Securities Law Alert
In This Edition:• Supreme Court Holds a Fiduciary’s Allegedly Imprudent Retention of an Investment May Be an “Action” or“Omission” for Purposes of Triggering the Six-Year Statute of Repose for ERISA Claims• Sixth Circuit Applies the Reves Factors to Find That Promissory Notes Are “Securities” Subject to theFederal Securities Laws
• Seventh Circuit Vacates Jury Verdict in HSBC Securities Fraud Action on Loss Causation Grounds, Finding
Plaintiffs’ Loss Causation Model Failed to Eliminate Firm-Specific, Nonfraud Factors That May Have
Impacted HSBC’s Stock Price• Southern District of New York Dismisses Securities Fraud Action Against Prosensa, Finding Companies
Have No Obligation to Spell Out Inferences or Draw Conclusions for Investors• Delaware Supreme Court Holds Plaintiffs Must Plead a Non-Exculpated Claim Against Disinterested,
Independent Directors to Survive a Motion to Dismiss Even If the Transaction at Issue Is Subject to Entire
Fairness Review• Delaware Chancery Court Rules That Self-Interested Director Compensation Decisions May, Under Certain
Circumstances, Be Subject to Entire Fairness Review• Delaware Chancery Court Relies on the Merger Price in Appraising AutoInfo’s Shares
May 2015

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Simpson Thacher & Bartlett LLPSupreme Court Holdsa Fiduciary’s Allegedly
Imprudent Retention of
an Investment May Be an“Action” or “Omission” forPurposes of Triggering the
Six-Year Statute of Repose
for ERISA Claims
On May 18, 2015, the Supreme Court
considered “whether a fiduciary’s allegedly
imprudent retention of an investment isan ‘action’ or ‘omission’ that triggers therunning” of the six-year statute of repose forbreach of fiduciary duty claims brought under

the Employee Retirement Income Security
Act of 1974 (“ERISA”).1 Tibble v. Edison
Int’l, 2015 WL 2340845 (May 18, 2015)(Breyer, J.).

BackgroundIn 2007, beneficiaries of the Edison 401(k)Savings Plan (the “Plan”) brought suit in
the Southern District of California against
Edison International and the Plan’sfiduciaries alleging that defendants had
1. Pursuant to ERISA, “a breach of fiduciary duty complaint istimely if filed no more than six years after ‘the date of the lastaction which constituted a part of the breach or violation’ or ‘inthe case of an omission the latest date on which the fiduciary
could have cured the breach or violation’” (quoting 29 U.S.C.
§ 1113).

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“acted imprudently by offering six higher
priced retail-class mutual funds as Plan
investments when materially identical lower
priced institutional-class mutual funds wereavailable.” Three of these funds were added to
the Plan in 1999, more than six years before
plaintiffs filed suit.
The district court dismissed plaintiffs’
claims in connection with these three funds
on timeliness grounds. The Ninth Circuit
affirmed, finding plaintiffs’ claims “untimely
because [plaintiffs] had not established achange in circumstances that might trigger
an obligation to review and to change
investments within the 6-year statutory
period.” The Ninth Circuit focused “uponthe act of ‘designating an investment forinclusion’ to start the 6-year period” (quoting
Tibble v. Edison Int’l, 729 F.3d 1110 (9th Cir.
2015)). In the Ninth Circuit’s view,“‘[c]haracterizing the mere continued
offering of a plan option, without more, as asubsequent breach would render’ the statutemeaningless and could even expose present
fiduciaries to liability for decisions madedecades ago” (quoting Tibble, 729 F.3d 1110).
Plaintiffs appealed.

Supreme Court Holds a Plaintiff
May State an ERISA Breach of
Fiduciary Duty Claim by Alleging
That the Fiduciary Failed to
Monitor Plan Investments andRemove Imprudent Investments
Within the Six Year Statute of
ReposeThe Supreme Court determined that “theNinth Circuit [had] erred by applying a
6-year statutory bar based solely on theinitial selection of the three funds without
considering the contours of the alleged breachof fiduciary duty.” The Court explained that
“under trust law,” which courts “often must
look to” when “determining the contours of
an ERISA fiduciary’s duty,” “a fiduciary is
required to conduct a regular review of its
investment with the nature and timing of thereview contingent on the circumstances.”
Examining trust law, the Court found that “atrustee has a continuing duty to monitor trust
investments and remove imprudent ones.”
The Court stated that “[t]his continuing duty
exists separate and apart from the trustee’s
duty to exercise prudence in selecting

investments at the outset.” A trustee may
not “assume that if investments are legal
and proper for retention at the beginningof the trust, or when purchased, they willremain so indefinitely.” Instead, a trustee
must systematically review trust investments“‘at regular intervals’ to ensure that they areappropriate.”
Applying these trust law principles to ERISA
fiduciaries, the Court held that “[a] plaintiff
may allege that a fiduciary breached the dutyof prudence [under ERISA] by failing toproperly monitor investments and remove
imprudent ones.” The Court further ruledthat an ERISA claim “is timely” “so long as
the alleged breach of [this] continuing duty
occurred within six years of [the] suit.”
The Court remanded the action to the Ninth
Circuit for consideration of whether the
ERISA duty of prudence “require[d] a reviewof the contested mutual funds here, and if
so, just what kind of review” was required.
Notably, the Court “express[ed] no view on
the scope of respondents’ fiduciary duty inthis case.”

Sixth Circuit Applies theReves Factors to Find That
Promissory Notes Are“Securities” Subject to theFederal Securities Laws
On May 21, 2015, the Sixth Circuit considered
whether promissory notes representing
what turned out to be “fake investments in
Saudi Arabian oil” that were sold “to dozens
of unsuspecting victims” were “securities”
subject to the federal securities laws. SEC
v. Zada, 2015 WL 2402136 (6th Cir. 2015)(Kethledge, J.). Applying the four-factor test
set forth in Reves v. Ernst & Young, 494
U.S. 56 (1990), the Sixth Circuit determinedthat all four Reves factors “reinforce[d] [the]presumption” that the notes were “securities”
subject to the federal securities laws.
The Sixth Circuit explained that in order“[t]o rebut the presumption that a particularnote is a security, a defendant must showthat the note bears a ‘family resemblance’”
to “instruments that are not securities,”
such as “consumer debt, home-mortgage
loans, character loans to bank customers,2and short-term commercial debt.” “Whether
the note bears a resemblance to one ofthose instruments depends on four factors”
established in Reves: (1) “the motivation
prompting the transaction;” (2) the “planof distribution;” (3) the “‘reasonable
expectations of the investing public;’”
and (4) “whether a ‘risk-reducing factor’(for example, another regulatory scheme)
makes ‘application of the [federal securities
laws] unnecessary.’”
The Sixth Circuit stated that “[t]he first
Reves factor—the motivations that prompted
the buyers to enter into the transactions—turns on whether the buyers’ purposewas ‘investment (suggesting a security)
or commercial or consumer (suggesting a
non-security).’” In the case before it, “theSEC [had] presented testimony from several
investors and an affidavit from another, all tothe effect that [defendant had given] them thenotes as part of a scheme to invest in Saudioil.” With respect to defendant’s contention
that “some of the investors referred to thetransactions as ‘loans,’” the Sixth Circuit
explained that a financial instrument can beat once a loan and a security. The court notedthat “[a] corporate bond, for example, is botha loan to the corporation and an investment
for the lender.” The Sixth Circuit underscoredthat “economic realities” are what mattermost when determining whether an
instrument is a security. Here, the court foundit “doubtful that 60 investors—including
several firefighters and a horse trainer—
would make personal loans to a self-styled
multimillionaire.”
The Sixth Circuit next considered the “planof distribution” for the promissory notes atissue. The court stated that “[i]f notes are soldto a wide range of unsophisticated people,
as opposed to a handful of institutional
investors, the notes are more likely to be
securities.” Here, defendant “sold the notes toa variety of laypersons.” The court found that
this supported the SEC’s claim that the notes
constituted “securities.”
As to the third Reves factor (“the reasonable
expectations of the investing public”), theSixth Circuit explained that notes are likely
to be “securities if a reasonable person would
expect the securities laws to apply” to thosenotes. In the case at hand, the court observedthat defendant’s “victims thought they weremaking lucrative investments in oil, which

is traded on global markets.” Because the“federal securities laws are broad enough tocover ‘virtually any’ marketable investment,”
the Sixth Circuit determined that “areasonable person who gave [defendant]
money to invest in oil markets would
expect that the securities laws appl[ied] tothe transaction.”
Finally, the Sixth Circuit found that“[t]he final Reves consideration—whether
a risk-reducing factor makes application of
the Securities Acts unnecessary—likewisesuggest[ed] that [defendant] sold securities.”
The court explained that “[i]f the notesthat [defendant] sold were not securities,
then they ‘would escape federal regulation
entirely.’” The court determined that “thisfactor favor[ed] the SEC as well.”Based on the Reves analysis, the Sixth Circuit
concluded that the notes were securities
subject to the requirements of the federal
securities laws.

Seventh Circuit Vacates Jury
Verdict in HSBC Securities
Fraud Action on Loss
Causation Grounds, Finding
Plaintiffs’ Loss Causation
Model Failed to Eliminate
Firm-Specific, Nonfraud
Factors That May Have
Impacted HSBC’s Stock PriceOn May 21, 2015, the Seventh Circuit
vacated a jury verdict finding Household
International, Inc., now known as HSBC
Finance Corp. (“HSBC”), and several of its
executives liable for $2.46 billion in damages
for securities fraud. Glickenhaus & Co. v.
Household Int’l, Inc., 2015 WL 2408028 (7thCir. 2015) (Sykes, J.). Relying on the Supreme
Court’s decision in Dura Pharm., Inc. v.
Broudo, 544 U.S. 336 (2005), the Seventh
Circuit held that defendants were entitled toa new trial because plaintiffs’ leakage modelof loss causation “did not adequately accountfor the possibility that firm-specific, nonfraud
related information may have affected thedecline in [HSBC’s] stock price during therelevant time period.”3

Background
Plaintiffs brought suit “alleging that on
numerous occasions [HSBC] and its
executives [had] misrepresented [HSBC’s]
lending practices, delinquency rates, andearnings from credit-card agreements.”
The case proceeded to trial before a jury.
During trial, plaintiffs’ expert presented two
different models—the specific-disclosure
model and the leakage model—for measuring
the amount by which HSBC’s stock price was“overpriced” as a result of defendants’ alleged
misrepresentations.
The specific-disclosure model measured
the effect of each “major disclosure event”
on HSBC’s stock price on the specific dayof that event. Plaintiff’s expert determined“[t]he effect of a disclosure event” based
on “the actual return on the day of thedisclosure minus the predicted return(using [a] regression model and the broader
market returns that day).” The leakage
model accounted for the possibility that“the information contained in a major
disclosure event often leaks out to somemarket participants before its release.” Theleakage model factored in “every difference,both positive and negative, between thestock’s predicted returns … and the stock’s
actual returns during the disclosure period.”
Pursuant to the leakage model, plaintiffs’
expert assumed that the effect of defendants’disclosures was equal to “[t]he total sum ofthese residual returns.”
During trial, the jurors were asked todetermine “which model more accurately
measured the effect of disclosures,” among
other issues. The jury “adopted and applied
the leakage model,” and found defendants
liable for $2.46 billion in damages. Defendants
appealed the jury verdict on the grounds
that, inter alia, “the leakage model … did
not account for firm-specific, nonfraud
factors that may have affected the decline in[HSBC’s] stock price.”
Defendants also contended that the court had“incorrectly instructed” the jury “on what itmeans to ‘make’ a false statement in violationof the securities laws.” The district court had
advised the jury that in order “[t]o prevailon their 10b-5 claim against any defendant,
plaintiffs must prove … the defendantmade, approved, or furnished information
to be included in a false statement of fact.”

Defendants moved for a new trial basedon the Supreme Court’s decision in Janus
Capital Group v. First Derivative Traders,
131 S. Ct. 2296 (2011), which was issued
after the trial.2 The Janus Court held that“[f]or purposes of Rule 10b-5, the makerof a statement is the person or entity withultimate authority over the statement,
including its content and whether and how
to communicate it.” The district court denied
defendants’ motion, “reasoning that the[Janus] Court’s holding applied only to legallyindependent third parties (like the investment
advisor in Janus itself), not corporate insiders
like the individual defendants here, all top
executives at [HSBC].” Defendants appealed.

Seventh Circuit Finds a New Trial
Is Warranted on Loss Causation
Grounds Because the Leakage
Model Did Not Account for FirmSpecific, Nonfraud Factors
On appeal, the Seventh Circuit found that“in order to prove loss causation” underDura, 544 U.S. 336, “plaintiffs in securitiesfraud cases need to isolate the extent towhich a decline in stock price is due tofraud-related corrective disclosures and notother factors.” The court observed that inDura, the Supreme Court recognized thata stock price decline “may reflect, not theearlier misrepresentation, but [also] changed
investor expectations, new industry-specificor firm-specific facts, conditions, or otherevents, which taken separately or together
account for some or all of that lower price”(quoting Dura, 544 U.S. 336) (emphasis
added by the Seventh Circuit).
The Seventh Circuit determined thatplaintiffs’ “leakage theory … did notadequately account for the possibility thatfirm-specific, nonfraud related information
may have affected the decline in [HSBC’s]stock price.” The court found that“[t]he model assume[d] that any changes in[HSBC’s] stock price—other than those that
[could] be explained by general market andindustry trends—[were] attributable to thefraud-related disclosures.” In the event that“there was significant negative information[during the class period] about [HSBC]
unrelated to these corrective disclosures(and not attributable to market or industry
2. Please click here to read our prior discussion of Janus decision.

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trends),” then the court determined that“the model would [have] overstate[d] theeffect of the disclosures and in turn of thefalse statements.” Conversely, if “there
was significant positive information about[HSBC]” during the class period, “then themodel would [have] understate[d] the effectof the disclosures” (emphasis in the original).
The Seventh Circuit acknowledged that“[f]irm-specific, nonfraud factors were notentirely ignored” under plaintiffs’ leakage
model. Plaintiffs’ expert “testified that helooked for company-specific factors during
the relevant period and did not find any
significant trend of positive or negative
information apart from the fraud-related
disclosures.” However, defendants argued
that “this was not enough” under Durabecause the “loss-causation model must
itself account for, and perfectly exclude, any
firm-specific, nonfraud related factors that
may have contributed to the decline in a
stock price.”
The Seventh Circuit observed that “[i]t may
be very difficult, if not impossible, for any
statistical model” to “perfectly exclude”
nonfraud factors. The court found that“[a]ccepting the defendants’ position likely
would doom the leakage theory as a methodof quantifying loss causation.” However, thecourt also recognized that “if it’s enough fora loss-causation expert to offer a conclusory
opinion that no firm-specific, nonfraud
related information affected the stock priceduring the relevant time period, then it may
be far too easy for plaintiffs to evade the losscausation principles explained in Dura.”
Finding neither option perfect, the Seventh
Circuit adopted a “middle ground” position.
The court found that “[i]f the plaintiffs’
expert testifies that no firm-specific, nonfraud
related information contributed to the decline
in stock price during the relevant time period
and explains in nonconclusory terms thebasis for this opinion,” then defendants must
“identify[ ] some significant, firm-specific,
nonfraud related information that could haveaffected the stock price.” If defendants cannot
do this, then “the leakage model can go to thejury.” If defendants can identify any firmspecific, nonfraud factors, however, then theburden “shifts back to the plaintiffs to accountfor that specific information or provide aloss-causation model that doesn’t suffer fromthe same problem, like the specific-disclosure

model.” The court observed that “[o]nepossible way to address the issue is to simply
exclude from the model’s calculation any
days identified by the defendants on whichsignificant, firm-specific, nonfraud related
information was released.”
The Seventh Circuit vacated the jury verdict
and remanded the action for a new trial on
the loss causation issue “consistent with[this] approach.”

Seventh Circuit Holds the District
Court Erred by Limiting the Janus
Holding to Corporate Outsiders
The Seventh Circuit further held that the
district court had erred in concluding that theSupreme Court’s decision in Janus “applie[s]only to legally independent third parties” andnot “corporate insiders.” The Seventh Circuit
found that “[n]othing in Janus limits its
holding to legally independent third parties.”
Rather, the Supreme Court’s interpretationof Rule 10b-5 “applies generally, not just to
corporate outsiders.”
The Seventh Circuit determined that the
district court’s jury instruction on what itmeans to “make” a statement for Rule 10b-5
purposes “directly contradict[ed] Janus.”
The court had “instructed the jury that theplaintiffs could prevail on their Rule 10b-5
claim if they proved that the defendant ‘made,approved, or furnished information to be
included in a false statement’” (emphasisin the original). The Seventh Circuit foundthat “[t]his goes well beyond the narrowinterpretation [of Rule 10b-5] adopted in
Janus” and “plainly misstated the law.”
The Seventh Circuit held that this
instructional error did not prejudice HSBC
itself, because “[t]he company stipulated
that it [had] ‘made’ all statements in its SEC
filings and press releases.” However, thecourt found that the error did prejudice theindividual defendants, including HSBC’sCEO. For example, the Seventh Circuit foundno basis for plaintiffs’ claim that the CEO had“‘made’ the statements in the [company’s]press releases.” The court noted that the CEO“had authority over the press releases in thesense that he could have exercised control
over their content” (emphasis in the original).
However, the Seventh Circuit explained that
“if that were enough to satisfy Janus, then5CEOs would be liable for any statements
made by their employees acting within thescope of their employment.” The court foundthat such an approach “wouldn’t square with
the Court’s reminder about ‘the narrow scopethat we must give the implied private right ofaction’ under Rule 10b-5.” To satisfy Janus’s
requirements, the Seventh Circuit explainedthat HSBC’s CEO “must have actually
exercised control over the content of the press
releases and whether and how they werecommunicated” (emphasis in the original).
The Seventh Circuit held that all three HSBC
executives were entitled to a new trial on
the issue of whether they had “made” thestatements alleged within the meaning ofJanus.

Southern District of New York
Dismisses Securities Fraud
Action Against Prosensa,
Finding Companies HaveNo Obligation to Spell
Out Inferences or Draw
Conclusions for Investors
On May 5, 2015, the Southern District of
New York dismissed a securities action
brought under Sections 11 and 15 of the
Securities Act against Prosensa Holdingon the grounds that plaintiffs had failed toallege any misstatements or omissions in thecompany’s registration statement concerning
the clinical trials for drisapersen, a muscular
dystrophy drug. Singh v. Schikan, 2015
WL 2070222 (S.D.N.Y. 2015) (Buchwald,J.).3 The court found that plaintiffs were
“essentially” demanding “an extra levelof disclosure spelling out inferences anddrawing conclusions for investors” withrespect to the likelihood that the Phase III
trial for drisapersen would succeed. The court
held that “defendants were not required to
draw out such inferences or to make suchforecasts in order to provide complete andaccurate disclosures.”3. Simpson Thacher represents the underwriter defendants in thisaction. Plaintiffs’ have moved for reconsideration of the court’s
May 5, 2015 decision.

Court Finds Prosensa Disclosed All
Material Information Concerning
the Phase II and Phase III Clinical
Trials for Drisapersen, and Had
No Obligation to Analyze That
Information for Investors
At the outset of its analysis, the court
observed that plaintiffs did not allege “anyaffirmative misstatements” in Prosensa’s
registration statement. Rather, plaintiffs“only alleged omissions regarding certain
differences between” the Phase II andPhase III clinical trials for drisapersen(“DEMAND-II” and “DEMAND-III”
respectively). Specifically, plaintiffs allegedthat because of “DEMAND-III’s reduced
enrollment criteria and … its expanded testing
locations,” “defendants knew or shouldhave known … the DEMAND-III study was
fundamentally flawed and was not likely
to produce positive results as DEMAND-II
had.” Plaintiffs claimed that “the Registration
Statement should have highlighted thesedifferences and should have disclosed thenegative impact these differences would likely
have on the study’s findings and therefore on
the drug’s prospects.”
The court determined that “no facts per sewere omitted from the prospectus.” Plaintiffs
did not dispute that “the key details of bothstudies, including their respective enrollment
criteria and DEMAND-III’s expanded testing
universe, were disclosed in the Registration
Statement.” The court found that whatplaintiffs were “essentially” challenging was
defendants’ failure to “spell[ ] out inferences”
and “draw[ ] conclusions” based on the
differences between the DEMAND-II and
DEMAND-III studies. The court held that thedisclosure obligations of the securities laws
do not require defendants to “draw out suchinferences” or “make such forecasts.”

Court Clarifies That Companies
Have No Obligation to Present
Material Facts in a Negative Light
The court found meritless plaintiffs’
contention that defendants were required
to “emphasize” the differences between the
DEMAND-II and DEMAND-III studies and“to note that these changes were likely tonegatively impact” the DEMAND-III study.
The court explained that there was no needfor defendants to “highlight these differences”

6because “the relevant information—eachstudy’s design and results, if available—was
easily located and … accurately described”
in the Registration Statement, “allowing
investors to compare the trials themselves.”
Moreover, the court held that “defendants’disclosures” were not actionable simply“because they failed to characterize thedifferences between the studies in a certain
way.” The court stated that “the law isclear that companies need not depict facts
in a negative or pejorative light or draw
negative inferences to have made adequate
disclosures.”Court Finds Defendants Are Not
Required to Speculate About thePossibility of Failure
The court also rejected “[p]laintiffs’ broader
claim that defendants should have disclosedthat the differences in the DEMAND-III study
would cause it to fail.” The court found thatplaintiffs had “made no allegations suggestingthat defendants could have known that the
study would in fact produce worse results.”
Given “the absence of data establishing that
DEMAND-III would not meet its endpoints,”
the court held that “defendants were notrequired to predict negative results or tohypothesize [the study’s] failure.” Thecourt found this conclusion “all the more
appropriate where, as here, such speculation
would have been based solely on facts
disclosed in the Registration Statement, fromwhich investors were equally free to assess thestudy’s likelihood of success.”
The court determined that “defendants [had]disclosed the facts known at the time of the
IPO that would subsequently affect the study
and the stock price, and were not required
to foresee the failure of the study or the
specific reasons for its hypothetical failure.”
The court held that defendants had “fulfilled
their disclosure obligations” and therefore
dismissed plaintiffs’ claims.

Delaware Supreme Court
Holds Plaintiffs Must Pleada Non-Exculpated Claim
Against Disinterested,
Independent Directors toSurvive a Motion to Dismiss
Even If the Transaction at
Issue Is Subject to Entire
Fairness Review
On May 14, 2015, the Delaware Supreme
Court addressed the following question: “inan action for damages against corporate
fiduciaries, where the plaintiff challenges aninterested transaction that is presumptively
subject to entire fairness review, must theplaintiff plead a non-exculpated claim against
the disinterested, independent directors
to survive a motion to dismiss by those
directors?” In re Cornerstone Therapeutics
Inc., S’holder Litig., 2015 WL 2394045(Del. 2015) (Strine, C.J.) (Cornerstone II).
The court “answer[ed] that question in theaffirmative,” and held that “[a] plaintiff
seeking only monetary damages must plead
non-exculpated claims against a director
who is protected by an exculpatory charter
provision to survive a motion to dismiss,regardless of the underlying standard ofreview for the board’s conduct.”

Background
The Delaware Supreme Court consideredappeals in two cases in which the Delaware
Chancery Court had denied defendants’
motions to dismiss claims against
independent directors in transactions subject
to the entire fairness standard of review eventhough plaintiffs had failed to plead nonexculpated claims against those directors. In
re Cornerstone Therapeutics Inc. Stockholder
Litig., 2014 WL 4418169 (Del. Ch. Sept. 10,2014) (Cornerstone I);4 In re Zhongpin Inc.
Stockholders Litig., 2014 WL 6735457 (Del.
Ch. Nov. 26, 2014).
Both cases “involve[d] damages actions bystockholder plaintiffs arising out of mergers
in which the controlling stockholder,
who had representatives on the board of
directors, acquired the remainder of the
4. Please click here to read our prior discussion of theCornerstone I decision.

7

shares that it did not own in a Delaware
public corporation.” Cornerstone II, 2015
WL 2394045. In both instances, the “mergers
were negotiated by special committees of
independent directors, were ultimately
approved by a majority of the minority
stockholders, and were at substantial
premiums to the pre-announcement market
price.” However, because the companies “didnot follow the process established in” Kahn
v. M&F Worldwide Corporation, 88 A.3d635 (Del. 2014)5 “as a safe harbor to invoke
the business judgment rule in the context ofa self-interested transaction,” the Chancery
Court found in both cases that “the entire
fairness standard presumptively applied.”
In both cases, an exculpatory provision adopted
in accordance with 8 Del. C. § 102(b)(7)protected the independent directors frommonetary damages for breach of the dutyof care. The Chancery Court interpreted
Delaware precedent to find that “even if theplaintiffs could not plead a non-exculpatedclaim against any particular director, as longas the underlying transaction was subject tothe entire fairness standard of review, andthe plaintiffs were therefore able to state
non-exculpated claims against the interested
parties and their affiliates, all of the directors
were required to remain defendants until theend of litigation.” Defendants appealed.

Delaware Supreme Court Holds
Plaintiffs Must Plead NonExculpated Claims Against
Independent Directors to Survive
Dismissal Regardless of the
Applicable Standard of Review
On appeal, the Delaware Supreme Court
held that “plaintiffs must plead a nonexculpated claim for breach of fiduciary duty
against an independent director protectedby an exculpatory charter provision, or that
director will be entitled to be dismissed fromthe suit.” The court underscored that this“rule applies regardless of the underlying
standard of review for the transaction.” The
Delaware Supreme Court explained that“the mere fact that a plaintiff is able to plead
facts supporting the application of the entire
fairness standard to the transaction, and canthus state a duty of loyalty claim against theinterested fiduciaries, does not relieve the5. Please click here to read our prior discussion of the M&F
decision.

plaintiff of the responsibility to plead a nonexculpated claim against each director whomoves for dismissal.”
In so holding, the Delaware Supreme Court
relied on its earlier decision in Malpiedev. Townson, 780 A.2d 1075 (Del. 2001).
There, the court “analyzed the effect of a
Section 102(b)(7) provision on a due careclaim against directors who [had] approved
a transaction which the plaintiffs argued
should be subject to review under the Revlon
standard.” The court found that “[b]ecause
a director will only be liable for monetarydamages if she has breached a non-exculpatedduty, a plaintiff who pleads only a due careclaim against that director has not set forth
any grounds for relief” since the Section
102(b)(7) exculpatory provision bars such aclaim as a matter of law.

Delaware Supreme Court Rejects
an Automatic Inference of
Director Disloyalty in Controller
Transactions as Inconsistent with
“Basic Tenets of Delaware Law” andNot in the Best Interests of Minority
Stockholders
The Delaware Supreme Court in Cornerstone
II determined that there were “several
problems” with plaintiffs’ contention that“they should be entitled to an automatic
inference that a director facilitating aninterested transaction is disloyal because thepossibility of conflicted loyalties is heightenedin controller transactions.” First, the court
explained that “each director has a right to beconsidered individually when the directors
face claims for damages in a suit challenging
board action.” This “individualized
consideration does not start with theassumption that each director was disloyal;rather, ‘independent directors are presumed
to be motivated to do their duty with fidelity.’”
Second, the Delaware Supreme Court
found that such an inference “would likely
create more harm than benefit for minority
stockholders in practice.” The court explainedthat Delaware law has long “recognizedthat the negotiating efforts of independent
directors can help to secure transactions with
controlling stockholders that are favorable
to the minority.” The court stated that it“decline[d] to adopt an approach that would
create incentives for independent directors to8

avoid serving as special committee members,
or to reject transactions solely because
their role in negotiating on behalf of thestockholders would cause them to remain
as defendants until the end of any litigation
challenging the transaction.” The Cornerstone
II court observed that “the fear that directors
who faced personal liability for potentiallyvalue-maximizing business decisions might
be dissuaded from making such decisions
is why Section 102(b)(7) was adopted in thefirst place.”

Delaware Supreme Court Finds
That Emerald Partners Does Not
Support Plaintiffs’ Position
The Chancery Court had relied on the
Delaware Supreme Court’s prior decision
in Emerald Partners v. Berlin, 787 A.2d 85(Del. 2001), in denying defendants’ motion
to dismiss claims against the independent
directors. On appeal, the Cornerstone II court
found Emerald Partners distinguishable
because the case involved “a viable, nonexculpated loyalty claim against eachputatively independent director.” Given thecircumstances, the Emerald Partners court“held that the determination of whether any
failure of the putatively independent directors
was the result of disloyalty or a lapse in care
was best determined after a trial, because
the substantive fairness inquiry would shedlight on why the directors acted as theydid.” The Cornerstone II court explainedthat Emerald Partners “did not answer the
specific question” of “whether the applicationof the entire fairness standard requires the
Court of Chancery to deny a motion to dismissby independent directors even when theplaintiffs may not have sufficiently pled a nonexculpated claim against those directors.”
The Delaware Supreme Court in Cornerstone
II held that “when the plaintiffs have pledno facts to support an inference that any of
the independent directors breached their
duty of loyalty, fidelity to the purpose of
Section 102(b)(7) requires dismissal of thecomplaint against those directors.” The court
reversed the Chancery Court’s judgments
in both Cornerstone I and Zhongpin and“remand[ed] each case for the Court ofChancery to determine if the plaintiffs havesufficiently pled facts suggesting that theindependent directors committed a nonexculpated breach of their fiduciary duty.”

Delaware Chancery Court
Rules That Self-Interested
Director Compensation
Decisions May, Under Certain
Circumstances, Be Subject toEntire Fairness Review
A recent Delaware Chancery Court decisionconfirms that, as the court held three
years ago in Seinfeld v. Slager, 2012 WL
2501105 (Del. Ch. June 29, 2012), there
is no shareholder ratification defense forself-awarded director compensation granted
under a stockholder-approved option orbonus plan that lacks “‘sufficiently definedterms’” or “some meaningful limit” ondirector discretion. Calma v. Templeton,
2015 WL 1951930 (Del. Ch. Apr. 30, 2015)(Bouchard, C.) (quoting In re 3COM Corp.
Shareholders Litig., 1999 WL 1009210 (Del.
Ch. Oct. 25, 1999)).

I. General Standard
Director decisions are generally afforded wide
latitude under the business judgment rule.6
The protections of the business judgment
rule, however, “can only be claimed bydisinterested directors.” Aronson, 473 A.2d805. The “directors can neither appear on
both sides of a transaction nor expect toderive any personal financial benefit from it in
the sense of self-dealing … .”A decision by directors to award themselvescompensation necessarily fails this test,
subjecting the decision to the entire fairness
standard—a higher level of scrutiny. However,the court will apply the more deferential
business judgment rule to a director
compensation decision if such decision was“made under a stock option plan approved by
the corporation’s shareholders.” In re 3COM
Corp. S’holders Litig., 1999 WL 1009210 (Del.
Ch. 1999) . This is known as a stockholder
ratification defense.

6. When reviewing a business decision under the businessjudgment rule standard, the court presumes that in making thebusiness decision, “the directors of a corporation acted on an
informed basis, in good faith and in the honest belief that theaction taken was in the best interests of the company.” Aronson v.
Lewis, 473 A.2d 805 (Del. 1984).

9

II. Calma and Slager:
A Recent Trend
In a recent pair of shareholder derivative
cases, the Delaware Court of Chancery
narrowed the application of the stockholder
ratification defense. Most recently, on April
30, 2015, the Court of Chancery held in
Calma v. Templeton that a board decision to
grant restricted stock units (“RSUs”) to thenon-employee directors of Citrix Systems, Inc.
was subject to the entire fairness standardof review.
In Calma, 2015 WL 1951930, the board’s
compensation committee granted RSU
awards under Citrix’s 2005 Equity Incentive
Plan (the “Plan”). The Plan was approved bya majority of Citrix’s stockholders in a priorvote. While the majority of the directors’compensation consisted of these RSU awards,
the Plan applied to multiple classes ofbeneficiaries—not just directors—including
Citrix’s officers, employees, consultants andadvisors. The only limit on compensation
imposed by the Plan was that “no beneficiary
could receive more than one million shares(or RSUs) per calendar year.” There wereno sub-limits in the Plan based on thebeneficiary’s position within Citrix (e.g.,
separate limits for non-employee directors
and consultants). Based on Citrix’s stock
price, one million RSUs were worth over $55
million on the date the lawsuit was filed.
Although Citrix’s non-employee directors
were awarded between 3,000 and 4,000
RSUs in each of 2011, 2012, and 2013—wellbelow the one million RSU limit under thePlan—the stockholder plaintiff challenged
the RSU grants for these years, arguingthat they were “excessive” when comparedto the compensation received by directorsof Citrix’s peers. The defendants took theposition that the Board’s decision to award
directors RSUs should be subject to thebusiness judgment rule standard of review
because the decision was consistent with
the Plan and stockholders had ratified thePlan. Relying on a prior case, Seinfeld v.
Slager, the plaintiff argued that even though
the RSU awards were granted under thestockholder-approved Plan, the defendants
must “establish the entire fairness of the RSU
Awards because the Plan ‘has no meaningful
limits’ on the total equity compensation that
the Company’s non-employee directors could
hypothetically receive.”

The court agreed with the plaintiff, holdingthat “advance stockholder approval of acompensation plan with multiple classes ofbeneficiaries and a single generic limit on theamount of compensation that may be awarded
in a given year” is not sufficient to establish
a ratification defense. Accordingly, the court
ruled that the board’s decision was subject
to the entire fairness standard of review
under which the directors have the burdenof establishing that “‘the transaction was the
product of both fair dealing and fair price.’” In
distinguishing the case before it from the sixty
years of precedent the defendants pointed
to, the court noted that in prior cases theratification defense was recognized because
stockholders approved specific director
compensation awards or Plans with directorspecific compensation ceilings.7 By contrast,
in Calma, the stockholders “were never asked
to approve—and thus did not approve—any
action bearing specifically on the magnitude
of compensation for the Company’s nonemployee directors” (emphasis in theoriginal). The Citrix stockholders did not votein favor of the specific RSU grants at issue orvote to impose a meaningful limit on directors
specifically.
Calma continues a trend begun three years
earlier in a similar case: Seinfeld v. Slager,
2012 WL 2501105. In Slager, a RepublicServices, Inc. stockholder challenged thefairness of RSUs granted to the company’s
non-employee directors under the company’s
stockholder-approved compensation plan.
As in Calma, the beneficiaries of the plan
included the company’s directors, officers,
and employees. The plan similarly did notinclude specific RSU grants for directors
or set forth a director-specific ceiling oncompensation. Rather, the plan imposed
generic limits of 10.5 million shares total and1.25 million shares that any one beneficiary
could receive per year. With twelve directors,
the Board could have theoretically awarded
each director 875,000 RSUs, which were
worth over $21.6 million per recipient at thetime. The court held that even though thestockholders approved the plan, the director
7. For cases in which the ratification defense was applied, see, e.g.,
Cambridge Retirement System v. Bosnjak, 2014 WL 2930869(Del. Ch. June 26, 2014) (stockholders specifically approved theawards at issue); In re 3COM Corp. Shareholders Litig., 1999 WL
1009210 (the plan imposed a director-specific ceiling); Lewis v.
Vogelstein, 699 A.2d 327 (Del. Ch. 1997) (stockholders approveda plan that detailed the specific compensation to be paid to
directors); Steiner v. Meyerson, 1995 WL 441999 (Del. Ch. July
19, 1995) (same); Kerbs v. California E. Airways, Inc., 90 A.2d652 (Del. 1952) (same).

10compensation decision was still a self-dealingtransaction because the stock plan lacked“sufficient definition.”8 Accordingly, the court
held that the board’s decision was subject tothe entire fairness standard of review.

III. Pending Cases
At least two similar cases challenging director
compensation decisions are currently pending
before the Delaware Chancery Court: one
involving Facebook, Inc. and one involving
Celgene Corporation. In a shareholder
derivative complaint filed against Facebook
on June 6, 2014, the plaintiffs allege that
Facebook’s directors awarded themselves
unfair, excessive compensation and are
therefore liable for breach of fiduciary duty,
waste of corporate assets, and unjust
enrichment.9 As in Calma and Slager,
Facebook’s shareholders approved an Equity
Incentive Plan. However, the only limits
in the plan are a total limit of 25 million
shares and a per person annual limit of 2.5
million shares. At the time the complaint
was filed, 2.5 million Facebook shares were
worth approximately $145 million, which thecomplaint alleges is “not a true limit.”10

8. The court opined:“The sufficiency of definition that anoints astockholder-approved option or bonus plan withbusiness judgment rule protection exists on acontinuum. Though the stockholders approved thisplan, there must be some meaningful limit imposedby the stockholders on the Board for the plan to …
receive the blessing of the business judgment rule … .
A stockholder-approved carte blanche to the directors
is insufficient. The more definite a plan, the more
likely that a board’s compensation decision will belabeled disinterested and qualify for protection underthe business judgment rule. If a board is free to use its
absolute discretion under even a stockholder-approved
plan, with little guidance as to the total pay that can beawarded, a board will ultimately have to show that thetransaction is entirely fair.”Although this principle as it applies to director compensation
was announced in Slager, the idea that a stockholder-approved
carte blanche is insufficient to qualify for the protection of thebusiness judgment rule is not new. As Chancellor Bouchard
noted in Calma, this idea was actually announced years earlier
in Sample v. Morgan, 914 A.2d 647 (Del. Ch. 2007). In Sample,
the court explained that “the Delaware doctrine of ratification
does not embrace a ‘blank check’ theory… . [T]he mere approval
by stockholders of a request by directors for the authority to takeaction within broad parameters does not insulate all future action
by the directors within those parameters from attack.”
9. See Verified Shareholder Derivative Complaint for Breachof Fiduciary Duty, Waste of Corporate Assets, and Unjust
Enrichment at 1-2, Espinoza v. Zukerberg, C.A. No. 9745-CB(Del. Ch. June 6, 2014).
10. Facebook filed a Motion to Dismiss and for Summary
Judgment. The court is expected to hear oral arguments on the
motion on July 28, 2015.

The shareholder derivative lawsuit on behalfof Celgene Corporation, filed in October
2014, alleges that the compensation madeto non-employee directors in 2013 and 2014
was excessive compared to grants made to
directors of peer companies.11 As in Calma,
Slager, and the case against Facebook,Celgene has a shareholder-approved Stock
Incentive Plan. The only limit under Celgene’s
2013 plan is that no individual can receive
more than 1.5 million shares per year. Asof the date of filing, 1.5 million shares were
worth approximately $130 million.

Delaware Chancery Court
Relies on the Merger Price inAppraising AutoInfo’s Shares
On April 30, 2015, the Delaware Chancery
Court determined that the merger pricewas “the best estimate” of the fair value of
AutoInfo’s shares in a Section 262 appraisal
action brought in connection with Comvest
Partners’ acquisition of AutoInfo. Merlin
Parters LP v. AutoInfo, Inc., 2015 WL
2069417 (Del. Ch. Apr. 30, 2015) (Noble,
V.C.).
Pursuant to 8 Del. C. § 262, “stockholders
who elect against participating in certain
merger transactions may petition the Court
to determine the fair value of their stock.”
In assessing “fair value” for purposes ofSection 262, a court must “independently
evaluate[ ] the evidence concerning fairvalue” and may not “presumptively deferto any particular valuation metric.” Thecourt may consider a discounted cash flow(“DCF”) analysis, “a comparable transactions
analysis, a comparable companies analysis,or the merger price itself” in making
its determination.
In evaluating the ‘fair value’” of AutoInfo’sshares, the court found plaintiffs’ expert’s
DCF analysis unreliable because plaintiffs
had “failed to establish the credibility” ofthe management projections on which thatanalysis was based. The court explained that
AutoInfo’s management had not preparedprojections in the ordinary course of business,and that the projections “created during the
11. See Verified Stockholder Derivative Complaint for Breachof Fiduciary Duty, Waste of Corporate Assets, and Unjust
Enrichment, Steinberg v. Casey, C.A. No. 10190-CB (Del. Ch. Oct.
2, 2014).

11

sales process” were “indisputably optimistic”
and thus “deserve[d] little deference.”
The court also gave “no weight” to plaintiffs’
experts’ comparable companies analyses
because the comparable companies were “allsignificantly larger than AutoInfo.” The court
explained that it may “reject comparable
companies analyses based on purported
comparables that differ significantly in size
from the company being appraised” because“smaller firms are riskier and thus [typically]
face higher costs of equity capital” thanlarger firms. The court also faulted plaintiffs’
expert for failing to consider business model
differences between AutoInfo and thecomparable companies selected.
In view of the absence of other “credible
valuations,” the court found that the merger
price was “a strong indicator of value.” Thecourt reasoned that “the sales process was
generally strong and [could] be expected
to have led to a [m]erger price indicative offair value.” The court observed that the case

did “not involve self-interest or disloyalty.”
Moreover, “[t]he [m]erger was negotiatedat arm’s length, without compulsion, andwith adequate information.” The court
further observed that “[i]t was the resultof competition among many potential
acquirers.” While “[a]ny real-world sales
process may be criticized for not adhering
completely to a perfect, theoretical model,”the court determined that “AutoInfo’s process
was comprehensive” and there was noevidence “that the outcome [could] have beena merger price drastically below fair value.”
Prior to “placing full weight on the [m]erger
price, the [c]ourt performed its own DCF
analysis” and arrived at a price of 0.93 pershare—less than the merger price of $1.05
per share. Nevertheless, because the court
found that “the [m]erger price appear[ed]to be the best estimate of value,” the court“put full weight on that price” for purposes ofplaintiffs’ appraisal action.

The Securities Law Alertis edited by Paul C. Gluckow(pgluckow@stblaw.com/+1-212-455-2653), Peter E. Kazanoff(pkazanoff@stblaw.com/+1-212-4553525) and Jonathan K. Youngwood(jyoungwood@stblaw.com/+1-212-455-3539).

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