INNOVATION IN DISCLOSURE-BASED SHAREHOLDER SUITS.

AuthorGriffith, Sean J.
Position2018 Leet Business Law Symposium: Fiduciary Duty, Corporate Goals, and Shareholder Activism

CONTENTS INTRODUCTION I. TRULIA TRIGGERS INNOVATION II. PROCESS INNOVATION: MERGER CLAIMS IN OTHER STATES A. The Extraterritoriality of Trulia B. The Obligation to Disclose Trulia as Precedent in Disclosure-Based Settlements III. PRODUCT INNOVATION: MOOTNESS SETTLEMENTS IV. PROCESS AND PRODUCT INNOVATION COMBINED: FEDERAL COURT FILINGS AND THE ALT-DISCLOSURE CLAIM A. Merger Claims Under the Federal Securities Laws B. Alternative Disclosure Claims Under Federal Law V. COMPETITIVE INNOVATION CONCLUSION INTRODUCTION

Economist Joseph Schumpeter famously argued that change occurs through a process of creative destruction. (1) Competitors innovate new ways of doing things, which ushers in a new world to which competitors must adapt, sparking further rounds of innovation and adaptation. The law is no less subject to these processes than business, as recent developments in shareholder litigation show.

State corporate law governs the relationship between shareholders and boards of directors and confers upon shareholders the right to sue directors for breaches of fiduciary duty. (2) Most powerful among these, at least historically, is the fiduciary duty cause of action available to shareholders when the company they own is merged with or acquired by another company. (3) In merger litigation, shareholders can sue the board of directors for following a flawed sale process (4) or for failing to disclose adequate information prior to the shareholder vote on the transaction. (5) For many years, approximately one-third to one-half of all merger deals valued over $100 million attracted such claims. Then suddenly, in 2009, the proportion of transactions attracting merger litigation jumped from about half to approximately 85 percent. (6) The higher number became the new normal. In each year from 2009 until 2016, somewhere between 85 and 95 percent of all deals attracted litigation. (7)

What happened in 2009 that generated this spike in merger litigation? A respected practitioner once explained it to me as a function of a policy change at public relations firms. According to him, in 2009 the two top public relations firms began accepting press releases from law firms announcing "investigations" of board conduct in connection with corporate transactions. Once a deal was announced, plaintiffs' firms could immediately announce an investigation of the board. Inevitably these announcements linked to the plaintiffs' website and suggested that anyone holding stock in the target company contact the law firm for further information on the investigation. Packaged as press releases, these announcements were then picked up by websites, such as Yahoo Finance. As a result, shareholders looking up news of a merger announcement or simply tracking their investments would find, on the same web page, the announcement of an investigation into board misconduct in connection with the transaction. The announcements were, of course, a veiled form of attorney advertising for those lawyers specializing in disclosure-based claims (the "disclosure bar"). (8) Anyone who contacted the law firm was a potential plaintiff who might be willing to let the firm file a suit in their name against the target company. Thus, announcing the "investigation" as a press release became the key to finding a plaintiff. The policy change at the public relations firms enabled the disclosure bar to find a shareholder in, and thus to file a claim against, every deal.

That story may be apocryphal. But at its core is a truth about innovation. It begins with an outside shock that leads to adaptation and, in the view of many, destruction. (9) Delaware responded to the development with a 2016 decision of the Court of Chancery, In re Trulia, (10) which made disclosure-based merger claims harder to settle. (11) But the story did not end there. It is not so easy to halt the process of creative destruction. Trulia only spurred the disclosure bar to further innovation.

This Article treats Trulia as a beginning, rather than an end. It shows that the case has spurred the disclosure bar to innovate in order to protect their fees. These innovations have taken the form of both process innovations and product innovations. The disclosure bar's first step after Trulia was to seek an alternative forum, bringing disclosure claims in states other than Delaware and in federal courts. (12) This is a process innovation. Soon, however, the disclosure bar began to change the nature of the claims themselves--seeking "mootness fees" instead of "disclosure settlements" and ultimately widening the scope of possible disclosure-based claims. (13) This is a product innovation, a change in the nature of the product itself. This Article examines both forms of innovation in shareholder suits post -Trulia. The consistent theme throughout is that so long as the holdup value of litigation exceeds the cost of bringing a lawsuit, merit less claims will persist as the disclosure bar innovates to its advantage.

From this introduction, the Article proceeds as follows: Part I introduces the crisis in shareholder litigation created by the proliferation of disclosure-based claims and the response of the Delaware Court of Chancery in Trulia. Part II follows the movement of disclosure-based claims to other state courts in the wake of that case. Part III discusses the transformation of disclosure settlements into disclosure-based mootness fees. Part IV describes the further migration of disclosure claims into federal court and, once there, their mutation into alternative forms of disclosure-based claims. (14) Part V analyzes why the defense bar has lagged behind the disclosure bar in innovation and suggests that the best way for defendants to solve the problem is by credibly committing not to pay the disclosure bar's fees, ultimately arguing that the proliferation of meritless, disclosure-based claims will end only when the holdup value of such claims is lower than the cost of pursuing them.

  1. TRULIA TRIGGERS INNOVATION

    The crisis in shareholder litigation that began in 2009 was evident not only in the frequency with which merger claims were brought but also in the way in which those claims were typically resolved. (15) Merger litigation was brought in almost every deal, and most merger claims settled. (16) However, the vast majority of these settlements provided no monetary recovery to the plaintiff class. (17) Instead, merger claims typically resulted in supplemental disclosures--so called, "disclosure settlements"--that became the basis of the plaintiffs' attorney's fee award. (18) Defense attorneys insisted that the release bind all shareholders as a class and that it contain a broad release of any and all related claims. (19)

    Because these claims were settled on a class basis, courts had to approve the fairness of the settlement. (20) At fairness hearings, judges are ordinarily uninformed about the low value of the settlement disclosures, and the former adversaries work together to keep them that way so that they will approve their settlement agreement. (21) However, the Delaware Court of Chancery had seen enough such cases to worry that meaningful shareholder rights were imperiled by such practices. (22) By the end of 2015, that court had made it clear that it was considering change. (23) In January 2016, change finally came with Trulia.

    In Trulia, Chancellor Bouchard reaffirmed longstanding Delaware precedent that a supplemental disclosure offered in settlement is an adequate basis for a fee award only if it provides a material benefit to the shareholder class. (24) In Delaware, as in federal law, information is material only "if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." (25) Lest there be any doubt that Delaware judges would no longer rubber stamp disclosure settlements, the Chancellor wrote:

    [Practitioners should expect that disclosure settlements are likely to be met with continued disfavor in the future unless the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently. In using the term "plainly material," I mean that it should not be a close call that the supplemental information is material as that term is defined under Delaware law. (26) In applying a high standard of materiality as a condition for the approval of disclosure settlements, Trulia announced that such settlements would no longer be welcome in Delaware. The disclosure bar would have to take their meritless settlements somewhere else. And so they did.

  2. PROCESS INNOVATION: MERGER CLAIMS IN OTHER STATES

    Merger claims can be brought in three places: in the state of incorporation, in the headquarters state, or in federal court. (27) When a company's headquarters state is different from its state of incorporation, as is almost always the case for companies incorporated in Delaware, the complaint can be heard in up to three different courts. An early process innovation in the wake of Trulia was, therefore, to bring the claim and seek approval of the settlement in an alternative forum. This was an incremental innovation. A willingness to file merger claims outside of Delaware preceded Trulia. (28) Nevertheless, the Court of Chancery's apparent hostility to disclosure settlements led to a flood of merger litigation in other states after Trulia. (29)

    An obvious question raised by merger claims brought in other states is whether Trulia applies outside of Delaware, either as controlling or persuasive authority. The answer to this question, in turn, feeds into the litigants' potential obligation to disclose Trulia to the court in the alternative forum. Both of these questions are analyzed below.

    1. The...

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