Securities Law Alert
In This Edition:• D.C. Circuit: Federal Courts Have No Jurisdiction Over Constitutional Claims Brought by Respondents in
Pending SEC Enforcement Proceedings• Ninth Circuit: Adverse Interest Exception to Imputing an Executive’s Scienter to the Corporation Does Not
Apply If (1) the Executive Acted with Apparent Authority; and (2) an Innocent Third Party Relied on the
Executive’s Misrepresentations• Delaware Supreme Court: Business Judgment Rule Standard of Review Applies to Non-Controlling
Stockholder Transactions Approved by a Majority of Fully Informed, Disinterested Stockholders• Delaware Supreme Court: Allegations of Both a Close Friendship and a Business Relationship with an
Interested Party May Be Sufficient to Plead That a Director Could Not Act Independently of the Interested
Party for Demand Futility Purposes• Delaware Chancery Court: Merger Price May Provide the Best Indication of Fair Value for Section 262
Appraisal Purposes If the Sales Process Was Thorough and Unbiased• New York Appellate Division: First Department Adopts Garner Test for Determining Whether the
Fiduciary Exception to the Attorney-Client Privilege Applies
October 2015

Simpson Thacher’s“[i]mpressive bench
is notably well-versed incomplex securities
class actions.”– Chambers USA
2015

Simpson Thacher & Bartlett LLP

D.C. Circuit: Federal Courts
Have No Jurisdiction Over
Constitutional Claims Brought
by Respondents in Pending
SEC Enforcement Proceedings
On September 29, 2015, the D.C. Circuit
held that respondents in pending SEC
administrative enforcement proceedings
may only “secure judicial review” in federal
court “when (and if) the proceeding[s]culminate[ ] in [an adverse] resolution.”
Jarkesy v. SEC, 2015 WL 5692065 (D.C.
Cir. 2015) (Srinivasan, J.). The D.C. Circuit
determined that even if respondents assert
constitutional or other challenges to the SEC’s
authority, they may not “‘jump the gun’ by
going directly to [a] district court to develop
their case.” Earlier this year, the Seventh

Circuit reached the same conclusion in Bebo
v. SEC, 799 F.3d 765 (7th Cir. 2015).

Background
When enforcing the federal securities laws incivil proceedings, the SEC may either “bringa civil action against the alleged violator infederal district court, or it can initiate anadministrative enforcement proceeding.” See
15 U.S.C. § 78u(d) et seq. Respondents in SEC
enforcement proceedings may appeal adverse
agency resolutions in federal court. See 15
U.S.C. § 78y(a)(1).
In the case before the D.C. Circuit, the SEC
had commenced administrative enforcement
proceedings against an unregisteredinvestment adviser and its manager. Before
the SEC hearing began, respondents filed suitin federal district court raising constitutional
1challenges to the SEC’s authority to bringenforcement proceedings. The district
court dismissed respondents’ complaint
for lack of subject-matter jurisdiction.
Defendants appealed.

if respondents … could countermand the[SEC]’s choice by filing a court action.”

Applying the Thunder Basin
Test, D.C. Circuit Finds Congress
Implicitly Precluded Federal
Court Jurisdiction Over
Constitutional Challenges Brought
by Respondents in Pending SEC
Enforcement Proceedings

The D.C. Circuit determined that “‘a findingof preclusion’ would not ‘foreclose all
meaningful judicial review’ of [respondents’]claims.” The court found it immaterial that“the [SEC] lack[ed] the authority to rule on”
respondents’ constitutional claims. The D.C.
Circuit explained that the Supreme Court’s
recent decision in Elgin “reiterated that,
so long as a court can eventually pass upon
the challenge, limits on an agency’s own
ability to make definitive pronouncements
about a statute’s constitutionality do notpreclude requiring the challenge to go
through the administrative route.” “Because[respondents’] constitutional claims … [could]
eventually reach ‘an Article III court fullycompetent to adjudicate’” those claims, theD.C. Circuit concluded that it was “of nodispositive significance whether the [SEC]ha[d] the authority to rule on them in thefirst instance during the agency proceedings”(quoting Elgin, 132 S. Ct. 2126).

The D.C. Circuit applied the two-part
test set forth in Thunder Basin Coal Co.
v. Reich, 510 U.S. 200 (1994) to assess“whether Congress [had] implicitly precluded[respondents’] district-court suit bychanneling [respondents’] challenges throughthe securities laws’ scheme of administrative
adjudication and judicial review in a courtof appeals.” Pursuant to the Thunder Basintest, a court can “determine that Congress
intended that a litigant proceed exclusively
through a statutory scheme of administrativeand judicial review when (i) such intent is‘fairly discernible in the statutory scheme,’and (ii) the litigant’s claims are ‘of thetype Congress intended to be reviewed
within [the] statutory structure’” (quoting
Thunder Basin, 510 U.S. 200). Courts mustalso consider “whether the claims can beafforded meaningful [judicial] review” under
the statutory scheme. Thunder Basin, 510
U.S. 200.
Court Finds It “Fairly Discernible” That
Congress Intended Appellate Review of Final
SEC Resolutions to Be the Exclusive Meansfor Respondents in Pending SEC Enforcement
Proceedings to Obtain Judicial Review

The D.C. Circuit found that it could “fairly
discern Congress’s intent to preclude suits
by respondents in SEC administrative
proceedings in the mine-run of cases.”
Jarkesy, 2015 WL 5692065. In light of the“‘painstaking detail with which’ Congress
set forth the rules governing the court ofappeals’ review of [SEC] action,” the D.C.
Circuit concluded that “‘Congress intended todeny [aggrieved respondents] an additional
avenue of review in district court’” (quoting
Elgin v. Dep’t of Treasury, 132 S. Ct. 2126
(2012)). The D.C. Circuit reasoned that
“Congress granted the choice of forum to the[SEC], and that authority could be for naught

Court Concludes That the Statutory Scheme Will
Ultimately Allow for “Meaningful Review” of
Respondents’ Constitutional Claims

Court Rejects Respondents’ Contention That theConstitutional Claims at Issue Were Not of theType Congress Intended to Be Reviewed within
the Statutory Scheme

Respondents contended that theirconstitutional challenges were “‘whollycollateral’ to the securities laws’ scheme” andwere “not of the type Congress intended tobe reviewed within this statutory structure’”(quoting Thunder Basin, 510 U.S. 200). The
D.C. Circuit found this argument “simply
incorrect.” The court determined that
respondents’ “constitutional … claims[did] not arise ‘outside’ the SEC
administrative enforcement scheme—they[arose] from actions the [SEC] took in thecourse of that scheme.” The court found “thefact that [respondents’] claims attack[ed] theprocess rather than the result [did] not mean
[their] claims should receive preemptive
resolution in a district court.”
The D.C. Circuit reasoned that creating “anexception to an otherwise exclusive scheme
for constitutional challenges in general,or facial attacks on a statute in particular,
or some other as-yet-undefined categoryof constitutional claims, would encourage2

respondents in administrative enforcement
proceedings to frame their challenges to the[SEC’s] actions in those terms and thereby
earn access to another forum in which toadvance their arguments.” The court found it
doubtful that “Congress intended that result.”
The D.C. Circuit concluded that “the securities
laws provide an exclusive avenue for judicial
review that [respondents] may not bypass byfiling suit in district court.” The court affirmed
dismissal of respondents’ claims for lack ofsubject-matter jurisdiction.

Ninth Circuit: Adverse Interest
Exception to Imputing an
Executive’s Scienter to the
Corporation Does Not ApplyIf (1) the Executive Actedwith Apparent Authority; and(2) an Innocent Third Party
Relied on the Executive’s
Misrepresentations
On October 23, 2015, the Ninth Circuit
held that fraudulent misrepresentations
made by Ron Chan, the founder and CEO of
ChinaCast Education Corporation, could be
imputed to ChinaCast even though Chan had
acted adversely to ChinaCast’s interests by“embezzl[ing] millions” from the company.
In re ChinaCast Educ. Corp. Sec. Litig., 2015
WL 6405680 (9th Cir. 2015) (McKeown, J.)(ChinaCast II). The Ninth Circuit determinedthat the adverse interest exception to thegeneral rule imputing an executive’s
scienter to the corporation did not apply
because the complaint alleged that (1) “Chan[had] acted with apparent authority on behalfof the corporation” and (2) “third-party
shareholders [had] understandably relied on
Chan’s representations, which were madewith the imprimatur of the corporation that
selected him to speak on its behalf and sign
SEC filings.”

Background
ChinaCast is “a for-profit postsecondary
education and e-learning services provider”
that at one point “boasted a market
capitalization topping $200 million.” In
March 2011, ChinaCast disclosed that its

outside accounting firm (an affiliate of
Deloitte & Touche LLP) “had identified‘serious internal control weaknesses’with respect to [the company’s] financial
oversight.” Plaintiffs alleged that “despite this‘clear warning from Deloitte’ … the company
and its board ‘turned a blind eye’ to the
problem.”
Between June 2011 and April 2012, “Chan[allegedly] ‘transferred’ $120 million of
corporate assets to outside accounts that were
controlled by him and his allies” and also
engaged in a variety of other maneuvers thateventually “brought ChinaCast to financial
ruin.” During this time, Chan allegedly“emphasized the company’s financial
health and stability” in public statements toinvestors. In March 2012, after “ChinaCast’sboard discovered that Chan had attempted
to interfere with an annual audit,” the board
removed Chan as chairman and CEO.
ChinaCast’s shareholders subsequently
brought the instant securities fraud action.
In December 2012, the Central District ofCalifornia dismissed plaintiffs’ complaint
with prejudice for failure to allege scienter.
In re ChinaCast Educ. Corp. Sec. Litig., 2012
WL 6136746 (C.D. Cal. Dec. 7, 2012) (Walter,J.). The court held that Chan’s scienter could
not be imputed to ChinaCast based on theadverse interest exception, pursuant to which
courts “refus[e] to impute scienter from thefraud of a rogue agent.” The court found that
here, there was “no allegation that Chan or
his accomplices [had] acted out of anythingother than their own self-interest, or that
their conduct [had] in any way benefitted
ChinaCast.” Plaintiffs appealed.

Ninth Circuit Reverses, Finding
That Chan’s Scienter May Be
Imputed to ChinaCast Because theCompany’s Shareholders Relied on
Misrepresentations Made by Chan
within the Scope of His Apparent
Authority
On appeal, the Ninth Circuit explainedthat it has “adopted the general rule of
imputation” pursuant to which “a corporationis responsible for a corporate officer’s
fraud committed ‘within the scope of his
employment’ or ‘for a misleading statement
made by an employee or other agent who
has actual or apparent authority’” ChinaCast
II, 2015 WL 6405680 (quoting Hollinger
3

v. Titan Capital Corp., 914 F.2d 1564 (9thCir. 1990)). The Ninth Circuit noted thata number of courts in other circuits have“follow[ed] the same principles, even after theadvent of” the Private Securities Litigation
Reform Act (“PSLRA”) “and its strict focus
on scienter.”Here, defendants did “not dispute that Chan[had] acted within the scope of his apparent
authority,” but claimed that “the ordinary ruleof imputation [was] inapposite because of
the common law’s so-called ‘adverse interest
exception.’” The Ninth Circuit acknowledgedthat Chan had “lined his own pockets at
the expense of ChinaCast’s interests,” butdetermined that “the adverse interest ruledoesn’t apply in every instance where there
is a faithless fraudster within the corporate
ranks.”The Ninth Circuit found that “the adverse
interest exception itself has an exception: theprincipal is charged with even the faithless
agent’s knowledge when an innocent thirdparty relies on representations made withapparent authority.” Because plaintiffs allegedthat ChinaCast’s shareholders had “relied on
Chan’s representations,” the Ninth Circuit
held that “Chan’s scienter [could] be imputed
to ChinaCast” at the pleading stage “forthose material misrepresentations oromissions made within the scope of[his] apparent authority.”
The Ninth Circuit held that it was appropriate
to impute Chan’s scienter to ChinaCast given
the “public policy goals of both securities
and agency law—namely, fair risk allocationand ensuring close and careful oversightof high-ranking corporate officials to deter
securities fraud.” The court found thatplaintiffs had “pled sufficient allegations to
support imputation and survive the pleading
requirements of the PSLRA.” The court notedthat even though the ChinaCast board hadreceived an audit report indicating significant
internal control weaknesses, the board had“failed to take significant action or heighten
oversight.” The court emphasized that “Chanwas hardly a random corporate bureaucrat or
mid-level manager.” As the company’s CEO,
Chan was “the one person on whom the board
undoubtedly should have kept close tabs.”

Ninth Circuit Discusses Whether
Defendants Can Obtain Dismissal
of Securities Fraud Complaints at
the Pleading Stage Based on theAdverse Interest Exception
The Ninth Circuit observed that “at thepleading stage, a key inquiry in § 10(b) andRule 10b-5 cases is whether the complaint
sufficiently alleges scienter attributable to thecorporation.” The court stated that in cases
where defendants assert the adverse interest
exception, “[a] threshold question is whether
the pleadings support application of theadverse interest rule at all.” The Ninth Circuit
found that “as a practical matter, having aclean hands plaintiff eliminates the adverse
interest exception in fraud on the market suits
because a bona fide plaintiff will always be an
innocent third party.”
However, the Ninth Circuit noted that theadverse interest exception may provide abasis for dismissal on the merits at a laterstage if defendants can either show that theplaintiff was not an innocent party or rebut
the presumption of reliance.

Delaware Supreme Court:
Business Judgment Rule
Standard of Review Applies to
Non-Controlling Stockholder
Transactions Approved by a
Majority of Fully Informed,
Disinterested Stockholders
On October 2, 2015, the Delaware Supreme
Court affirmed dismissal of an action broughtby stockholders of KKR Financial Holdings
LLC (“Financial Holdings”) who sought postclosing damages in connection with Financial
Holdings’ acquisition by KKR & Co. L.P.
(“KKR”). Corwin v. KKR Financial Holdings
LLC, 2015 WL 5772262 (Del. 2015) (Strine,C.J.) (KKR II). The Delaware Supreme
Court found that plaintiffs’ allegations failed
to support an inference that KKR was acontrolling stockholder of Financial Holdings.
The Court further held that “the voluntaryjudgment of the disinterested stockholders
to approve the merger invoked the businessjudgment rule standard of review.” The
Delaware Supreme Court reasoned that
“Delaware corporate law has long been4

reluctant to second-guess the judgment of
a disinterested stockholder majority that
determines that a transaction with a party
other than a controlling stockholder is in theirbest interests.”

Delaware Supreme Court Finds theComplaint Does Not Allege Facts
Supporting an Inference That KKR
Was a Controlling Stockholder ofFinancial Holdings
The Delaware Supreme Court found that
the Chancery Court had properly rejected
plaintiffs’ contention that “KKR was acontrolling stockholder of Financial Holdings”
and that “the transaction was [therefore]
presumptively subject to the entire fairness
standard of review.” The Chancery Court
found it significant that “KKR owned lessthan 1% of Financial Holdings’ stock, had noright to appoint any directors, and had nocontractual right to veto any board action.”
The court recognized that a KKR affiliate
managed Financial Holdings pursuant to“a contractual management agreementthat could only be terminated by Financial
Holdings if it paid a termination fee.”
Applying Delaware precedent, the Chancery
Court “looked for a combination of potent
voting power and management control suchthat [KKR] could be deemed to have effective
control of the [Financial Holdings] board
without actually owning a majority of stock.”
The Chancery Court found “no well-pled facts
from which it [was] reasonable to infer that
KKR could prevent the [Financial Holdings]
board from freely exercising its independentjudgment in considering the proposed
merger or … that KKR had the power toexact retribution by removing the [Financial
Holdings] directors from their offices if they
did not bend to KKR’s will in considerationof the proposed merger.” In re KKR Fin.
Holdings LLC Shareholder Litig., 101 A.3d
980 (Del. Ch. 2014) (Bouchard, C.) (KKR
I). The Chancery Court expressly declined“to impose fiduciary obligations on [KKR]”
even if “pre-existing contractual obligations
with [KKR] that constrain[ed] the businessor strategic options available to [Financial
Holdings].” KKR II, 2015 WL 5772262.
The Delaware Supreme Court determinedthat the Chancery Court had “correctly
applied the law” in holding that KKR was
not a controlling stockholder of Financial

Holdings and in finding that the transaction
was therefore not subject to the entire fairness
standard of review.

Delaware Supreme Court Holds theBusiness Judgment Rule Standardof Review Applied Because a Fully
Informed Majority of Financial
Holdings’ Stockholders Voluntarily
Approved the Merger
The Delaware Supreme Court found that the
Chancery Court had properly applied thebusiness judgment rule standard of review
to the KKR-Financial Holdings transaction“because the merger was approved by adisinterested stockholder majority.” Thecourt explained that “when a transaction
not subject to the entire fairness standard isapproved by a fully informed, uncoerced voteof the disinterested stockholders, the businessjudgment rule applies.”
The Delaware Supreme Court found that
the Chancery Court had correctly heldthat Gantler v. Stephens, 965 A.2d 695(Del. 2009) “did not alter the effect oflegally required stockholder votes on theappropriate standard of review.” In Gantler,
the Delaware Supreme Court determinedthat the entire fairness standard of review
applied to a reclassification of a corporation’sshares that was approved by a majority of
the corporation’s disinterested stockholders
where the proxy disclosures were allegedly
materially misleading. The KKR II court
agreed with the Chancery Court that “theeffect a statutorily required vote [would
have] had on the appropriate standard ofreview … was not even squarely before the
Court in Gantler because [the Gantler Courthad] found the relevant proxy statement
to be materially misleading.” The KKR II
court also concurred with the Chancery
Court’s view that if Gantler had “intended
to unsettle a long-standing body of caselaw” on the effect of a fully-informed voteof a majority of disinterested stockholders
on the appropriate standard of review, theDelaware Supreme Court would “likely havesaid so.” “To erase any doubt on the part ofpractitioners,” the KKR II court clarified that
Gantler did not address “the question of whatstandard of review applies if a transaction
not subject to the entire fairness standard isapproved by an informed, voluntary vote ofdisinterested stockholders.”

5

The KKR II Court emphasized that thebusiness judgment rule only applies incases involving “fully informed, uncoerced
stockholder votes.” In the event that“troubling facts regarding director behavior
were not disclosed that would have beenmaterial to a voting stockholder, then thebusiness judgment rule is not invoked.”
Finally, the KKR II Court explained that“the long-standing policy of [Delaware]
law has been to avoid the uncertainties
and costs of judicial second-guessing when
the disinterested stockholders have had
the free and informed chance to decide on
the economic merits of a transaction forthemselves.” The Court stated that “thecore rationale of the business judgment rule
… is that judges are poorly positioned toevaluate the wisdom of business decisions
and there is little utility to having themsecond-guess the determination of impartial
decisionmakers with … an actual economic
stake in the outcome.” Provided “stockholders
have had the voluntary choice to accept or
reject a transaction,” the Delaware Supreme
Court stated that “the business judgment
rule standard of review is the presumptively
correct one and best facilitates wealthcreation through the corporate form.”

Delaware Supreme Court:
Allegations of Both a
Close Friendship and a
Business Relationshipwith an Interested Party
May Be Sufficient to Plead
That a Director Could Not
Act Independently of theInterested Party for Demand
Futility Purposes
On October 2, 2015, the Delaware Supreme
Court reversed dismissal of a shareholder
derivative action brought against the directorsof the Sanchez Energy Corporation alleging
a “gross overpayment” in connection witha transaction involving Sanchez Resources,
LLC. Del. Cnty. Emps. Ret. Fund v.
Sanchez, 2015 WL 5766264 (Del. 2015)(Strine, C.J.). Two of the Sanchez Energy
directors—including the chairman of Sanchez
Energy—were interested in the transaction.

The Delaware Supreme Court found that“plaintiffs had pled particularized facts
raising a pleading-stage doubt about theindependence of” Alan Jackson, one of theother Sanchez Energy directors, by alleging
that (1) Jackson “had a close friendship ofover half a century with” the chairman ofSanchez Energy; and (2) Jackson’s “primary
employment (and that of his brother) was
as an executive of a company over which
the [chairman of Sanchez Energy] had
substantial influence.”

Delaware Supreme Court Finds
Jackson’s Close Personal andEconomic Ties to the Chairmanof Sanchez Energy, Considered
Together and in Context, Sufficientto Plead That Jackson Was
Interested in the Transaction
for Purposes of the Demand
Futility Analysis
The Delaware Supreme Court explained thatin order “[t]o plead demand excusal under
Rule 23.1, a plaintiff in a derivative action
must plead particularized facts creating a‘reasonable doubt’ that either ‘(1) the directors
are disinterested and independent or(2) the challenged transaction was otherwise
the product of a valid exercise of businessjudgment’” (quoting Aronson v. Lewis, 473
A.2d 805 (Del. 1984)). The Court underscoredthat “all reasonable inferences from the pledfacts must … be drawn in favor of the plaintiff
in determining whether the plaintiff has met
its burden under Aronson.”In the case before it, the Delaware Supreme
Court determined that the Chancery Court
had erred in “consider[ing] the facts theplaintiffs pled about Jackson’s personal
friendship with [the chairman of Sanchez
Energy] and the facts they pled regarding[Jackson’s] business relationships [with thechairman] as entirely separate issues.” The
Chancery Court had “concluded that neither
category of facts on its own was enough tocompromise Jackson’s independence forpurposes of demand excusal.” The Delaware
Supreme Court found “[t]he problem with[the Chancery Court’s] approach is that
[Delaware] law requires that all the pled facts
regarding a director’s relationship to theinterested party be considered in full context
in making the, admittedly imprecise, pleading
stage determination of independence.”6

Here, the Delaware Supreme Court foundthat plaintiffs had not pled “the kind ofthin social circle friendship … which was at
issue in” Beam v. Stewart, 845 A.2d 1040
(Del. 2004). The Beam court “held that
allegations that directors ‘moved in the samesocial circles, attended the same weddings,
developed business relationships before
joining the board, and described each other as‘friends,’ … [were] insufficient, without more,
to rebut the presumption of independence’”(quoting Beam, 845 A.2d 1040 (Del. 2004)).
In Sanchez, the Delaware Supreme Court
clarified that the Beam decision did not mean
to “suggest that deeper human friendships
could not exist that would have the effect ofcompromising a director’s independence.”
The court found that “[w]hen, as here, aplaintiff has pled that a director has beenclose friends with an interested party fora half century, the plaintiff has pled facts
quite different from those at issue in Beam.”
The court reasoned that “when a close
relationship endures for that long, a pleading
stage inference arises that it is important to
the parties.”
The Sanchez Court found it significant
that plaintiffs “did not rely simply on”
allegations of a close friendship between
Jackson and the chairman of Sanchez
Energy to plead Jackson’s interestedness inthe transaction. Plaintiffs also “pled facts
regarding the economic relations [between
Jackson and the chairman] that buttress[ed]their contention” that Jackson and thechairman were “confidants and that there
is a reasonable doubt that Jackson [could
have] act[ed] impartially in a matter of
economic importance to [the chairman]
personally.” The Court determined that these
allegations gave rise to “a pleading stage
inference that Jackson’s economic positions
derive[d] in large measure from his 50-year
close friendship with [the chairman], andthat he [was] in these positions because[the chairman] trust[ed], care[d] for, andrespect[ed] him.”
The Delaware Supreme Court concluded thatthe plaintiffs had “pled particularized facts,that when considered in the plaintiff-friendly
manner required, create[d] a reasonable
doubt about Jackson’s independence.” The
Court found that plaintiffs had adequately
alleged demand excusal under Rule 23.1
and Aronson, and reversed dismissal ofplaintiffs’ complaint.

Delaware Chancery Court:
Merger Price May Be theBest Indication of Fair Valuefor Section 262 Appraisal
Purposes If the Sales Process
Was Thorough and Unbiased
On October 21, 2015, the Delaware Chancery
Court issued a post-trial decision in an
appraisal action brought in connection withthe private equity buyout of BMC Software.
Merion Capital LP v. BMC Software, Inc.,
2015 WL 6164771 (Del. Ch. 2015) (Glasscock,V.C.). The court held that it was “appropriate
to look to the price generated by the market
through a thorough and vigorous sales
process as the best indication of fair value.”

BackgroundAt the outset of its analysis, the Chancery
Court observed that the case “present[ed]what has become a common scenario.” Thecourt explained that the buyout involved“a robust marketing effort for a corporate
entity result[ing] in an arm’s length sale
where the stockholders [were] cashedout, which sale [was] recommended by anindependent board of directors and adopted
by a substantial majority of the stockholders
themselves.” After the sale, “dissenters …
[sought] statutory appraisal of their shares.”
During the trial that followed, “the dissenters/
petitioners present[ed] expert testimony
opining that the stock was wildly undervalued
in the merger, while the company/respondent
present[ed] an expert, just as distinguishedand learned, to tell [the court] that the merger
price substantially exceed[ed] fair value.”

Chancery Court Conducts Its Own
DCF Analysis and Determines the
Fair Value to Be Slightly Higher
Than the Merger Price
The Chancery Court noted that 8 Del. C. § 262“vests the [c]ourt with significant discretion
to consider the data and use the valuation
methodologies it deems appropriate.” Thecourt began its analysis with the discounted
cash flow (“DCF”) valuation approach, which
both parties agreed was “the appropriate
method by which to determine the fair valueof BMC.” The court’s DCF analysis produced
a valuation of $48 per share—slightly higher
7than the merger price of $46.25 per share.
However, the court was “reluctant to defer”
to its own DCF valuation because it was
based on management projections that
were, according to the company’s expert,“historically problematic, in a way that
could distort value.” The court was also“concerned about the discount rate” given
the “meaningful debate on the issue of using
a supply side versus historical equity risk
premium.” (Following recent Delaware
precedent, the court used a supply side equity
risk premium (“ERP”), but recognized that“there is an argument in favor of using thehistorical ERP.”) Finally, the court used“the midpoint between inflation and GDP
as the [c]ompany’s expected growth rate” inaccordance with Chancellor Strine’s decision
in Global GT LP v. Golden Telecom, Inc., 993
A.2d 497 (Del. Ch. 2010), aff’d, 11 A.3d 214(Del. 2010), but stated that it did not have“complete confidence in the reliability ofthis approach.”

Chancery Court Finds the Merger
Price to Be the Best Indicationof Fair Value Because the Sales
Process Was Thorough and Fair
The Chancery Court then considered themerger price. The court explained that in
Huff Fund Investment Partnershp v. CKx,
Inc., 2015 WL 631586 (Del. Feb. 12, 2015),
aff’g, 2013 WL 5878807 (Del. Ch. Nov. 1,
2013), the Delaware Supreme Court heldthat “the deal price is a relevant measureof fair value” provided “the sales process isthorough, effective, and free from any spectreof self-interest or disloyalty.” Here, the court
found that BMC had engaged in “a robust,
arm’s-length sales process during which
the [c]ompany … conducted two auctions
over roughly the course of a year, actively
marketed itself for several months in each,
as well as vigorously marketed itself in the
30-day Go Shop period.” The court deemed
meritless petitioners’ claims that an activist
investor had pressured BMC “into a rushed
and ineffective sales process that ultimately
undervalued the [c]ompany.” While thecourt found that the investor “was clearlyagitating for a sale,” the court determinedthat this “agitation did not compromise theeffectiveness of the sales process.”
The court further found that no reduction to
the merger price was warranted to account formerger-related synergies as opposed to valuethat could be “attributed to the corporation
as an independent going concern.” The court
rejected petitioners’ contention that the
court should deduct “tax savings and othercost savings that the acquirer professed it
would realize once BMC [was] a private
entity.” The court reasoned that “such …
savings [are] logically a component of the
intrinsic value owned by the stockholder thatexists regardless of the merger.” The court
further found that even if the merger pricereflected some merger-related synergies,
petitioners had failed to meet their burden
to demonstrate that there “were synergies
realized from the deal” that “were … captured
by sellers in the deal price.”
Because “the sales process was sufficiently
structured to develop fair value” for BMC,
the court held that “the merger price [was]the most persuasive indication of fairvalue available.”

New York Appellate Division:
First Department Adopts
Garner Test for Determining
Whether the Fiduciary
Exception to the AttorneyClient Privilege Applies
Pursuant to the fiduciary exception to theattorney-client privilege, shareholders whobring suit against corporate management forbreach of fiduciary duty or similar claims may,under certain circumstances, obtain accessto communications between management
and corporate counsel. On October 8, 2015,
the New York Appellate Division, First
Department, adopted the multifactor test set
forth in Garner v. Wolfinbarger, 430 F.2d
1093 (5th Cir. 1970) for determining whether
the fiduciary exception applies with respect
to any given attorney-client communication.
NAMA v. Greenberg Traurig LLP, 2015 WL
5839311 (1st Dep’t. 2015) (Acosta, J.).

BackgroundIn the case before the court, NAMA Holdings,
an investor in a real estate development
entity, The Alliance Network, brought suitagainst the managers and other membersof that entity asserting various direct andderivative claims, including breach offiduciary duty claims. Defendants objected8to certain of NAMA’s document requests
in connection with the suit on grounds ofattorney-client privilege. NAMA asserted
that “the ‘fiduciary exception’ to the attorneyclient privilege compelled production,
because the [m]anagers owed a fiduciary duty
to NAMA and accordingly sought legal advice
on its behalf.”
The trial court found that the key inquiry
for purposes of the fiduciary exception was“whether NAMA and Alliance [had] everdeveloped an adversarial relationship.”
Following a hearing on the issue, a specialreferee “concluded that no such relationshipexisted” and therefore found that all of the
disputed documents must be produced.
The trial court adopted the special referee’s
report and ordered defendants to produce
all documents as to which defendants
had asserted the attorney-client privilege.
Defendants appealed.

Rejecting the Trial Court’s
Adversity-Based Analysis, First
Department Holds the Garner
Factors Govern the Application of
the Fiduciary Exception
On appeal, the First Department stated that“the fiduciary exception has been widely
accepted throughout most of the UnitedStates in trustee-beneficiary and corporationshareholder cases.” The court noted that“[s]everal New York courts have also
recognized the fiduciary exception.” The First
Department explicitly adopted the Garner
test for assessing whether the fiduciary
exception applies.
In Garner, the Fifth Circuit “set forth a
non-exhaustive list of factors that should beconsidered to determine whether a party has
shown good cause for applying the exception
in a given case.” “These factors include(1) ‘the number of shareholders and thepercentage of stock they represent,’(2) ‘the bona fides of the shareholders,’(3) ‘the nature of the shareholders’ claim
and whether it is obviously colorable,’(4) the apparent necessity or desirability ofthe shareholders having the information andthe availability of it from other sources,’(5) ‘whether, if the shareholders’ claim isof wrongful action by the corporation, it
is of action criminal, or illegal but notcriminal, or of doubtful legality,’(6) ‘whether the communication related topast or to prospective actions,’ (7) ‘whether
the communication is of advice concerning
the litigation itself,’ (8) ‘the extent to which
the communication is identified versus theextent to which the shareholders are blindly
fishing,’ and (9) ‘the risk of revelation of
trade secrets or other information in whose
confidentiality the corporation has an interestfor independent reasons’” (quoting Garner,
430 F.2d 1093). The First Department
found that the Garner test “strikes theappropriate balance between respect for theprivilege and the need for disclosure.” TheFirst Department further found that theGarner test’s “requirement of a good-cause
showing appropriately accounts for thesensitive nature of discovery disputes overattorney-client privilege, particularly in thecorporate context.”
The First Department explained that although“some factors in the Garner test are relevant
to a determination of adversity, Garner did
not create a categorical adversity limitation.”
The Court concluded that “adversity is nota threshold inquiry” for purposes of thefiduciary exception but rather, “a componentof the broader good-cause inquiry.” TheFirst Department found that under Garner,
whether the fiduciary exception applies
to attorney-client communications madeduring the existence of an adversarial
relationship depends on the nature of thosecommunications. Communications “that(1) concerned how to deal with the plaintiff,(2) were specifically relevant to the handlingof the very issues the plaintiff had been
threatening to litigate, or (3) were of advice
concerning the litigation itself will likely
remain privileged—unless other factors arestrong enough to establish good cause.”
However, “[o]ther communications that are
germane to the allegations in the complaint,even those that occurred after adversity
arose, would still be discoverable pursuant
to the fiduciary exception (provided goodcauses exists).” The First Department
reasoned that “[t]his communication-specificadversity inquiry operates as a fail-safe,
maintaining balance in the operation of thefiduciary exception.”9First Department Remands Case
for a Comprehensive Good Cause
Analysis and an In-Camera Review
of Each Contested Document
The First Department remanded the case forthe trial court “to conduct a comprehensive
good-cause analysis” under Garner. The First
Department explained that the trial court,“given its discretion under CPLR article 31,
may not need to evaluate each factor listed
in Garner.” However, the First Departmentemphasized that if “a court finds that ashareholder has demonstrated good cause to
apply the fiduciary exception and pierce thecorporate attorney-client privilege, it must atleast address those factors that support sucha finding.”

Notably, the First Department stated that “acourt’s ability to conduct an in camera reviewof the communications” can be “crucial” tothe analysis. Here, the special referee had
not “review[ed] a single document in camera,
despite being instructed by the motion court
to conduct an item-by-item review.” The First
Department found that “[a]bsent a review of
the communications (or at least a sampling
thereof), it would be impossible to determine
whether they involved advice concerning
the instant litigation or ‘how to deal with’
NAMA.” The First Department concluded
that it could not “affirm an order directing the
production of more than 3,000 purportedly
privileged communications without a single
one of those communications having beenreviewed.”

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