Securities Law Alert
In This Edition:• Third Circuit: A Company Has No Stand-Alone Obligation to Disclose Alleged Regulatory
Violations by an Affiliated Entity• Delaware Chancery Court: An Activist Investor Aided and Abetted Directors’ Breaches of
Fiduciary Duty
• Delaware Chancery Court: More Detailed Disclosures May Be Required When Directors
Propose a Transaction While the Company Is Facing Challenging Circumstances
November 2018

Third Circuit: A Company Has
No Stand-Alone Obligation to
Disclose Alleged Regulatory
Violations by an AffiliatedEntitySimpson Thacher’s“deep bench of trial
and appellate lawyers” are“regularly retained to act on
multibillion-dollar securities
class actions and derivative
suits.”–Chambers USA 2018

On November 14, 2018, the Third Circuit
affirmed dismissal of a securities fraud action
alleging that a company failed to disclose
regulatory violations by an affiliated entity.
City of Cambridge Ret. Sys. v. Altisource
Asset Mgmt. Corp., 2018 WL 5931509 (3dCir. 2018) (Fisher, J.). The Third Circuit
found “no authority to support the conclusionthat [the defendant company] was obligatedto disclose the flaws of a separate entity in its
own filings.” The court also observed that“[w]hen a stock experiences the rapid riseand fall that occurred here, it will not usually
prove difficult to mine from the economic
wreckage a few discrepancies in the nowdeflated company’s records.” The court
underscored that “[h]indsight . . . is not acause of action.”
As a preliminary matter, the Third Circuit
declined to consider alleged misstatements
made by any entities affiliated with thedefendant company. The defendant company

and other entities had been spun off from theaffiliated entity at issue, and the companies
worked together to capitalize on opportunities
in the real estate market. The court explainedthat under the Supreme Court’s decisionin Janus Capital Grp. v. First Derivative
Traders, 564 U.S. 135 (2011), the “maker” ofa statement for Rule 10b-5 purposes is “theperson or entity with ultimate authority overthe statement.”1 The court therefore
determined that “statements made bycompanies other than” the defendantcompany had no “legal significance” withrespect to plaintiffs’ Rule 10b-5 claims.
The Third Circuit then considered thedefendant company’s statements concerning
the manner in which it benefited from its
affiliate’s mortgage servicing expertise. The
defendant company stated that it depended
on the affiliate for mortgage servicing andwould face financial risks if the affiliate could
no longer provide these services. Plaintiffs
contended that these statements weremisleading because the defendant company
was allegedly aware of but did not disclose
the affiliate’s alleged regulatory violations.
But the Third Circuit found that the defendantcompany’s statements did “not imply
anything about the quality of [the affiliate’s]
1

Simpson Thacher & Bartlett LLP

Please click here to read our prior discussion of the Supreme
Court’s decision in Janus.

loan servicing.” The court determined that
there was no basis for holding that thedefendant company’s “reference to [theaffiliate] carried some form of implied
warranty” as to the quality of the affiliate’s
services. The court stated that “[e]ven
assuming that such an obligation could arise
in some cases, it would make no sense toimpose such a requirement where, as here,
the allegedly ‘concealed’ information—[the affiliate’s] regulatory failures—was
not only well-known, but typical of most
mortgage servicers at the time.”
Plaintiffs also claimed that the defendantcompany misrepresented its recusal policy,
pursuant to which the chairman of the
defendant company’s board was required torecuse himself from transactions involving
affiliated entities because the chairman
founded these entities. Plaintiffs did not allege
that the chairman failed to recuse himself
from any transactions between the defendantcompany and the affiliated mortgage servicing
entity. Instead, plaintiffs “speculate[d] that[the chairman] must have violated the . . .
recusal policy because he is suspected tohave done so with other companies.” The
Third Circuit found plaintiffs’ allegations
constituted “the very sort of speculative fraud
by hindsight that the [Private Securities
Litigation Reform Act] was intended
to eliminate.”

Delaware Chancery Court:
An Activist Investor Aided and
Abetted Directors’ Breaches of
Fiduciary Duty
On October 16, 2018, the Delaware Chancery
Court held that an activist investor aided andabetted a board’s breaches of fiduciary duty
in connection with the sale of the company.
In re PLX Tech. Stockholders Litig., 2018
WL 5018535 (Del. Ch. 2018) (Laster, V.C.).2
The trial took place solely against the activist
investor; the other parties were either
dismissed or settled. At issue were the actionsof the activist investor’s board designee, who
the court found did not disclose significant
information concerning the acquisition
to his fellow board members. The court
2 Simpson Thacher represented Avago Technologies Limitedin this matter, and PLX Technology, Inc. after the closing.
Simpson Thacher also represented Avago Technologies
Limited in its acquisition of PLX Technology, Inc.

further found that the conduct of the activist
investor’s board designee could be attributed
to the activist investor because the board
designee was a co-managing member of theactivist investor and played an important“role in directing and implementing [theactivist investor’s] strategy” with respect tothe sale of the company. Significantly, thecourt stated that its holding did “not standfor the proposition that the actions of thedirector-representative of a stockholder canalways be attributed to . . . the stockholderthat nominated or appointed him, simply
by virtue of the fact of the nomination
or appointment.”

The court found that the activist investor
had purchased a stake in the company forthe specific purpose of engineering a saleof the company. Following a proxy contest,
the activist investor placed its co-managing
member on the board. The activist investor’sboard designee subsequently learned thatan acquiror intended to purchase thecompany and was informed of the price theacquiror was willing to pay. The activist
investor’s board designee did not disclose
this information to his fellow board members.
The acquiror ultimately bid for the company,
and the company’s directors quickly
recommended that stockholders approve
the sale of the company to the acquiror.
A majority of the company’s stockholders
tendered their shares in the first step of
the merger.
The court found that there was a predicate
breach of fiduciary duty by the directors by(a) engaging in a sales process without
2

knowing critical information about the tip(though Vice Chancellor Laster noted thisinformation was withheld from them),and (b) issuing the Recommendation
Statement without disclosing (i) the
information concerning the acquiror’sinterest in purchasing the company, (ii) therole of the activist investor’s designee inthe sales process, or (iii) a discounted cash
flow analysis commissioned by the Special

Committee. The court further found that the
Recommendation Statement mischaracterized
projections that were prepared specifically forthe purpose of the acquisition as projections
made in the ordinary course of business.
Because the court determined that thestockholders’ approval was not fully informed,
the court held that the business judgment
rule did not apply to the sales process underCorwin v. KKR Fin. Holdings, 125 A.3d304 (Del. 2015).3 The court instead appliedenhanced scrutiny, the default standard ofreview when a company is sold for cash.
Under this standard, plaintiffs suing a third
party for aiding and abetting a breach offiduciary duty “bear the burden of provingthat the directors’ conduct fell outside therange of reasonableness.” The court explainedthat “evidence of self-interest” can lead to afinding of unreasonableness.
The court observed that an investor’s large
stock holding would normally “undermine
any concern about divergent interest.” Thecourt explained that “[w]hen directors or
their affiliates own material amounts of3 Please click here to read our prior discussion of the Delaware
Supreme Court’s decision in Corwin.

common stock, it aligns their interests
with other stockholders by giving thema motivation to seek the highest price.”
However, the court stated that “particular
types of investors may espouse short-term
investment strategies and structure theiraffairs to benefit economically from thosestrategies, thereby creating a divergent
interest in pursuing short-term performanceat the expense of long-term wealth.” Thecourt noted that “[i]n particular, activist
hedge funds are impatient shareholders,
who look for value and want it realized in
the near or intermediate term.” Here, thecourt found that the activist investor and its
board designee “had a divergent interest inachieving quick profits by orchestrating anear-term sale” of the company. The court
also found that “the incumbent directors
deferred to [the activist investor’s board
designee] when he sought to position himself
to best achieve a sale,” and “permitted [him]to take control of the sale process when it
mattered most.” The court concluded that thedirectors breached their fiduciary duties inconnection with the sales process and further
held that the activist investor’s board designee
knowingly aided and abetted those breaches
by “creat[ing] a critical informational gap.”
The court nevertheless ruled in favor of theactivist investor because the court foundplaintiffs failed to prove damages. Whilethe court determined that the transaction
was “flawed from a fiduciary standpoint,”
the court concluded that “the sale process
was sufficiently reliable” to show that “theplaintiffs received consideration that exceeded
the value of the Company on a stand-alone
basis” because the board “combined a narrow,pre-signing canvass with a post-signingmarket check.” The court relied on the
Delaware Supreme Court’s decision in Dell v.
Magnetar Glob. Event Driven Master Fund,
177 A.3d 1 (Del. 2017), to find that the deal
price was a “persuasive source of valuation
evidence.”4 The court determined that thedeal price likely exceeded the standalone
value of the company because the transaction“involved a combination between two
companies operating in the same industry.”

4 Please click here to read our prior discussion of the Delaware
Supreme Court’s decision in Dell.

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Delaware Chancery Court:
More Detailed Disclosures
May Be Required When
Directors Propose aTransaction While theCompany Is Facing
Challenging Circumstances
On November 20, 2018, the Delaware
Chancery Court held that stockholder
approval of a take-private acquisition thattook place while the company was underduress did not warrant application of thebusiness judgment rule standard of review
at the pleading stage because plaintiffs
adequately alleged that stockholders were
not fully informed. In re Tangoe Stockholders
Litig., 2018 WL 6074435 (Del. Ch. 2018)(Slights, V.C). The court also found plaintiffs
adequately alleged non-exculpated breachesof the duty of loyalty.
The court explained that in order to meritbusiness judgment deference for transactions
made during a “regulatory storm,” “thedirectors must demonstrate that they carefully
and thoroughly explained all material
aspects of the storm to stockholders—how
the company sailed into the storm, how thecompany has been affected by the storm, what
alternative courses the company can take tosail out of the storm and the bases for theboard’s recommendation that a sale of thecompany is the best course.” The court statedthat “[e]xtraordinary transactions proposed
to stockholders in the midst of extraordinary
times must be explained with commensuratecare.” The court also underscored that “intrying times, the directors must remain
focused on the best interests of stockholders,
not their own interests.”

Plaintiffs Alleged Material
Disclosure Deficiencies Sufficientto Defeat Application of the Corwin
Doctrine at the Pleading Stage
Under Corwin v. KKR Fin. Holdings, 125
A.3d 304 (Del. 2015), the business judgment
rule applies to transactions approved by“a fully informed, uncoerced majority of thedisinterested stockholders.” In Tangoe, theDelaware Chancery Court explained that inorder to defeat application of the Corwin
doctrine at the pleading stage, plaintiffs must

allege that the disclosures provided by theboard in connection with the transaction did
not include all material information.
The transaction at issue in Tangoe took
place after the company failed to completea restatement in a timely manner; NASDAQ
had delisted the company, and the SEC had
threatened the company with deregistration.
The Tangoe court found that plaintiffs
adequately alleged that shareholder approvalof the transaction was not fully informed
because defendants failed to provide
stockholders with (i) audited financials, and(ii) information concerning the status of
the restatement. The court recognized that
Delaware law “by no means deems audited
financial statements material per se.”However, the court found it “reasonably

conceivable that a reasonable stockholder
would have deemed audited financials
important when deciding whether to approve
the [t]ransaction” in view of the allegedly“sporadic and heavily qualified” financial
information provided by the board. The court
noted that the board allegedly commissioned
a quality of earnings report for the acquiror,
yet “elected not to disclose that report to the
public stockholders.” The company also failed
to file several quarterly reports, and did not
hold annual stockholders meetings for three
years. Given this “information vacuum,” thecourt found plaintiffs sufficiently alleged thatstockholder approval “was not fully informed”
because stockholders lacked access to“adequate financial information about the[c]ompany and its value.”
With respect to the status of the restatement,
the court rejected defendants’ contention
that they had “no duty to make a prediction”
as to when the restatement would be finalized.
The court found that defendants allegedly
4knew the restatement was nearing completion,
yet “chose not to share this information withthe stockholders and, thus, deprived them of
the opportunity to consider whether to stay thecourse and allow the [r]estatement to proceedor whether to sell as the consequences of theunfinished [r]estatement were still unfolding.”
The court therefore concluded that the Corwin
doctrine did not apply because plaintiffs“adequately pled that the [company’s]
stockholders were not fully informed when
they approved the [t]ransaction.”

Plaintiffs Adequately Alleged
Non-Exculpated Breaches of the
Duty of Loyalty
Because of the Section 102(b)(7) exculpatory
clause in the company’s certificate ofincorporation, plaintiffs could survive a motion
to dismiss only by alleging breaches of the dutyof loyalty. The court explained that pleadinga breach of the duty of loyalty requires
allegations of “sufficient facts to support a
rational inference that the corporate fiduciary
acted out of material self-interest that diverged
from the interests of the shareholders.”
Here, SEC rules prohibited defendants fromobtaining equity awards under the company’s
existing incentive plan while the restatement
was pending. Plaintiffs alleged that inorder to secure their own compensation,
defendants established new incentive awards
that would vest in the event of a change
in control. Plaintiffs alleged that this new
incentive plan motivated defendants toexpedite the sale of the company. The court
found that the new incentive plan “provided
reasonably conceivable material benefits” tothe defendants, whose “compensation wascomprised primarily of equity awards.” Thecourt recognized that the existing equity
awards were “increasingly chimerical as theunfinished [r]estatement wore on.” The court
found that the alleged “temporal connection”
between defendants’ adoption of the new
incentive plan and their “decision to shift
course toward an allegedly ill-advised sale ofthe [c]ompany” suggested defendants were
motivated by personal financial interests. The
court also found it significant that the board
faced the threat of a proxy contest, even though
the possibility of a proxy contest, standing
alone, does not defeat application of thebusiness judgment rule. The court concluded
that plaintiffs adequately pled a claim forbreach of the fiduciary duty of loyalty as toeach of the defendants and allowed the case toproceed to discovery.

This edition of the
Securities Law Alert was edited by
Paul C. Gluckow
pgluckow@stblaw.com / +1-212-455-2653,
Peter E. Kazanoffpkazanoff@stblaw.com / +1-212-455-3525,
Linton Mann III
lmann@stblaw.com / +1-212-455-2654,
and Lynn K. Neuner
lneuner@stblaw.com / +1-212-455-2696.

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Michael D. Kibler+1-310-407-7515
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