Securities Snapshot
April 24, 2019

Delaware Supreme Court Partially Reverses Dismissal Of Shareholder Class Action Over MFW Protections

Delaware Supreme Court reverses shareholder class action due to MFW protections; New Jersey District Court dismisses securities class action against Roche alleging false and misleading statements; Tenth Circuit dismisses shareholder derivative action against Western Union for lack of pre-suit demand on the board; Delaware Supreme Court reverses Court of Chancery decision on appraisal of Aruba Networks; Jumio’s former CEO and CFO settle with SEC over false financial filings.

On April 5, 2019, the Delaware Supreme Court in Olenik v. Lodzinski affirmed in part and reversed in part the Court of Chancery’s dismissal of a stockholder complaint challenging a controller transaction between Earthstone Energy, Inc. and Bold Energy III LLC. The complaint alleged that EnCap Investments L.P. controlled both parties and caused Earthstone stockholders to approve the unfair transaction based on a misleading proxy statement. The Court of Chancery had dismissed the case under the business judgment rule, holding that the controller-led merger was nonetheless subject to the business judgment rule because Earthstone had instituted minority stockholder protections under Kahn v. M&F Worldwide Corp.

Under MFW, the business judgment rule applies to mergers proposed by a controlling stockholder and its corporate subsidiary “when conditioned from the beginning ‘upon the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and the uncoerced, informed vote of a majority-of-the-minority of stockholders.’” The plaintiff appealed the Court of Chancery’s dismissal, arguing that there were “substantive economic negotiations” before the MFW protections were put into place in August 2016. While the parties briefed the appeal, the Delaware Supreme Court decided Flood v. Synutra International, Inc., which held that the controller must “self-disable before the start of substantive economic negotiations” in order for MFW protections to apply. 

Applying Synutra, the Delaware Supreme Court agreed with the plaintiff’s arguments. In particular, it found that the plaintiff had pled facts showing “substantial” economic negotiations took place before the creation of a special committee. In particular, the Delaware Supreme Court held that although “preliminary discussions [between Earthstone and Encap] transitioned to substantive economic negotiations when the parties engaged in a joint exercise to value Earthstone and Bold.” Because those exercises occurred before MFW protections were implemented, the Delaware Supreme Court reversed the Court of Chancery’s dismissal to the extent it was based on application of the business judgment rule. This case demonstrates the importance of implementing MFW protections in controller-led transactions before “substantial,” price-related negotiations take place to ensure that the transaction receives the benefit of the business judgment rule in any resulting litigation.


On April 3, 2019, the District of New Jersey in Biondolillo v. Roche Holding AG dismissed claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 that alleged Roche and members of its executive committee made false and misleading statements about Roche’s APHINITY Phase III study. The court had previously dismissed the plaintiff’s first amended complaint because it found that the alleged statements were not materially misleading and that the complaint had failed to allege scienter for certain individual defendants. 

In his second amended complaint, the plaintiff alleged two new sets of false and misleading statements. The first set of statements concerned representations that the Breast International Group (“BIG”), one of the study collaborators, “collaborat[ed] with, but work[ed] independently from, the pharmaceutical industry.” The plaintiff claimed that this statement was misleading because Roche had paid a study collaborator and executive member of BIG more than $3 million in consulting fees and a stake in a company Roche acquired. The plaintiff also alleged that certain individual defendants made false and misleading statements concerning whether the APHINITY study and Roche’s drugs “move[d],” “improve[d]” or “increase[d]” the “standard of care.” The plaintiff argued that these statements were false and misleading because “standard of care” meant “treatment that is accepted by medical experts as a proper treatment for a certain type of disease and that is widely used by healthcare professionals,” when, in reality, APHINITY results only supported treatment for a subgroup of patients.

In dismissing the complaint, the court held that none of the alleged statements were false or misleading. The court held that the statement that BIG was “collaborating with, but working independently from, the pharmaceutical industry” was “oxymoronic, not misleading” because collaborate meant to “work jointly with” so BIG could not both collaborate with and work independently from the pharmaceutical industry. The court also rejected the plaintiff’s arguments concerning the “standard of care” statements because, among other things, the statements related to, and were accurate statements of, the company’s strategy rather than APHINITY’s results, and because the statements were matters of opinion, which were honestly believed and supported by a reasonable basis. However, the court granted the plaintiff leave to file another  amended complaint. The dismissal provides guidance on the importance of having a reasonable basis for any statements of opinion regarding pharmaceutical studies, but also highlights judicial scrutiny of claims based on statements that are oxymoronic and incapable of being false.


On April 16, 2019, the Tenth Circuit affirmed the District of Colorado’s decision in City of Cambridge Retirement System v. Ersek. The plaintiffs, putative shareholders of Western Union Company, had alleged that the company’s directors and officers breached their fiduciary duties by “willfully failing to implement and maintain an effective anti-money-laundering-compliance program . . . despite knowing of systematic deficiencies in the company’s AML compliance.” The defendants argued that the complaint should be dismissed because the plaintiffs failed to make a pre-suit demand on Western Union’s board. The plaintiffs acknowledged that they failed to make a pre-suit demand, but argued that such demand would have been futile. The District of Colorado agreed with the defendants, dismissing the case because the plaintiffs did not show that such demand would have been futile. 

On appeal, the Tenth Circuit held that dismissals under Rule 23.1 concerning demand futility will be reviewed de novo—an issue of first impression for the Circuit. The Tenth Circuit held that the relevant entity to look to when evaluating demand futility was the 11-member board that was in place when the second amended complaint was filed. While board composition is generally determined at the time that the plaintiffs initiate the action, where there is a change in the board’s composition between the original filing and an amended complaint, the new board at the time of the amendment is relevant for any derivative claims that are “not already validly in litigation.” Because it dismissed the original complaint and would have dismissed the first amended complaint if the plaintiffs did not file the second amended complaint before it could, the District of Colorado held that the claims before it were not “valid” until the filing of the second amended complaint. As a result, the District of Colorado looked to the composition of Western Union’s board at the time the second amended complaint was filed to determine whether making a pre-suit demand would have been futile.

The District of Colorado noted that six members of the 11-member board had joined the board “well after most of the red-flag events that the Shareholders allege should have alerted the Board to [the relevant] issues.” Of these six directors, the second amended complaint did not provide any arguments concerning the three newest directors, and for the other three directors, it only alleged a “general awareness of systematic deficiencies” and did not show “any of those directors consciously disregarded any contemporaneous violations of specific requirements imposed by past settlements.” Thus, the second amended complaint alleged “at most” that five of the 11 directors risked personal liability, short of the majority required to plead demand futility. Accordingly, the Tenth Circuit held that the plaintiffs’ obligation to make a pre-suit demand was not excused. 


On April 16, 2019, the Delaware Supreme Court, in Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., reversed the Court of Chancery’s decision on the fair value of Aruba Networks, Inc. The Court of Chancery had been presented with three valuation measures: (1) the “unaffected market price” of Aruba’s stock before news of the merger was leaked; (2) the deal price minus synergies; and (3) the two expert witnesses’ valuations, which were based on discounted cash flow models. In making its determination, the Court of Chancery relied on the “unaffected market price,” which was calculated by averaging the trading price of Aruba’s stock during the thirty days before news of the merger was leaked. In so doing, the Court of Chancery indicated that it intended to “back out” certain “reduced agency costs” that result from unitary or controlling ownership.

The Delaware Supreme Court rejected the Court of Chancery’s reliance on unaffected market price to account for “reduced agency costs,” because it held that there was no evidence that the deal price minus synergies valuation did not already account for those agency cost reductions. It also rejected the Court of Chancery’s reasoning that prior decisions, namely Global Corp. v. Muirfield Value Partners, L.P. (“DFC”) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, required reliance on market prices.  According to the Delaware Supreme Court, DFC and Dell did not suggest that market price of a stock is “necessarily the best estimate,” but instead recognize that “when a market was informationally efficient . . . the market price is likely to be more informative of fundamental value.” Here, the Delaware Supreme Court held that the deal price was a better assessment of the “going concern” value because the unaffected market price was measured three or four months prior to the valuation date and because the buyer had material nonpublic information that was not reflected in the market price. The court therefore ordered a final judgment be entered in the amount of the deal price minus any synergies, plus any interest to which petitioners may be entitled. 


On April 2, 2019, the Securities and Exchange Commission (SEC) settled with Jumio’s former CEO, Daniel Mattes, and former CFO and General Counsel, Chad Starkey, concerning the filing of allegedly false and misleading financial statements from which Mattes and Starkey profited. Jumio was a mobile payment company that filed for bankruptcy in 2016. The complaint alleged that Mattes overstated Jumio’s Processing Business revenue and Product Business revenue on its financial statements for 2013 and 2014. Mattes then set up a stock sale program for Jumio employees through which he sold his Jumio shares without the required board consent. To induce investors to invest in Jumio, Mattes further misrepresented to investors that he was not selling his shares. The SEC also alleged that Starkey was complicit in Mattes’ misstatements of Jumio’s revenue when he knew or should have known that they were false. Starkey had also sold some of his shares of Jumio stock during the relevant time period and profited from those sales.

In his settlement, Mattes was enjoined from future violations of the securities laws and prohibited from acting as an officer or director of any publicly listed U.S. company.  Mattes was also ordered to pay $14,617,922 in disgorgement, plus $2,145,112 in prejudgment interest, and a civil penalty of $640,000. Likewise, Starkey was also enjoined from future violations of the securities laws and ordered to pay a disgorgement of $364,000, plus a prejudgment interest of $56,894.97. The SEC did not impose a civil penalty on Starkey at that time based on “his agreement to cooperate in a related enforcement action.”