Securities Law Alert
In This Edition:• Supreme Court: Vacates Second Circuit Decision Holding That Plaintiffs Satisfied Fifth Third’s “MoreHarm Than Good” Pleading Standard By Alleging That Delaying an Inevitable Disclosure Results inGreater Stock Price Harm
• Second Circuit: When Plaintiffs Allege Securities Fraud Based on the Nondisclosure of Illegal Activity,
Plaintiffs Must Plead the Alleged Illegal Acts With Particularity• District of Maryland: Omission of the Industry Classification of Companies Used in a Comparable PublicCompanies Analysis Did Not Render a Proxy Statement Misleading• Delaware Supreme Court: Approval of a “Flawed Transaction” After Consideration of Its Risks Does Not
Give Rise to an Inference of Bad Faith• Delaware Chancery Court: Stockholders Seeking to Inspect Books and Records Under Section 220 Do Not
Have to Present Evidence of an Actionable Claim Against the Company’s Directors
January 2020

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Simpson Thacher & Bartlett LLPSupreme Court: Vacates
Second Circuit Decision
Holding That Plaintiffs
Satisfied Fifth Third’s “MoreHarm Than Good” PleadingStandard by Alleging That
Delaying an Inevitable
Disclosure Results in Greater
Stock Price Harm
On January 14, 2020, the Supreme Court
vacated a Second Circuit decision holding thatplaintiffs satisfied Fifth Third’s “more harmthan good” pleading standard for an insideinformation-based ERISA claim against thefiduciaries of an employee stock ownershipplan (“ESOP”) by alleging that delaying aninevitable disclosure of an alleged fraud
results in greater stock price harm. Ret. Plans

Comm. of IBM v. Jander, 2020 WL 201024(2020) (per curiam).1 The Court noted thatin Fifth Third, it previously recognized that“additional considerations arise” regarding
the interplay between ERISA and the federal
securities laws when a complaint “faults
fiduciaries for failing to decide, on the basisof the inside information, to refrain frommaking additional stock purchases or for
failing to disclose that information to the
public so that the stock would no longer be
overvalued.” Id. (quoting Fifth Third). The
Court instructed that the Second Circuit
should have an opportunity to consider, inthe first instance, whether ERISA claims for
1. In Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014),
the Supreme Court held that in order “[t]o state a claim forbreach of the duty of prudence” against ESOP fiduciaries“on the basis of inside information, a plaintiff must plausibly
allege an alternative action that the defendant could havetaken that would have been consistent with the securities laws
and that a prudent fiduciary in the same circumstances would
not have viewed as more likely to harm the fund than to helpit.” Please click here to read our discussion of Fifth Third.

failure to disclose inside information arecompatible with the federal securities laws.
The Court noted that in their merits briefings,
petitioners went beyond the scope of theSecond Circuit’s decision and “argued thatERISA imposes no duty on an ESOP fiduciaryto act on inside information.” Counsel for theUnited States, as amicus curiae supporting
neither party, went even further and “argued
that an ERISA-based duty to disclose inside
information that is not otherwise required
to be disclosed by the securities laws
would conflict at least with objectives of
the complex insider trading and corporate
disclosure requirements imposed by thefederal securities laws.” The Court statedthat it would not reach these arguments
because they were not raised before, oraddressed by, the Second Circuit. The Court
noted that in Fifth Third, it recognized thatthe view of the SEC “may well be relevant”
to the question of whether an ERISA-based
duty to disclose might “conflict” with federal
securities laws. Id. (quoting Fifth Third). The
Court stated that the Second Circuit “shouldhave an opportunity to decide whether
to entertain these arguments in the first
instance” and then “tak[e] such action as it
deems appropriate.”
In a concurring opinion joined by JusticeGinsburg, Justice Kagan expressed her viewthat Fifth Third “makes clear that an ESOP
fiduciary at times has” a duty to “act on
insider information.” She stated that there
is a “conflict-free zone” in which an ESOP
fiduciary might be able to disclose inside
information without running afoul of the
securities laws. She explained that under Fifth
Third, “[t]he question in that conflict-freezone is whether a prudent fiduciary would
think the action more likely to help than toharm the fund.” She stated that adopting theGovernment’s position “would mostly wipeout [this] central aspect of the [Fifth Third]
standard” and would therefore “not accord”
with Fifth Third.
In a separate concurring opinion, JusticeGorsuch stated that requiring ESOP
fiduciaries to disclose inside information
under any circumstances would require
fiduciaries to “act[] in their capacities ascorporate officers, not ERISA fiduciaries.” Heobserved that “[b]ecause ERISA fiduciaries
are liable only for actions taken while acting
as a fiduciary, it would be odd to hold thesame fiduciaries liable for alternative actions
they could have taken only in some othercapacity.” Justice Gorsuch recognized that
Fifth Third “made plain that suits requiring
fiduciaries to violate the securities laws
cannot proceed.” However, he did not read
Fifth Third as “guaranteeing that all othersuits may” proceed. In Justice Gorsuch’sview, Fifth Third is “silent” on this issue
because “[n]o one in that case asked the
Court to decide whether ERISA plaintiffs
may hold fiduciaries liable for alternative
actions they could have taken only in a
nonfiduciary capacity.”

Second Circuit: When
Plaintiffs Allege Securities
Fraud Based on theNondisclosure of Illegal
Activity, Plaintiffs Must Plead
the Alleged Illegal Acts With
Particularity
On December 10, 2019, the Second Circuit
affirmed the dismissal with prejudice of asecurities fraud action alleging that a poultry
company failed to disclose an antitrust
conspiracy to inflate chicken prices. Gamm
v. Sanderson Farms, 944 F.3d 455 (2d Cir.
2019) (Winter, C.J.). The court held that“when a complaint claims that statements
were rendered false or misleading throughthe nondisclosure of illegal activity, the factsof those underlying illegal acts must also bepleaded with particularity.”
The Second Circuit rejected plaintiffs’
contention that “there is no public policy
reason supporting the use of a heightened
pleading standard for allegations ofanticompetitive conduct simply because2they underpin a securities fraud classaction.” The court explained that thePrivate Securities Litigation Reform Act(“PSLRA”) “requires that a securities
fraud claim based on information andbelief must ‘state with particularity all
facts on which that belief is formed.’” Id.
(quoting 15 U.S.C. § 78u-4(b)(1)). The court
observed that “[i]n this case, appellants’nondisclosure and material omission claims
are entirely dependent upon the predicate
allegation that [the company] participated ina collusive antitrust conspiracy.” The court
found that “[i]n order to properly provide ‘allfacts’ upon which their securities fraud claim
is based, their allegations must also provide
particularized facts about the underlying
conspiracy.” The court reasoned that suchparticularized allegations are necessary to“explain[] what rendered the statements
materially false or misleading.”
The Second Circuit explained that its
decision “comports with the stated intent
and public policy rationale of the PSLRA.”
The court noted that “[a] stock-issuing
company . . . cannot be required, wheneveraccused of illegal activity, to simultaneously
defend itself in an accompanying securities
fraud suit based on facts not alleged withthe level of particularity required by thestatute.” The court observed that “[s]ucha reality would harm the company’s stockand contravene the purpose of the securities
laws—to protect shareholders’ interests.”
The Second Circuit noted that in order toplead an antitrust conspiracy, plaintiffs
must allege “(1) a contract, combination,or conspiracy; (2) in restraint of trade; (3)affecting interstate commerce.” The court
recognized that “an agreement may be alleged
through conscious parallelism together withplus factors,” such as “a common motive
to conspire, evidence that shows that theparallel acts were against the apparent
individual economic self-interest of thealleged conspirators, and evidence of a highlevel of interfirm communications.” The court
found that plaintiffs “allege[d] mere parallel
conduct, and lack[ed] indicia of mutuality
or otherwise interdependent action.” Thecourt noted that plaintiffs “could have alleged
when [the company] decided on its course of
supply reduction, which industry peers werea part of that decision, how specific supply
reductions were performed by each of thedifferent poultry producers, what information[the company] knew about its peers’ supply
reductions, if any, and—perhaps most basicof all—whether [the company] actually
reduced chicken supply, and if so, by whatvolume.” The court emphasized that plaintiffs“provided none of these facts.” The court
concluded that plaintiffs “failed to plead thefirst element of antitrust conspiracy at evena basic level, much less with particularity.”
The court also found the complaint “entirely
silent” on whether the company’s actions“unreasonably restrained trade, and whether
that restraint affected interstate commerce.”
The court therefore concluded that plaintiffs’
complaint was “deficient.”

District of Maryland:
Omission of the Industry
Classification of Companies
Used in a Comparable PublicCompanies Analysis Did Not
Render a Proxy Statement
Misleading
On December 4, 2019, the District ofMaryland dismissed with prejudice asecurities fraud action alleging that a proxystatement (“Proxy”) issued in connection with3

the sale of an industrial real estate investment
trust (“REIT”) was materially misleading inviolation of Section 14(a) of the Securities
Exchange Act of 1934 and SEC Rule 14a-9.
Hurtado v. Gramercy Property Trust, 2019
WL 6618663 (D. Md. 2019) (Hollander, J.).2
Plaintiff alleged that the Proxy’s summaryof a comparable public companies analysis(“CPC Analysis”) that underpinned afairness opinion was misleading because
it did not disclose that only two of the fivecomparator companies were industrial
REITs. The court found this “omission was
not material” in view of “the full mix ofstatements in the Proxy as well as the Proxy’s
tailored warnings, combined with publicly
available information.”

The court explained that “[t]he materiality ofan omission must be examined in context andin light of the total mix of information madeavailable to investors,” including “the entiretyof the relevant SEC filing” and “informationin the public domain.” Here, the Proxy “setforth twenty-nine material factors that the[b]oard considered before recommending theacquisition.” The court found “the Proxy madeclear that the [f]airness [o]pinion was but oneof many variables the [b]oard evaluated inarriving at its decision.” Moreover, the court
found the Proxy “contained an exhaustive
summary” of the seven financial analyses
that were discussed in the fairness opinion,
and noted that “the per share valuation range
produced by the CPC Analysis fit comfortably
within the estimates produced by the other”
analyses. “Given these comprehensive
disclosures,” the court determined that “theProxy provided shareholders more thanenough information to decide how to vote.”
With respect to the CPC Analysis, the court
found the Proxy “disclosed the five companies
2. Simpson Thacher represents Gramercy Property Trust in thismatter.

that [the financial advisor] selected ascomparators,” and explained that thesecompanies were selected “because they sharedsimilar business characteristics” with thecompany. The Proxy “expressly disavowed
any representation that the comparator
companies used in the CPC Analysis were aperfect match to [the company].” The Proxyalso disclosed that the financial advisor“made judgments and assumptions” when“evaluating companies.” The court foundthese warnings “negate the materiality of thealleged omission.”
The court emphasized that the classificationof the comparator companies “was notuniquely in the possession of defendants.”
Rather, “the way in which the market indicesclassify these companies is information easily
accessible in the public domain.” The court
observed that “an interested shareholder had
the option of researching the comparatorsand determining for herself whether thecomparators were good ones.” The court heldthat “the omission of this information did
not affect the information available to [thecompany’s] shareholders.”“Even assuming, for the sake of argument,that the omitted information was material,”
the court found that “it did not render any
statements contained in the Proxy false or
misleading.” The court reasoned that theProxy did not represent that the comparator
companies were selected “based on howmarket indices classified them.” Moreover,the Proxy “fully disclosed” that the CPC
Analysis “was suffused with subjective
judgments and may undervalue or overvalue[the company’s] stock price.”

Delaware Supreme Court:
Approval of a “Flawed
Transaction” After
Consideration of Its Risks
Does Not Give Rise to an
Inference of Bad Faith
On January 13, 2020, the Delaware
Supreme Court held that a board’s approvalof a “flawed transaction” that implicatedthe misappropriation of a competitor’s
confidential information did not give riseto an inference of bad faith, where “thedirectors considered the risks and nonetheless4

proceeded with the transaction.” McElrath v.
Kalanick, 2020 WL 131371 (Del. 2020) (Seitz,
C.J.). The court underscored that “there isa vast difference between an inadequate or
flawed effort to carry out fiduciary duties anda conscious disregard for those duties.”
The court explained that because of theexculpation clause in the company’s
Certificate of Incorporation, the directors
could face personal liability only if “theirconduct [was] motivated by an actual intent
to do harm,” or if there was “an intentionaldereliction of duty.” The court emphasizedthat “[p]leading bad faith is a difficult
task and requires that a director acted
inconsistent[ly] with his fiduciary duties and,most importantly, that the director knew hewas so acting.”
Here, plaintiff alleged that the “directors
heard a presentation that summarized
the transaction [proposed by the CEO],reviewed the risk of litigation . . . , generally
discussed due diligence, asked questions,and participated in a discussion.” Whilethe court recognized that the CEO “might
have a background that would lead areasonable board member to dig deeper
into representations he made about thetransaction,” there were “no allegations
that [the CEO] had a history of lying to theboard.” Moreover, the court found “the record
supports the conclusion that the diligencepresented to the board was, in fact, ‘okay.’”
The court acknowledged that it was “unusual”
that the transaction indemnified the target
company’s employees for certain premerger conduct. However, the court rejected
plaintiffs’ contention that these provisions put
the directors on notice that “the transaction
was nothing more than a vehicle to steal [itscompetitor’s] proprietary information.” Thecourt found “the reasonable inference is thatthe board should have done more, not that it
acted in bad faith.”

before approving the hiring of the company’s
president. McElrath, 2020 WL 131371(discussing Disney). Here, the “board met
to consider the [] acquisition,” hired outside
counsel and an investigative firm to conduct
due diligence, listened to a presentationfrom the company’s CEO, and “discussed
the terms of the deal and its risks.” Thecourt determined that “the board’s failure toinvestigate further cannot be characterized
fairly as an intentional dereliction of
its responsibilities.”

Delaware Chancery Court:
Stockholders Seeking to
Inspect Books and Records
Under Section 220 Do Not
Have to Present Evidence ofan Actionable Claim Against
the Company’s Directors
On January 13, 2020, the Delaware Chancery
Court held that a stockholder seeking books
and records pursuant to Section 220 of
the Delaware General Corporation Law
does not have to “introduce evidence fromwhich a court could infer the existence ofan actionable claim” against the company’sboard. Lebanon Cty. Emps. Ret. Fundv. AmerisourceBergen Corp., 2020 WL
132752 (Del. 2020) (Laster, V.C.). Rather,a stockholder must simply “establish, by apreponderance of the evidence, that there isa credible basis to infer possible corporate
wrongdoing or mismanagement.” Thecourt stated that “[w]hen a corporation has
suffered a significant trauma, and when astockholder can establish a credible basis to

The court concluded that “[t]he complaint’s
allegations do not lead to a reasonable
inference that the board intentionally ignored
the risks of the transaction.” The court notedthat the case before it was unlike In re Walt
Disney Co. Derivative Litigation, 825 A.2d275 (Del. Ch. 2003), where the Chancery
Court found the allegations sufficientto plead bad faith because the directors
allegedly “devoted very little time, had nopresentations, and asked no questions”
5suspect a possible violation of positive law,
the stockholder has stated a proper purpose
for an inspection of books and records” under
the Delaware Supreme Court’s decision in
Seinfeld v. Verizon Communications, 909
A.2d 117 (Del. 2006).

Court Finds Stockholders Alleged
a Credible Basis to Infer Possible
Mismanagement or Wrongdoing
Warranting Further Investigation
Section 220 provides that stockholders
may “inspect for any proper purpose” thecompany’s books and records. 8 Del. C.
§ 220(b). The AmerisourceBergen court
explained that “a mere statement of apurpose to investigate possible generalmismanagement, without more, will
not entitle a shareholder to broad § 220
inspection relief.” 2020 WL 132752 (quoting
Seinfeld). Rather, “a stockholder must ‘show,
by a preponderance of the evidence, a credible
basis from which the Court of Chancery caninfer there is possible mismanagement thatwould warrant further investigation.’” Id.
(quoting Seinfeld). The court emphasizedthat “[t]he ‘credible basis’ standard is the‘lowest possible burden of proof.’” Id.
(quoting Seinfeld). To meet this standard,a stockholder “may rely on circumstantial
evidence” or “on hearsay, as long as it issufficiently reliable.” The court stated that“[o]ngoing investigations and lawsuits canprovide the necessary evidentiary basis tosuspect wrongdoing or mismanagement
warranting further investigation,” particularly“when governmental agencies or armsof law enforcement have conducted theinvestigations or pursued the lawsuits.”
In the case before the court, the stockholders
sought “to investigate possible breaches offiduciary duty, mismanagement and otherviolations of law” by the directors and thecompany’s management “in connection with[the company’s] distribution of prescription
opioid medications.” The court held that“the flood of government investigations andlawsuits relating to [the company’s] opioiddistribution practice is sufficient to establish
a credible basis to suspect wrongdoing
warranting further investigation,” particularly
because the company “is suffering asignificant corporate trauma” in connection
with these matters. The court found that
there was “a credible basis to suspect that [thecompany’s] situation did not result from an
ordinary business decision that, in hindsight,
simply turned out poorly.” Rather, the court
found “strong circumstantial evidence” thatthe company “may have pushed opioids into
the distribution chain under circumstanceswhere [the company] knew or should have
known that they would be diverted for
improper purposes.”

Stockholders Need Not Specify How
They Intend to Use the Results of
the Section 220 Investigation
The court rejected the company’s position
that “if a stockholder wants to investigate
corporate wrongdoing and use the resulting
documents to achieve an end other than
filing litigation, then the stockholder mustsay so in the demand.” The court stated that“[a] responsible stockholder cannot identify
all of the potential uses for books and records
before knowing what the books and records
reveal.” The court acknowledged that a
number of recent cases have interpreted
Section 220 to require that “a stockholder
must not only state a proper purpose, but also
must state a reason for the purpose, i.e., what
it will do with the information, or an end towhich the investigation may lead.” The court
found this “goes beyond what Section 220 andDelaware Supreme Court precedent require.”

Stockholders Do Not Haveto Provide Evidence of an
Actionable Claim Against theBoard to Investigate Wrongdoingor Mismanagement
The court found the stockholders’ demand“signaled that they are not solely interested infiling a derivative lawsuit to pursue a damages
remedy,” but are “open to considering otherpossible remedies, corrective measures, andmethods of addressing the wrongdoing that6

they believe has occurred.” The company,
however, “interpreted the [d]emand asconfined to investigating a Caremark claim”
and contended that the stockholders “mustpresent evidence demonstrating a credible
basis to suspect actionable wrongdoing on thepart of the [b]oard.”
The court found the company’s asserted“actionable-wrongdoing requirement imposes
an onerous burden on stockholders that goesbeyond the standard established in Seinfeld.”
The court emphasized that “[t]he Delaware
Supreme Court has not required a stockholder
seeking books and records to introduce
evidence from which a court could infer the
existence of an actionable claim,” nor has it
ever “equated the credible-basis standard
with an actionable-claim requirement.” Thecourt explained that “[u]nder Seinfeld, theoperative question is whether a stockholder
has shown a credible basis to suspectpossible mismanagement or wrongdoingat the corporation.” The court noted that“[t]his standard does not require tying themismanagement or wrongdoing to the board.”
The court found it significant that “[t]heDelaware Supreme Court has repeatedly
urged stockholders to use Section 220 toinvestigate possible wrongdoing before
filing derivative actions, recognizing thatwithout doing so, plaintiffs typically lack thefacts necessary to plead an actionable claim
against the board that can survive a Rule23.1 motion.” The court explained that “[t]helogical implication of this message is thatto obtain books and records, a stockholder
does not have to introduce evidence fromwhich a court could infer the existence of anactionable claim.”
The court rejected the company’s meritsbased defenses to the stockholders’ Section
220 demand “for the threshold reason thatthe plaintiffs are not seeking books andrecords for the sole purpose of investigating
a potential Caremark claim.” Moreover, thecourt found it “would be premature to allow[the company] to rely on its exculpatory
provision to foreclose an inspection into
possible corporate wrongdoing” because“[t]he issues that the plaintiffs wish toinvestigate could well lead to non-exculpatedclaims.” The court stated that “[a] failure
to act in good faith may be shown if thedirectors act with a purpose other thanthat of advancing the best interests of thecorporation, such as by consciously failingto attempt to take action in good faith toprevent a corporate trauma.” The court
similarly found that it would be “premature to
determine . . . that any possible claim that theplaintiffs might bring would be time-barred.”
The court observed that “doctrines likefraudulent concealment or equitable tolling
could enable the plaintiffs to pursue otherwise
stale claims,” and they might also be able to“use the earlier information to show that thedirectors engaged in a sustained or systemic
failure to exercise oversight.”

Court Permits Stockholders to
Take a Rule 30(b)(6) Deposition to
Ascertain the Scope of Their Section
220 DemandWith respect to the scope of a Section
220 demand, the court explained that a“plaintiff should receive access to all of the
documents in the corporation’s possession,custody or control, that are necessary tosatisfy the plaintiff’s proper purpose.” If“a plaintiff has shown evidence of wideranging mismanagement or waste, a morewide-ranging inspection may be justified.”
The court noted that “[t]he starting point(and often the ending point) for an adequate
inspection will be board-level documents thatformally evidence the directors’ deliberations
and decisions and comprise the materials
that the directors formally received andconsidered (the ‘Formal Board Materials’).”The court instructed that “[i]f the plaintiff
makes a proper showing, an inspection may
extend to informal materials that evidence
the directors’ deliberations, the informationthat they received, and the decisions theyreached (‘Informal Board Materials’).” Suchmaterials “may include emails and other typesof communications sent among the directors
themselves, even if the directors used noncorporate accounts.” The court stated that7

“[i]n an appropriate case, an inspection may
extend further to encompass communications
and materials that were only shared amongor reviewed by officers and employees(‘Officer-Level Materials’).” The court statedthat “[w]hether a stockholder is entitled toa particular category of documents is fact
specific and will necessarily depend on thecontext in which the shareholder’s inspection
demand arises.” The court noted that “[i]t isoften helpful when ruling on a Section 220
demand to have information about whattypes of books and records exist and who
has them.”

Here, the company “prevented the plaintiffs
from obtaining any information about whattypes of books and records exist and who
has them.” The court therefore held that“the plaintiffs may conduct a Rule 30(b)(6)
deposition” to ascertain what documents
are available. The court found that thestockholders had already “shown that they
are entitled to Formal Board Materials,” andheld that they may also “make a follow-on
application for Informal Board Materials or
Officer-Level Documents” if the parties areunable to reach agreement on the scope of thedemand after the Rule 30(b)(6) deposition.

This edition of the
Securities Law Alert was edited by
Susannah S. Geltman
sgeltman@stblaw.com / +1-212-455-2762,
Paul C. Gluckow
pgluckow@stblaw.com / +1-212-455-2653,
and Linton Mann III
lmann@stblaw.com / +1-212-455-2654.

8

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