a Rule 10b-5 claim asserted by the Securities & Exchange Commission (“SEC”) against defendants James Tambone and Robert Hussey. In doing so, the First Circuit clarified what it means to “make” a statement under Rule 10b-5(b) promulgated under Section 10(b) of the Securities Exchange Act of 1934 (“1934 Act”).
 

In Bixler v. Foster, No. 09-2138, 2010 WL 597477 (10th Cir. Feb. 22, 2010), the United States Court of Appeals for the Tenth Circuit affirmed the dismissal of a class action lawsuit brought by minority shareholders of Mineral Energy and Technology Corporation (“METCO”) against its directors and lawyers. Plaintiffs alleged that defendants violated the civil Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. §§ 1961-1968, for authorizing and facilitating the transfer of METCO’s assets to an Australian corporation. The Tenth Circuit held that, among other things, (1) plaintiffs lacked standing under RICO to assert shareholder derivative claims and (2) allegations of securities fraud did not establish predicate acts under RICO. This decision confirms that the civil RICO statutes generally are not available to shareholders and investors seeking redress for alleged ordinary corporate misconduct.
 

In Operating Local 649 Annuity Trust Fund v. Smith Barney Fund Management LLC, No. 07-5125-cv, 2010 WL 520896 (2d Cir. Feb. 16, 2010), the United States Court of Appeals for the Second Circuit vacated an order dismissing a securities fraud class action brought on behalf of investors against the manager of a family of mutual funds. The Court held, among other things, that the defendants’ alleged misrepresentations regarding transfer agent fees paid by the funds were material under the “total mix” materiality test. This decision provides guidance regarding disclosures to be made by mutual funds concerning the details of transfer fee arrangements.
 

In New York City Employees’ Retirement System v. Jobs, No. 08-16488, 2010 WL 309028 (9th Cir. Jan. 28, 2010), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a class action lawsuit against Apple, Inc. (“Apple”) and fourteen of its officers and directors for the alleged false and misleading proxy solicitation of a stock option plan on the ground that plaintiff-appellant did not adequately plead economic loss in the form of “dilution to shareholder interests.”  This decision provides yet another instance where courts have strictly applied the “loss causation” principles set forth in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342-48 (2005), in describing the contours of “loss” in private actions under the federal securities laws.
 

In Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., No. 09-10954, 2010 WL 154519 (11th Cir. Jan. 19, 2010), the United States Court of Appeals for the Eleventh Circuit affirmed the dismissal of securities fraud and insider trading claims arising out of options backdating. This decision represents the most recent effort by the Eleventh Circuit to apply the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 (“Reform Act”) and the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) [see blog article here], to allegations of securities fraud arising from options backdating.
 

In Konkol v. Diebold, Inc., No. 08-4572, 2009 WL 4909110 (6th Cir. Dec. 22, 2009), the United States Court of Appeals for the Sixth Circuit applied the United States Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) (see blog article here), to hold that securities fraud plaintiffs must plead an inference of scienter that is both “cogent and at least as compelling as any opposing competing inference.”  The Sixth Circuit clarified that, under Tellabs, the inference of defendants’ scienter be “cogent” requires plaintiffs to plead “with particularity” facts supporting each individual allegation of scienter. Additionally, the Sixth Circuit held that Tellabs does not impose any burden on defendants to set forth a competing, non-fraudulent inference of scienter at the pleading stage. In reaching its decision, the Court attempted to harmonize Tellabs with the Sixth Circuit leading pre-Tellabs decision on the topic, Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001) (en banc).
 

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for 2009. (Their findings and analyses are summarized in press releases here: NERA, Cornerstone.) Both report that federal securities class action filings decreased from 2008, due to the easing of the financial crisis and reduced stock price volatility since the first quarter of 2009. (We previously reported on mid-year 2009 assessments here.)  One notable trend: an increasing number of cases are being filed six months or more after the end of the putative class periods, instead of immediately after a stock price drop, suggesting that plaintiffs’ counsel have turned to “clearing out inventory” of potential cases.

For further information, please contact John Stigi at (213) 617-5589.

In Bader v. Anderson, No. CV041521, 2009 Cal. App. LEXIS 1880 (Cal. App. Nov. 23, 2009), the California Court of Appeal for the Sixth Appellate District addressed two important issues affecting shareholder derivative actions under California law. First, the Court offered guidance regarding the distinctions between direct claims and derivative claims by shareholders against corporate management, holding that “incidental harm” to shareholders, in the form of reduced share value, does not transform a derivative claim into a direct cause of action. Second, the Court confirmed that no exception to the presuit demand requirement exists for claims alleging misleading statements or omissions in proxy statements.
 

In Electronic Trading Group, LLC v. Banc of America Securities LLC (In re Short Sale Antitrust Litigation), 2009 WL 4350035 (2d Cir. Dec. 3, 2009), the United States Court of Appeals for the Second Circuit affirmed the dismissal of a putative antitrust class action against certain financial institutions that serve as “prime brokers” in connection with short sale transactions, on the ground that the federal securities laws precluded application of antitrust law to the matters at hand. This was the first time the Second Circuit applied the considerations for the implied preclusion of antitrust laws by the securities laws outlined by the United States Supreme Court in Credit Suisse Securities (USA) LLC v. Billing, 551 U.S. 264 (2007).
 

Registrants should be aware of recent fee rate adjustments made by the Securities and Exchange Commission in response to President Obama’s recent signing of H.R. 3288, the appropriations bill that includes funding for the Securities and Exchange Commission. Specifically, the Section 6(b) fee rate applicable to the registration of securities, the Section 13(e) fee rate applicable to the repurchase of securities and the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions will increase from $55.80 per million dollars to $71.30 per million dollars. Note that the fee rate for Section 6(b) is also used to calculate fees payable with the Annual Notice of Securities Sold Pursuant to Rule 24f-2 under the Investment Company Act of 1940. The fee rate adjustments will be effective as of December 21, 2009.
 

In United States v. Berger, No. 08-50171, 2009 WL 4141478 (9th Cir. Nov. 30, 2009), a three-judge panel of the United States Court of Appeals for the Ninth Circuit declined to apply loss causation principles in civil securities fraud litigation established by the United States Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342-48 (2005), in connection with the sentencing of a defendant in a criminal securities fraud prosecution. Declining to follow two other circuits that had endorsed the application of Dura Pharmaceuticals to criminal sentencing, the Ninth Circuit held that the policies underlying the proper standard for pleading and proving a loss by investors in civil cases are not present in the criminal sentencing context and that applying Dura Pharmaceuticals’ civil rule to criminal sentencing would clash with Congress’ endorsement of that method. Notwithstanding that the split in circuit decisions may prompt Supreme Court review, this decision provides another instance where courts have applied policy distinctions between civil litigation and criminal/enforcement proceedings involving securities fraud.

In Siracusano v. Matrixx Initiatives, Inc., 2009 WL 3448282 (9th Cir. Oct. 28, 2009), the United States Court of Appeals for the Ninth Circuit reversed and remanded a decision by the United States District Court for the District of Arizona granting defendant Matrixx Initiatives, Inc.’s (“Matrix”) motion to dismiss a putative securities fraud class action brought under Section 10(b) of Securities Exchange Act of 1934.  In its decision, the Ninth Circuit rejected older precedent from the Second Circuit and held that the materiality or immateriality of an allegedly false statement generally is not to be determined at the pleading stage, but an issue of fact properly reserved for later stages of the proceeding. Additionally, the Ninth Circuit reiterated the Supreme Court’s recent admonition in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) [see blog article on Tellabs], that a plaintiffs’ failure to plead motive and opportunity is an insufficient basis on which to dismiss a complaint that otherwise alleges scienter with the particularity required by the Private Securities Litigation Reform Act of 1995. This decision in Siracusano largely echoes existing Ninth Circuit authority on the issues of materiality and scienter, as well as the interpretation and application of Tellabs.
 

In Murray v. Metropolitan Life Ins. Co., No. 09-3716-CV, 2009 WL 3080462 (2d Cir. Sept. 29, 2009), the United States Court of Appeals for the Second Circuit reversed an order by the district court disqualifying defense counsel for a life insurance company in an action alleging fraud in connection with the demutualization of defendant life insurance company. The Court held that the law firm did not have an attorney-client relationship with the policyholders (plaintiffs) by reason of counsel’s representation of the insurance company in the demutualization process several years earlier.  The Second Circuit’s decision provides clear guidance as to whether constituents of a mutual company have a direct attorney-client relationship with counsel for the company, slamming shut the door opened by the district court in this case.
 

In United States v. Ruehle, No. 09-50161, 2009 WL 3152971 (9th Cir. Sept. 30, 2009), the United States Court of Appeals for the Ninth Circuit reversed a controversial decision by the United States District Court for the Central District of California, which improperly excluded from evidence in a criminal prosecution certain statements made by a senior officer to corporate counsel conducting an internal investigation that the officer claimed were protected from disclosure by the attorney-client privilege. The Ninth Circuit held that the corporate counsel’s alleged failure to give an “Upjohn warning” — which comes from the United States Supreme Court’s decision in Upjohn Co. v. United States, 449 U.S. 383 (1981), and is sometimes referred to as “corporate Miranda warning” — to the officer does not necessarily bar the government from using the statements made by the officer to corporate counsel. The decision potentially has far-reaching implications for groups as diverse as government prosecutors, individual corporate officers and corporate counsel in connection with the conduct of internal investigations of alleged corporate wrongdoing.
 

On June 10, 2009, the Securities and Exchange Commission, or the SEC, proposed a comprehensive series of rule amendments to facilitate the rights of shareholders to nominate a minority slate of directors on corporate boards.[1]There was speculation that final action could be taken on the proposed rule amendments—known as the direct access proposal—as early as November 2009 and that the changes would be effective for the 2010 proxy season. Commissioner Elisse B. Walter, in a speech on October 2, 2009, indicated that it was unlikely that the proposed rules would be acted upon before the 2010 proxy season but assured that she is "quite serious" about the direct access proposal and expected the SEC to consider an adopting release in early 2010.[2]
 

On September 22, 2009, the Delaware Senate confirmed Wilmington corporate governance litigator J. Travis Laster to become a Vice Chancellor of the Delaware Chancery Court. Laster will replace outgoing Vice Chancellor Stephen Lamb, who retired at the end of his 12-year term. Laster was nominated by Delaware Governor Jack Markell in August and is expected to take his seat on October 9, 2009.
 

In SEC v. Dorozhko, 2009 WL 2169201 (2d Cir. July 22, 2009), the United States Court of Appeals for the Second Circuit held that computer hacking for purposes of obtaining and trading on inside information may be a “deceptive device” under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, even where the hacker owed no fiduciary duty to the issuer. This holding appears in conflict with a 2007 decision from the Fifth Circuit, and can be viewed as expanding the scope of liability for insider trading to those who owe no fiduciary duties to the issuers of the stock being traded.
 

In the latest of a series of chats with high-profile securities lawyers, Law 360 conducted a Q&A session with Sheppard Mullin partner and head of the firm's Corporate/Securities Litigation team, John P. Stigi III.

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first half of 2009. Both appear to report that federal securities class action filings, which had increased in 2008, have stabilized or dropped, due largely to a sharp decline in filings during the second quarter. 

In Institutional Investors Group v. Avaya, Inc., 2009 U.S. App. LEXIS 9110 (3d Cir. April 30, 2009), a panel of the United States Court of Appeals for the Third Circuit applied the United States Supreme Court’s 2007 decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), for the first time to existing case law in the Third Circuit. In Tellabs, the Supreme Court held that a plaintiff who seeks to bring a claim for securities fraud under the Private Securities Litigation Reform Act (the “Reform Act”) must plead an inference of scienter that is “cogent and at least as compelling as any opposing inference of non-fraudulent intent.” [See blog article on Tellabs.] In Avaya, the Third Circuit held that the standard articulated in Tellabs requires courts to review scienter holistically, and not through analysis of any individual allegation of scienter, though the court did confirm that the Reform Act’s particularity requirement for pleading scienter remains a determinative factor when conducting this analysis.
 

In Rubke v. Capitol Bancorp Ltd., 2009 WL 69278 (9th Cir. Jan. 13, 2009), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a class action complaint alleging violations of Section 11 of the Securities Act of 1933 and Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 through materially misleading statements and omissions in connection with a tender offer. The Ninth Circuit carefully considered each alleged misleading statement and omission, ultimately determining that none was actionable. The decision in Rubke highlights the types of statements and omissions that would not be viewed as materially misleading when made by a corporation in connection with a tender offer.

In Pfeffer v. Redstone, 2009 WL 188887 (Del. Jan. 23, 2009), the Delaware Supreme Court confirmed a Chancery Court holding that under Delaware law the heightened scrutiny of “entire fairness “ is not imposed on controlling shareholders, that make non-coercive tender or exchange offers to minority shareholders.  The case arose out of the Viacom's spin off of Blockbuster.  The plaintiffs alleged that Sumner Redstone and the other directors of Viacom and Blockbuster (as well as parent companies) breached duties of disclosure, care and loyalty in connection with a tender offer and related special dividend.  The court rejected the application of “entire fairness” scrutiny to defendants’ Rule 12(b)(6) motion due to the non-coercive nature of Viacom’s proposed tender offer.  The court went on to find that the complaint failed to adequately plead disclosure violations, despite actual misstatements and omissions by defendants, because plaintiffs failed to adequately plead the materiality of those misstatements and omissions.

The Delaware Supreme Court's recent decision in Gantler v. Stephens, No. 132, 2008 (January 27, 2009), confirms that officers of Delaware corporations have the same fiduciary duties of loyalty and care as directors. This has important implications for non-director officers of Delaware corporations, in particular because, as the Court points out in a footnote, there is at present no statutory authorization for the exculpation of officers for monetary liability for breach of their duty of care. The Court also holds that a statutorily required shareholder vote, such as for the approval of a merger, does not constitute ratification of breaches of fiduciary duties. Delaware companies now need to revisit their internal processes and indemnification and insurance arrangements to be sure that their corporate officers are protected.

In Zucco Partners, LLC v. Digimarc Corp., 2009 WL 311070 (9th Cir. Feb. 10, 2009), the United States Court of Appeals for the Ninth Circuit reaffirmed that when pleading a claim for securities fraud under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), plaintiffs are bound by prior Ninth Circuit authority that requires them to plead particularized facts giving rise to a strong inference that defendants knew, or were deliberately reckless in not knowing, that their statements were false when made.  The viability of the Ninth Circuit’s particularity requirement has been the subject of much debate since the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007).  In Tellabs, the Court held that, in order to survive dismissal, plaintiffs must plead an inference of scienter that is “cogent and at least as compelling as any opposing inference of nonfraudulent intent.”  [See blog article on Tellabs.]  In South Ferry LP, No. 2 v. Killinger, 542 F.3d 776 (9th Cir. 2008), a panel of the Ninth Circuit suggested in dicta that Tellabs’ holistic analysis may have superseded the Ninth Circuit’s particularity requirement.  [See blog article on South Ferry.]  That same term, however, two other panels confirmed that the earlier cases governing scienter were controlling.  See Metzler Inv. GMBH v. Corinthian Colleges, Inc., 540 F.3d 1049 (9th Cir. 2008) [blog article on Metzler]; Glazer Capital Management, LP v. Magistri, 549 F.3d 736 (9th Cir. 2008) [blog article on Glazer].  Now, with its most thorough decision to date on this issue, the Zucco court appears to have definitively resolved this question in favor of particularity, holding clearly that “Tellabs does not materially alter the particularity requirements for scienter claims established in our previous decisions.”

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for 2008.  Both report that federal securities class action filings increased over 2007, due largely to the economic crisis and the Madoff scandal.  The bulk of class action filings were made in the Second Circuit, and were focused heavily on the financial sector.  In fact, nearly one-third of all large investment banks were hit with securities class actions in 2008.  (We previously reported on mid-year 2008 assessments here.)

For further information, please contact John Stigi at (213) 617-5589.

In In re Digimarc Corporation Derivative Litigation, 2008 WL 5171347 (9th Cir. Dec. 11, 2008), the United States Court of Appeals for the Ninth Circuit held that Section 304 of the Sarbanes-Oxley Act (15 U.S.C. § 7243), which provides for the forfeiture of certain bonuses and profits when corporate officers fail to comply with securities law reporting requirements, does not create a private right of action.  Though several district courts had already arrived at the same conclusion, the issue was one of “first impression” for the Ninth Circuit Court of Appeals.  The ruling thus prevents individual shareholders from pursuing recovery of bonuses and stock sale proceeds from officers in situations where the company is required to issue a restatement of its financials as a result misconduct.

In Glazer Capital Management, LP v. Magistri, 2008 WL 5003306 (9th Cir. Nov. 26, 2008), the United States Court of Appeals for the Ninth Circuit held that when pleading scienter as to a corporate defendant, the Private Securities Litigation Reform Act of 1995 (the “Reform Act”) “requires [plaintiff] to plead scienter with respect to those individuals who actually made the false statements.”  This ruling clarifies that in all but the most unusual cases, a plaintiff in this Circuit may not rely upon notions of “collective scienter” — that is, the idea that a corporation’s state of mind for purposes of pleading securities fraud can be inferred from the collective knowledge of the totality of its employees, instead of the knowledge of a particular officer or director — to state a claim for securities fraud against a corporate defendant.  In addition, Glazer reaffirms longstanding Ninth Circuit authority holding that, when alleging scienter as to an individual defendant, the Reform Act requires plaintiff to “plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct” on the part of the defendant.

In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 2008 WL 4457544 (Del. Ch. Sept. 29, 2008), the Delaware Chancery Court, after an expedited six day trial, ruled that Hexion Specialty Chemicals, Inc. had breached various provisions of a July 2007 merger agreement.  By that agreement, Hexion, which is controlled by a private equity group, had agreed to acquire Huntsman Corp. in a leveraged cash transaction at a steep price following a bidding contest.  The terms of the merger agreement left Hexion with no “financing out” if it could not close due to a lack of funding.  Hexion’s efforts to extricate itself from the transaction arose in connection with the continuing crisis affecting the world-wide credit markets.  Hexion had sought to excuse any failure to close on its part by claiming that Huntsman’s operations had suffered a Material Adverse Effect (MAE) under the terms of the merger agreement and that the combined entity would be insolvent.  Issuing its decision before the merger agreement’s October 2, 2008 termination date, the court rejected these claims in a manner that suggested it found them pretextual and ordered Hexion to specifically perform all obligations necessary to close the deal (save the obligation to actually close, which the merger agreement exempted from a specific performance remedy).  This case is significant for its illustration of the approach that Delaware courts take in interpreting and applying a MAE clause when invoked to excuse performance under a merger agreement.  Also notable is the finding that Hexion had breached its covenant to use its reasonable best efforts to consummate the deal, a determination that required the court to reconcile a party’s contractual duty to use reasonable best efforts to consummate a transaction with that party’s alleged perceived need to avoid insolvency.  The case also demonstrates that Delaware courts will not hesitate to impose a specific performance remedy when a contract so provides, even when the consequences to one party may be ruinous.

In In re Heritage Bond Litigation, 2008 WL 4415172 (9th Cir. Oct. 1, 2008), the United States Court of Appeals for the Ninth Circuit held that a class action settlement bar limits only contribution, indemnity or other comparative fault claims against settling defendants where damages are calculated based on the amount of the non-settler’s liability to the class.  The appeal arose from a partial settlement in a securities fraud class action.  The district court’s broad bar order precluded non-settlers from bringing any future claims against settlers “arising out of or related to . . . any of the transactions or occurrences alleged.”  A non-settling defendant later brought breach of fiduciary duty, negligence, labor law and other claims against several settling defendants, including his former employer, and sought “both economic and reputational” damages.  The district court determined that its bar order precluded such claims.  The Ninth Circuit disagreed, vacating the order and remanded the matter to the district court.  The decision offers greater clarity on the scope of settlement bar orders, important mechanisms designed to encourage partial settlements but, at the same time, protect non-settlers’ rights.

In Millowitz v. Citigroup Global Markets, Inc., 2008 WL 4426412 (2d Cir. Sept. 30, 2008), the United States Court of Appeals for the Second Circuit held that the fraud-on-the-market doctrine established in Basic Inc. v. Levinson, 485 U.S. 224 (1988), applies in Rule 10b-5 suits challenging alleged misstatements contained in research analyst reports.  The fraud-on-the-market doctrine creates a presumption of reliance in 10b-5 securities fraud cases, and eliminates the need for plaintiffs to show individual reliance on the alleged fraudulent act.  In Millowitz, the Second Circuit concluded that the district court in the case had properly invoked the doctrine to decide whether common questions of law and fact predominated over individualized ones for purposes of certifying a class under Fed. R. Civ. P. 23(b)(3).  The Second Circuit also ruled that no showing of the analyst’s reports’ actual affect on the securities’ market price is required to trigger the presumption, something defendants had urged.  The decision is important because it may impose a risk of class action liability on public misstatements of fact even when the speaker is neither the issuer nor an agent of the issuer, provided the misstatement is material.

In South Ferry LP, #2 v. Killinger, 2008 WL 4138237 (9th Cir. Sept. 9, 2008), the United States Court of Appeals for the Ninth Circuit held that inferring scienter based upon nothing more than defendants’ senior management positions in a company does not satisfy the heightened pleading standards of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”).  The interlocutory appeal in this case arose from a series of apparently conflicting case law within the Ninth Circuit with respect the so-called “core operations inference” in securities fraud actions, i.e., an inference that senior management must be aware of all matters, including wrongdoing, affecting a company’s core operations.  This decision resolves that apparent conflict by reaffirming pre-existing law and distinguishing a handful of seemingly contrary Ninth Circuit decisions.

In In re Gilead Sciences Securities Litigation, 536 F.3d 1049 (9th Cir. 2008), a three-judge panel of the United States Court of Appeals for the Ninth Circuit reversed the dismissal of a securities fraud complaint that the district court had held failed to plead loss causation due to the passage of time between the disclosure of the alleged fraud and the drop in the company’s stock price. The Ninth Circuit held that the delay in market reaction was not dispositive because, according to plaintiffs, the analysts and investors were unaware of the financial impact of the matters discussed in the corrective disclosure until after the company issued its quarterly financial results. This decision comes just two weeks after another panel of the same court cautioned, based on similar facts, that “[e]nabling a plaintiff to proceed on such a theory would effectively resurrect what Dura [Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005),] discredited.”  Metzler Investment GMBH v. Corinthian Colleges, Inc., 2008 WL 2853402 (9th Cir. July 25, 2008, amended Aug. 26, 2008) [See blog article].

The SEC today issued an emergency order to temporarily ease the restrictions on the ability of issuers to repurchase their securities.  This change is intended to give issuers more flexibility to buy back their securities and, thereby, help restore liquidity to the securities markets.  The SEC's emergency order is effective at 12:01 a.m. EDT on September 19, 2008 and terminates at 11:59 p.m. on October 2, 2008 unless further extended by the SEC.

On August 5, 2008, the SEC announced the settlement of administrative proceedings against Ernst & Young and Mark C. Thompson, a former director of three public audit clients of Ernst & Young. The proceedings arose from a business relationship between Ernst & Young and Mr. Thompson which the SEC determined impaired the audit firm's independence and, thereby, caused each company to violate the federal securities laws. The proceedings clarify certain aspects of the SEC's rules regarding auditor independence, and highlight the need for public companies to periodically review any changes in the relationship between each director and the company and its audit firm that might affect auditor independence.

In Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. July 29, 2008), a case involving an unsolicited, all cash offer from an unrelated strategic acquirer at a substantial premium to the market price, the Court denied the defendants’ motions for summary judgment on breach of fiduciary duties associated with the sale process and the deal protections.  The Court also allowed monetary damages claims against the directors to proceed to trial based on the possibility that the directors’ conduct may have been so far below the standards of care that it involved a lack of good faith – despite there being no conflicts of interest.  The Court was critical of the Board’s response to a filing that put the company “in play,” the seven-day negotiating process for the actual deal, the failure to conduct a pre-signing market check, the failure to negotiate successfully for a post signing "go-shop," and deal protections including a 3% break-up fee and matching rights for a superior proposal.

In United States v. Finnerty, 2008 U.S. App. LEXIS 15296 (2d Cir. July 18, 2008), the United States Court of Appeals for the Second Circuit set aside a guilty verdict imposing securities fraud liability against a New York Stock Exchange Specialist who engaged in “interpositioning” and “trading ahead” transactions, on the ground that the prosecution failed to prove that the defendant’s conduct constituted deceptive conduct under the federal securities laws.  The court held that absent proof that the defendant actually conveyed a misleading impression to customers, finding securities fraud liability would “invite litigation beyond the immediate sphere of securities litigation.”  This decision provides yet another instance where courts have retained and applied traditional limits to securities fraud liability.

In Metzler Investment GMBH v. Corinthian Colleges, Inc., 2008 WL 2853402 (9th Cir. July 25, 2008), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal with prejudice of a securities fraud class action, holding that plaintiffs had failed to plead the essential elements of loss causation, scienter and falsity consistent with the requirements of prevailing Supreme Court and Ninth Circuit authority.  Corinthian Colleges is the most recent in a long line of Ninth Circuit decisions since 1999 that apply strictly the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”).

NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first half of 2008.  Both report that federal securities class action filings are up, due largely to the sub-prime mortgage, credit and auction rate securities crises.  The reports also note a correlation between increased market volatility and increased filings, as well as an increase in investor and market capitalization losses associated with the filed cases.  The increase in filings and losses in 2008 reflects a continuation of a trend that started in 2007 following the sharp decrease in securities litigation activity in 2005 and 2006.  Both summarize their findings and analyses in press releases (NERA, Cornerstone) issued on July 29, 2008.

In Julian v. Eastern States Construction Services, Inc., 2008 WL 2673300 (Del. Ch. July 8, 2008), the Delaware Chancery Court held that board members of a close corporation breached their duty of loyalty and would be required to disgorge bonuses where the directors approved self-compensation without sufficient independent protections.  This case provides guidance regarding the process board members must follow in order for a self-interested directorial compensation decision to survive an “entire fairness” review.

The Delaware Chancery Court recently decided two different motions for preliminary injunctions, with vastly different results. In both cases, the issue was whether disclosures in the respective proxy statements were sufficient to enable stockholders to consider fairly a proposed merger. In Wayne County Employees’ Retirement System v. Corti, C.A. No. 3534-CC (Del. Ch. July 1, 2008), Chancellor Chandler denied plaintiff’s motion for a preliminary injunction to halt a special meeting of stockholders based upon inadequate proxy statement disclosures. In David P. Simonetti Rollover IRA v. Margolis, C.A. No. 3694-VCN (Del. Ch. June 27, 2008), Vice Chancellor Noble granted a preliminary injunction based on inadequate disclosures in the challenged proxy statement. These two decisions, issued just days apart, provide further guidance to practitioners regarding the materiality of information to be included in proxy statements.

In SEC v. Talbot, 2008 WL 2574513 (9th Cir. June 30, 2008), the United States Court of Appeals for the Ninth Circuit held that a board member could be liable for insider trading under the “misappropriation theory” where the board member owed no fiduciary duty to the company whose stock he traded.  This holding reversed summary judgment granted in favor of the board member, and broadened the scope of potential liability for misappropriation of information by board members and officers of companies.

In Levitt Corp. v. Office Depot, Inc., 2008 WL 1724244 (Del. Ch. Apr. 18, 2008), the Delaware Chancery Court held that a company’s advance notice provision did not preclude a dissident shareholder from nominating its own slate of directors.  Levitt is part of a trio of cases recently issued by the Delaware Chancery Court that address the issue of the voting rights of shareholders.  Consistent with JANA Master Fund v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), aff’d, 2008 WL 2031337 (Del. May 13, 2008) [See blog article] and In re IAC/Interactive Corp., 2008 WL 2462767 (Del. Ch. Mar. 22, 2008) [See blog article], the Levitt court held that an advance notice provision that purported to require shareholders to give notice 120 days before nominating directors instead allowed shareholders to nominate directors without any independent notice.

In In re IAC/Interactive Corp., 2008 WL 2462767 (Del. Ch. Mar. 22, 2008), the Delaware Chancery Court held that management could spin the company into multiple parts without obtaining the approval of the majority shareholder.  The court’s 78-page decision boiled down to a deceptively simple question:  was the majority shareholder required to grant a consent to corporate management before IAC was broken up?  The court held that such approval was not necessary, finding that IAC’s governance agreement did not allow IAC to exercise its voting right.  This case, particularly when read with Levitt Corp. v. Office Depot, Inc., 2008 WL 1724244 (Del. Ch. Apr. 18, 2008) [See blog article] and JANA Master Fund v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), aff’d, 2008 WL 2031337 (Del. May 13, 2008) [See blog article], should signal to shareholders and corporate management alike that shareholder agreements between sophisticated parties will be strictly construed.

In JANA Master Fund v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), aff’d, 2008 WL 2031337 (Del. May 13, 2008), the Delaware Chancery Court held that CNET’s advance notice bylaw did not preclude JANA from financing and issuing its own proxy solicitation.  This case, in combination with Levitt Corp. v. Office Depot, Inc., 2008 WL 1724244 (Del. Ch. Apr. 18, 2008) [See blog article], and In re IAC/Interactive Corp., 2008 WL 2462767 (Del. Ch. Mar. 22, 2008) [See blog article], serves to remind companies that advance notice provisions will be narrowly construed under Delaware law, particularly where the franchise of the stockholder is at stake.

The March 17, 2008 issue of The National Law Journal features a special article by Sheppard Mullin partner John Stigi and associate Martin White analyzing how lower courts have applied the Supreme Court’s decision in Tellabs Inc. v. Makor Issues & Rights Ltd., 127 S. Ct. 2499 (2007), in light of pre-existing precedent within the various circuits.  As previously reported here, the Supreme Court in Tellabs addressed the heightened requirements for pleading scienter enacted in the Private Securities Litigation Reform Act of 1995.  Rejecting a relaxed “reasonable inference” approach adopted by the Seventh Circuit, the Supreme Court held that a securities fraud complaint will survive dismissal only if, based upon its factual allegations, the inference of defendant’s scienter is “cogent and at least as compelling as any opposing inference.”  As Stigi and White explain in The National Law Journal:

In Tzolis v. Wolff, 2008 WL 382345 (N.Y. Feb. 14, 2008), a majority of the New York State Court of Appeals held, over a vigorous dissent, that New York law permitted members of a limited liability company (“LLC”) to bring derivative suit on the LLC’s behalf.  As a result, under New York law, the right to bring a derivative suit has been broadened, and is no longer limited to shareholders of a corporation or limited partners of a partnership.  This ruling represents the third decision in just one week by a state’s highest court addressing the scope of legal standing for plaintiffs in shareholder derivative suits.  (We previously reported on decisions by the Delaware Supreme Court and California Supreme Court.)

In Grosset v. Wenaas, Case No. 139285, 2008 WL 383196 (Cal. Feb. 14, 2008), the California Supreme Court held that California law, like Delaware law, imposes a “continuous ownership” requirement on plaintiffs in shareholder derivative suits.  Thus, to have standing to assert and prosecute a shareholder derivative action, a plaintiff shareholder must hold stock in the corporation he or she is suing continuously throughout the entire litigation process.  This requirement applies even where the shareholder is involuntarily divested of his or her ownership interest in the corporation by virtue of a corporate merger.  While it was firmly established previously under both California and Delaware law that a shareholder could lose standing to sue by voluntarily selling his or her shares in the corporation, the decision in Grosset confirms that under California law a shareholder also may lose standing involuntarily by virtue of a merger.

In Schoon v. Smith, 2008 WL 375826 (Del. Feb. 12, 2008), the Delaware Supreme Court “decline[d] to enlarge” the standing requirement for plaintiffs in stockholder derivative actions, holding that non-stockholding directors lack standing to bring a derivative suit.  Although the court expressly reserved the power to grant “equitable standing” — standing that has not been formally granted by statute, but can be granted at the discretion of the court — it refused to make such a grant to non-stockholding directors.  Finding that there was no “failure of justice” sufficient to warrant an expansion of the equitable standing doctrine, the court concluded that the rights of the stockholders could best be protected by the stockholders themselves and not a non-stockholding board member.  This decision from Delaware’s highest court confirms that Delaware courts are unlikely to expand derivative standing to those who lack a personal financial stake in the corporation.