Securities Snapshot
March 15, 2017

Massachusetts Supreme Judicial Court Rules Merger Challenges Must Be Brought Derivatively

Massachusetts’ Supreme Judicial Court holds that shareholder challenges to a merger must  be brought derivatively; Delaware Chancery Court dismisses cashed-out shareholder’s Section 220 complaint for lack of standing; Southern District of New York  dismisses claims as time-barred under Sarbanes-Oxley; Southern District of California dismisses shareholder suit for failure to plead demand futility; New York Appellate Division reverses  denial of summary judgment, attributing investor losses to market-wide crash; former hedge-fund manager Raj Rajaratnam loses bid to vacate insider trading conviction; and Southern District of New York permanently dismisses FCA claim based on implied certification theory.

In International Brotherhood of Electrical Workers Local No. 129 Benefit Fund v. Tucci, the Massachusetts Supreme Judicial Court affirmed dismissal of a class action suit brought by shareholders of EMC Corporation alleging that EMC directors breached their fiduciary duties by failing to maximize shareholder consideration when approving a $67 billion merger with Denali Holding Inc. and Dell Inc. in October 2015.   The SJC agreed with the lower court’s determination that the shareholders’ claims could only be brought derivatively on behalf of EMC, not directly.  Specifically, the court held that, with limited exception, directors of Massachusetts corporations owe fiduciary duties to the corporation rather than its shareholders.  The court acknowledged that its decision conflicts with Delaware law, which holds that corporate directors owe fiduciary duties directly to shareholders, but nevertheless rejected plaintiffs’ request to bring Massachusetts law in line with Delaware.  As a result, shareholders of Massachusetts corporations will need to forego direct suits in favor of derivative actions and must be prepared to meet the corresponding demand requirements.  Goodwin represented Dell as Massachusetts counsel and a link to the Client Alert is here.

Massachusetts Federal Court Dismisses Shareholder Suit, Citing EMC Decision

The EMC decision is already having an impact on other shareholder suits.  Less than a week after the SJC ruled that, under Massachusetts law, corporate directors owe fiduciary duties to the corporation rather than shareholders, the District of Massachusetts, in an as yet unpublished ruling, dismissed counts against five former directors of Pioneer Behavioral Health in Maz Partners LP v. PHC Inc. et al.  Judge Patti B. Saris permitted the remaining claims arising out of Pioneer’s 2011 merger with Tennessee-based Acadia Healthcare to move forward but held that, in light of the SJC’s decision in EMC, the Pioneer shareholders were required to file a derivative rather than direct suit against the directors.


In Joe Weingarten v. Monster Worldwide, Inc., the Delaware Chancery Court dismissed plaintiff’s Section 220 complaint for lack of standing.  Addressing an issue that Vice Chancellor Sam Glasscock III described as “appear[ing] to be of first impression,” the court was asked to determine whether a former shareholder may nevertheless file suit under Section 220.  Plaintiff Weingarten was a shareholder of Monster Worldwide Inc. until November 1, 2016 when Monster was acquired by Randstad North America, Inc.  As a result of the merger, all outstanding Monster stock was cancelled and converted into the right to receive cash, thus eliminating Weingarten’s shareholder status.  Prior to close of the merger, on October 19, 2016, Weingarten sent a letter to Monster’s board demanding to inspect the company’s books and records.  Monster rejected the request on October 26, 2016.  On that same day, the plaintiff emailed Monster threatening to sue and specifically seeking a concession from Monster that it would not assert a standing defense if the merger were to close before Weingarten filed his complaint.  Monster responded two days later, refusing to refrain from asserting a standing defense.  On November 22, three weeks after close of the merger, Weingarten filed his Section 220 complaint.  Finding the language of Section 220(c) “plain and unambiguous,” the Chancery Court rejected plaintiff’s policy arguments, concluding that Section 220(c) clearly requires a plaintiff to show that he is a shareholder at the time of filing the complaint.      


The Southern District of New York, in Fogel v. Wal-Mart de Mexico SAB de CV, dismissed a putative class action suit brought by shareholders of the Mexican subsidiary of Wal-Mart Stores, Inc.  The shareholders alleged numerous violations of the Securities Exchange Act of 1934 based on alleged misstatements contained in annual reports issued between 2004 and 2011, as well as in press releases, reports, and SEC filings issued in 2012.  According to plaintiffs, the statements contained in these reports were false and misleading because Wal-Mart had ignored a Wal-Mex bribery scheme in order to benefit from strong growth at the subsidiary, a scandal that was not revealed until publication of a New York Times article in April 2012 that caused the value of Wal-Mex shares to plummet.  Applying the Sarbanes-Oxley statute of repose, which precludes plaintiffs from asserting a claim more than five years after the violation occurs, the court concluded that claims premised on the 2004, 2005, and 2006 reports were barred.  The court also applied the Sarbanes-Oxley two-year statute of limitations to bar claims against defendants who were not added until more than two years after the New York Times article was published, as well as new claims that were added but presented entirely new factual bases for liability.  Finally, the court dismissed the remaining claims for failure adequately to plead scienter or deceptive intent on the part of Wal-Mex or either of the named executives.


In In Re: BofI Holding Inc. S’holder Litig., the Southern District of California dismissed a shareholder derivative suit alleging that BofI’s board of directors engaged in multiple schemes revealed by a whistleblower suit filed in October 2015.  The revelation of these allegations led to a 30% one-day stock drop.  At issue for Judge Gonzalo P. Curiel was whether plaintiffs lacked standing to assert their claims by virtue of their failure to make a demand upon the board prior to filing suit.  Plaintiffs pleaded demand futility, asserting that the entire board was compromised.  Applying Delaware law to determine whether plaintiffs had properly met the standard for excusing demand on the board prior to filing suit as required by Federal Rule of Civil Procedure 23.1, the court concluded that plaintiffs failed to allege particularized facts supporting their demand futility allegations.  In particular, the court found that plaintiffs failed to alleged any particularized facts other than facts demonstrating that the board became aware of the whistleblower’s audit findings and subsequent suit.  However, plaintiffs failed to offer any particularized facts showing any misconduct by the board as a result of learning this information.  As Judge Curiel observed, “[t]he only key fact that the complaint pleads with particularity is that the board became aware of [the] whistleblower complaint on May 21, 2015.  What happened after May 21, 2015 is entirely unclear.”  


In Basis PAC-Rim Opportunity Fund (Master) v. TCW Asset Management Co., the New York Appellate Division reversed an earlier decision by the lower court denying TCW’s motion for summary judgment on common law fraud claims arising out of a 2007 investment by Basis PAC-Rim Opportunity Fund and Basis Yield Alpha Fund in Dutch Hill II, a collateralized debt obligation investment involving mortgage-backed securities for which TCW served as collateral manager.  The Basis funds alleged that TCW had encouraged them to invest more than $25 million in the now-defunct Dutch Hill II investment vehicle, despite harboring concerns about the continued viability of the sub-prime mortgage market.  The Appellate Division found that the Basis funds had failed to prove loss causation, ascribing their losses to the market-wide crash rather than any fraudulent conduct by TCW.  In particular, the court looked to competing evidence proffered by the parties’ experts and determined that TCW’s expert provided persuasive evidence that the Basis funds would have suffered losses regardless of the assets selected by TCW.  In contrast, the court held, the Basis funds’ expert merely addressed the issue of transaction causation, failing to offer any proof that their losses were the result of any fraud by TCW.  Accordingly, the court granted TCW’s motion for summary judgment.     


Judge Loretta A. Preska of the Southern District of New York, in U.S. v. Rajaratnam, denied former hedge fund manager and founder of the Galleon Group, Raj Rajaratnam’s motion to vacate his 2011 insider trading conviction.  As a result of that conviction, Rajaratnam received an 11-year sentence and was ordered to forfeit over $58 million.  In his motion to vacate his conviction, Rajaratnam, once dubbed “the modern face of illegal insider trading” by prosecutors, argued that his trial lawyers had failed to ensure that jury instructions included the requirement that the Government must prove both “knowledge” and “benefit” to succeed on an indictment of insider trading, and that his appellate counsel failed to raise this particular issue on direct appeal.  Judge Preska found this argument unpersuasive, concluding that Rajaratnam’s counsel acted reasonably in advancing other arguments in his defense.  Rajaratnam also argued that his sentence should be vacated under the “actual innocence” standard.  Judge Preska rejected this argument, as well, affirming that each trade at issue involved the exchange of personal benefit and that Rajaratnam knew that inside information was provided in exchange for such benefit.

Government’s Payment Despite Knowledge of Fraud Defeats FCA Claim

The Southern District of New York, in U.S. ex rel. Kolchinsky v. Moody’s Corp., dismissed a False Claims Act suit originally filed in 2012 by qui tam relator and former Managing Director of Moody’s Investors Services, Inc., Ilya Eric Kolchinksy.  Kolchinsky alleged that Moody’s issued inaccurate credit ratings leading up to the 2008 financial crisis.  However, the government declined to intervene following a two-year investigation and the court dismissed all but one of the claims asserted in Kolchinsky’s amended complaint.  The court permitted Kolchinsky to move forward with his “ratings delivery service” theory of liability, alleging that Moody’s had provided inaccurate ratings directly to subscribers, including government entities, in return for payment.  The court examined Kolchinsky’s implied certification theory under the holding set forth in Universal Health that False Claims Act allegations fail where “the chronology suggests that the Government knew of the alleged fraud, yet paid the contractor anyway.”  Finding that the Government had looked into credible reports of inaccuracies in Moody’s ratings but nevertheless continued to pay Moody’s, the court held that Kolchinsky failed to plead any actionable claims and dismissed the remainder of his case with prejudice.