Securities Law Alert
In This Edition:• Second Circuit Holds That a Failure to Comply With Item 303 of Regulation S-K Is Only Actionable If All
Requirements To State a Section 10(b) Claim Are Satisfied• Third Circuit Applies the “Irrevocable Liability” Test to Find That Morrison Reaches a Foreign Entity’s
Over-the-Counter Transactions in Domestic Securities• Ninth Circuit Holds That Rule 9(b)’s Particularized Pleading Requirements Apply to Loss Causation
Allegations• Tenth Circuit Finds Allegations of GAAP Violations and Claims That Defendants “Must Have Known” of the
Fraud Insufficient to Allege Scienter Under the PSLRA’s Heightened Pleading Standards• Delaware Supreme Court Reaffirms Passive Market Check May Satisfy Director Revlon Duties and Provides
Guidance on “Blue Pencil” Injunctions Modifying Merger Agreements• New York Courts Reject Disclosure-Only Settlements of Merger Litigation
January 2015

Second Circuit Holds That a
Failure to Comply With Item
303 of Regulation S-K Is Only
Actionable If All Requirements
To State a Section 10(b) Claim
Are Satisfied

Simpson Thacher is“[o]ne of the few firms
where securities litigation
has long been a central areaof expertise.”–Legal 500 2014

Item 303 of Regulation S-K sets forth
the disclosure requirements for theManagement’s Discussion and Analysis(MD&A) section of a public company’s Form
10-Qs and other SEC filings. In relevant part,
Item 303 states that a public company must“[d]escribe any known trends or uncertainties
that have had or that the registrant reasonably
expects will have a material favorable orunfavorable impact on net sales or revenues
or income from continuing operations.” 17
C.F.R. § 229.303(a)(3)(ii).
On January 12, 2015, the Second Circuit
held “as a matter of first impression … that a

Simpson Thacher & Bartlett LLP

failure to make a required Item 303 disclosure… is indeed an omission that can serve as
the basis for a Section 10(b) securities fraudclaim.” Stratte-McClure v. Morgan Stanley,
2015 WL 136312 (2d Cir. 2015) (Livingston,J.). However, the Second Circuit found that“such an omission is actionable only if itsatisfies the materiality requirements outlinedin [Basic Inc. v. Levinson, 485 U.S. 224(1988)], and if all of the other requirements
to sustain an action under Section 10(b)are fulfilled.”

Second Circuit Finds That Failingto Make Required Item 303
Disclosures Could Render Form
10-Qs and Other SEC Filings
Misleading Under Section 10(b)The Second Circuit determined that “Item303’s affirmative duty to disclose in Form
10-Qs can serve as the basis for a securities
fraud claim under Section 10(b)” because
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“omitting an item required to be disclosed on
a 10-Q can render that financial statement
misleading.” The court explained that “Form10-Qs are mandatory filings that ‘speak …
to the entire market.’” Item 303 disclosures
are “required elements” of Form 10-Q
filings that “give investors an opportunity
to look at the registrant through the eyesof management by providing a historicaland prospective analysis of the registrant’s
financial condition and results of operations.”
In view of the “obligatory nature” of Item
303 disclosures, the Second Circuit explainedthat “a reasonable investor would interpretthe absence of an Item 303 disclosure to
imply the nonexistence of ‘known trends or
uncertainties … that the registrant reasonably
expects will have a material … unfavorable
impact on … revenues or income fromcontinuing operations.’” The court therefore
concluded that “Item 303 imposes the type of
duty to speak that can, in appropriate cases,
give rise to liability under Section 10(b).”In so holding, the Second Circuit noted thatit has “already held that failing to comply
with Item 303 by omitting known trends or
uncertainties from a registration statement
or prospectus is actionable under Sections
11 and 12(a)(2) of the Securities Act of 1933”(citing Panther Partners Inc. v. Ikanos
Communications, Inc., 681 F.3d 114 (2d Cir.
2012) and Litwin v. Blackstone Group, L.P.,
634 F.3d 706 (2d Cir. 2011)). The Second
Circuit underscored the similarities between
Section 10(b) of the Exchange Act and Section
12(a)(2) of the Securities Act: “Like Section
12(a)(2), Rule 10b-5 requires disclosure of‘material fact[s] necessary in order to make …
statements made … not misleading.’”

Second Circuit Clarifies That
Omitting a Required Item 303
Disclosure Is Actionable Under
Section 10(b) Only If theDisclosure Would Have Been
Material Under BasicThe Second Circuit underscored that“[t]he failure to make a required disclosure
under Item 303 … is not by itself sufficient
to state a claim for securities fraud under
Section 10(b).” Rather, the court foundthat “a violation of Item 303’s disclosure
requirements can only sustain a claim under
Section 10(b) and Rule 10b-5 if the allegedly
omitted information satisfies Basic’s test formateriality.” For purposes of “Section 10(b)and Rule 10b-5, the materiality of an allegedly
required forward [ ] looking disclosure isdetermined [under the Basic test] by ‘abalancing of both the indicated probability
that the event will occur and the anticipatedmagnitude of the event in light of the totalityof the company activity.’” Stratte-McClure,2015 WL 136312 (quoting Basic, 485 U.S.
at 224).
The Second Circuit explained that “[t]heSEC’s test for a duty to report under Item
303 … involves a two-part … inquiry” that is“different” from the test for materiality under
Basic. When determining whether Item 303
mandates disclosure of a “known trend,”“management must make two assessments.”
First, management must consider whether the
known trend is “likely to come to fruition.”
Second, in the event that “management
cannot make that determination, it mustevaluate objectively the consequences of the
known trend … on the assumption that it will
come to fruition.” Item 303 then requires
disclosure of the trend “unless management
determines that a material effect on theregistrant’s financial condition or results ofoperations is not reasonably likely to occur.”
The Second Circuit noted that “[a]ccording to
the SEC, this disclosure standard is unique to
Item 303.”
The Second Circuit “conclude[d] thata violation of Item 303’s disclosure
requirements can only sustain a claim under
Section 10(b) and Rule 10b-5 if the allegedly
omitted information [also] satisfies Basic’s
test for materiality.” A plaintiff must firstestablish a duty to disclose by “alleg[ing] thatthe defendant failed to comply with Item 303
in a 10-Q or other filing.” Then, a plaintiff
must “allege that the omitted information wasmaterial under Basic’s probability/magnitudetest.” In addition, a plaintiff must satisfy
the other elements of a Section 10(b) claim,
including scienter, reliance, and economic
loss caused by plaintiff’s reliance.

Second Circuit Disagrees with
the Ninth Circuit’s Contrary
Holding in In re NVIDIA Corp.
Securities Litigation
The Second Circuit noted that its “conclusion
is at odds with the Ninth Circuit’s recent
opinion in” In re NVIDIA Corp. Securities
Litigation, 768 F.3d 1046 (9th Cir. 2014)
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(O’Connell, J.).1 There, the Ninth Circuit
held that “Item 303 does not create a duty
to disclose for purposes of Section 10(b) andRule 10b-5.” NVIDIA, 768 F.3d 1046. Inreaching its decision, the Ninth Circuit reliedon the Third Circuit’s decision in Oran v.
Stafford, 226 F.3d 275 (3d Cir. 2000). The
Oran court found that “a violation of thedisclosure requirements of Item 303 does notlead inevitably to the conclusion that suchdisclosure would be required under [Section
10(b) and] Rule 10b-5.” Oran, 226 F.3d 275.
The Second Circuit determined that theNinth Circuit had read the Third Circuit’s
decision in Oran too broadly. In the Second
Circuit’s view, the Oran court held that “aviolation of Item 303 ‘does not automaticallygive rise to a material omission under Rule10b-5’” given the differing standards ofmateriality that govern disclosures under
Section 10(b) and Rule 10b-5 as comparedwith disclosures under Item 303. StratteMcClure, 2015 WL 136312 (quoting Oran,
226 F.3d 275) (emphasis added). The Second
Circuit found that “Oran actually suggested,
without deciding, that in certain instances
a violation of Item 303 could give rise to amaterial [Rule] 10b-5 omission … as longas the omission is material under Basic,
and the other elements of Rule 10b-5 havebeen established.”
The Second Circuit further stated that
the Ninth Circuit had “misconstrue[d]the relationship between Rule 10b-5 andSection 12(a)(2) of the Securities Act.”
Like the Second Circuit, the Ninth Circuit
has held that “Item 303 creates a duty todisclose for the purposes of liability under
Section 12(a)(2).” Stratte-McClure, 2015 WL
136312 (citing Steckman v. Hart Brewing,Inc., 143 F.3d 1293 (9th Cir. 1998)). The
Second Circuit noted that “Section 12(a)(2)’sprohibition on omissions is textually identicalto that of Rule 10b-5: both make unlawfulomission of ‘material fact[s] … necessary inorder to make … statements, in light of thecircumstances under which they were made,not misleading.” The Second Circuit explainedthat “SEC regulations, like Item 303, dictate
the contents of mandatory disclosures—bethey Form 10-Qs in the case of Rule 10b-5
or prospectuses in the case of Section
12(a)(2)—and are therefore an essential
1. Please click here to read our discussion of the NVIDIA decisionin the October 2014 edition of the Alert.

part of the circumstances under which suchdisclosures are made.’”Second Circuit Addresses theContours of the Duty to Disclose
Under Item 303
As to the specific disclosure obligations
imposed by Item 303, the Second Circuit
found that “‘generic cautionary language’
does not satisfy Item 303[,]” particularly ifthese disclosures are “spread out over several
different filings” and are “unconnected tothe [discussion of] the company’s financial
position.” Rather than a “patchwork
commentary on the relevant market trends,”
the Second Circuit determined that “Item303 requires [both] disclosure of the known
trend and the ‘manner in which’ it ‘mightreasonably be expected to materially impact’ acompany’s overall financial position.” StratteMcClure, 2015 WL 136312 (quoting Litwin,
634 F.3d 706).
The Second Circuit recognized, however, that“[t]he SEC has cautioned that [Item 303]
requires ‘quantitative information’ only when
it is ‘reasonably available and will provide
material information for investors.’” The
Second Circuit explained that the SEC “hasnever gone so far as to require a company
to announce its internal business strategies
or to identify the particulars of its trading
positions.”

Second Circuit Finds Plaintiffs
Failed to State a Claim Under
Section 10(b) and Rule 10b-5
Based on Morgan Stanley’s
Alleged Failure to Make Required
Item 303 Disclosures
Turning to the allegations of the complaint
before it, the Second Circuit determinedthat plaintiffs had adequately alleged that
Morgan Stanley and several of its current andformer officers had “breached their Item 303
duty to disclose that Morgan Stanley faced
a deteriorating subprime mortgage market
that, in light of the company’s exposure to
the market, was likely to cause trading losses
that would materially affect the company’s
financial condition.” The court “assume[d],arguendo, that this omission was material
under Basic.” However, the Second Circuit
affirmed dismissal of plaintiffs’ claim for
failure to plead scienter adequately.
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Third Circuit Applies the“Irrevocable Liability” Test to
Find That Morrison Reaches
a Foreign Entity’s Over-theCounter Transactions in
Domestic Securities
In Morrison v. National Australia Bank
Ltd., 561 U.S. 247 (2010), the Supreme
Court held that “Section 10(b) applies only totransactions in securities listed on domestic
exchanges and domestic transactions inother securities.” On January 20, 2015, theThird Circuit ruled that “irrevocable liability
establishes the location of a securities
transaction” for purposes of determining
whether a transaction is “domestic” within
the meaning of the Morrison decision. UnitedStates v. Georgiou, 2015 WL 241438 (3dCir. 2015) (Greenaway, Jr., J.). Applying the“irrevocable liability” test, the Third Circuit
held “as a matter of first impression” thatover-the-counter “purchases and sales of
securities issued by U.S. companies throughU.S. market makers acting as intermediaries
for foreign entities constitute ‘domestictransactions’ under Morrison.”Third Circuit Holds That Securities
Listed on Either the OTC Bulletin
Board or the Pink OTC Markets
Are Not “Securities Listed on an
American Stock Exchange” forMorrison Purposes
At issue in the case before the Third Circuit
was a “stock fraud scheme … centered on
manipulating the markets of four stocks”
traded by foreign entities on two American
over-the-counter stock markets, the OTC
Bulletin Board (“OTCBB”) and the Pink OTC
Markets Inc. (“Pink Sheets”). The Third
Circuit noted that “[u]nder the first prongof Morrison, Section 10(b) applies to ‘thepurchase or sale of a security listed on an
American stock exchange.” The Third Circuit
found that “[s]ecurities listed on the OTCBB
and the Pink Sheets are not within theseparameters” for several reasons.
First, the Third Circuit pointed out that“[a]ccording to the SEC, there are eighteen
registered national security exchanges” but“the Pink Sheets and the OTCBB are notamong them.” Second, the court observedthat “the stated purpose of the [Securities
Exchange] Act refers to ‘securities exchanges’
and ‘over-the-counter markets’ separately,
which suggests that one is not inclusive of theother.” Georgiou, 2015 WL 241438 (citing
15 U.S.C. §78a et seq. (described as “[a]n Act[t]o provide for the regulation of securities
exchanges and of over-the-counter markets… [and] to prevent inequitable and unfair
practices on such exchanges and markets”)(emphasis added)). The Third Circuit
therefore concluded that the OTCBB and
the Pink Sheets “are not national securities
exchanges within the scope of Morrison.”Third Circuit Applies the“Irrevocable Liability” Test andDetermines That the Over-theCounter Transactions at Issue
Were “Domestic Transactions”
Under Morrison
The Third Circuit next considered whether theforeign entities’ over-the-counter transactions
in domestic securities constituted “domestictransactions” for purposes of Morrison’s
second prong. The court found that the caseat hand was distinguishable from Morrison.
While Morrison involved a foreign-cubed
action in which “all aspects of the tradesat issue occurred abroad,” the case before
the Third Circuit “involve[d] stocks of U.S.
companies” and transactions that “wereexecuted through American market makers.”
The Third Circuit explained that in order“[t]o determine whether the transactions at
issue were ‘domestic transactions,’ underMorrison,” it must “consider ‘not … the place
where the deception originated, but [the place
where] purchases and sales of securities’occurred” (quoting Morrison, 561 U.S. 247).
The court observed that several other circuits,
including the Second Circuit, have held that“a securities transaction is domestic when theparties incur irrevocable liability to carry out
the transaction within the United States orwhen title is passed within the United States”(quoting Absolute Activist Value Master Fund
Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012)).
Agreeing with these circuits, the Third Circuit
held “that irrevocable liability establishes
the location of a securities transaction” forpurposes of Morrison’s second prong. The
court noted that “[f]acts that demonstrateirrevocable liability’ include the ‘formationof the contracts, the placement of purchase4

orders, the passing of title, or the exchangeof money.’”
Applying the “irrevocable liability” test to thecase before it, the Third Circuit found that“at least one of the fraudulent transactions ineach of [the stocks at issue] was bought andsold through U.S.-based market makers.” Thecourt determined that “some of the relevanttransactions required the involvement of apurchaser or seller working with a market
maker and committing to a transaction in the
United States, occurring irrevocable liability
in the United States, or passing title in the
United States.” The Third Circuit therefore
held that the transactions at issue constituted“domestic transactions” within the meaningof the Morrison test, and affirmed theconviction under Section 10(b) and Rule10b-5 of a Canadian stockbroker involved in
the transactions.

Ninth Circuit Holds That Rule9(b)’s Particularized Pleading
Requirements Apply to Loss
Causation Allegations
Under Rule 8(a) of the Federal Rules ofCivil Procedure, plaintiffs need only provide“a short and plain statement of the claim
showing that the pleader is entitled torelief.” Fed. R. Civ. P. 8(a). However, Rule9(b) requires that a plaintiff “alleging fraud
or mistake … state with particularity thecircumstances constituting fraud or mistake.”Fed. R. Civ. P. 9(b).2 On December 16, 2014,
the Ninth Circuit held that “Rule 9(b) applies
to all elements of a securities fraud action,
including loss causation.” Oregon Public
Employees’ Retirement Fund v. Apollo
Group Inc., 2014 WL 7139634 (9th Cir. 2014)(Smith, Jr., J.).

2. In addition to the federal pleading requirements, securities
fraud plaintiffs must also comply with the Private Securities
Litigation Reform Act (“PSLRA”). The PSLRA requires that securities fraud complaints “state with particularity facts giving rise
to a strong inference that the defendant acted with the required
state of mind.” The PSLRA further mandates that securities fraud
complaints “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and,
if an allegation regarding the statement or omission is made on
information and belief, the complaint shall state with particularity
all facts on which that belief is formed.”

Ninth Circuit Finds Loss Causation
Is Among the “Circumstances
Constituting Fraud” Within the
Meaning of Rule 9(b)At the outset, the Ninth Circuit observedthat while “it is clear that Rule 9(b) and the[Private Securities Litigation Reform Act(“PSLRA”)] apply to almost all elements ofa securities fraud action, the law is less clear
about the pleading standard that applies
to the loss causation element.” The court
noted that in Dura Pharmaceuticals, Inc. v.
Broudo, 544 U.S. 336 (2005), “the Supreme
Court suggested that Rule 8’s ‘short and plain
statement’ might apply” to loss causation
allegations. The Ninth Circuit explained that“[a]fter Dura,” it had “applied a plausibility
standard to loss causation, which avoid[ed]the question of whether the Rule 8(a) or Rule9(b) pleading standard applie[d].” Under
this plausibility standard, courts in the Ninth
Circuit considered whether “the complaint
allege[d] facts that, if taken as true, plausibly
establish[ed] loss causation.” In re Gilead
Sciences Sec. Litig., 536 F.3d 1049 (9th Cir.
2008). On occasion, courts in the Ninth
Circuit “applied both Rule 8(a) and 9(b)standards to allegations of loss causation.”
Apollo, 2014 WL 7139634.
In Apollo, the Ninth Circuit squarely
addressed for the first time the questionof which pleading standard applies to losscausation allegations. The Ninth Circuit
determined that applying Rule 9(b) toloss causation allegations “is appropriate
for at least three reasons.” First, the court
reasoned that “[s]ince Rule 9(b) applies to all
circumstances of common-law fraud, … andsince securities fraud is derived from common
law fraud, it makes sense to apply the same
pleading standard to all circumstances of
securities fraud,” including loss causation.
The court noted that “[t]he requirement ofloss causation, in particular, is founded on thecommon law of fraud and deceit.” Second, theNinth Circuit found that “[l]oss causation ispart of the ‘circumstances’ constituting fraud”
within the meaning of Rule 9(b) “because,
without it, a claim of securities fraud does notexist.” Third, the Ninth Circuit explained thatits approach “creates a consistent standard
through which to assess pleadings in 10(b)actions, rather than the piecemeal standard
adopted by some courts.”

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Ninth Circuit Recognizes a Circuit
Split on Whether Rule 9(b) Applies
to Loss Causation Allegations
The Ninth Circuit discussed a circuit split
on the applicable pleading standard for losscausation allegations. The Fourth and Seventh
Circuits have “suggested that heightened
pleading standards apply to loss causation”(citing Katyle v. Penn Nat’l Gaming, Inc.,
637 F.3d 462 (4th Cir. 2011); Tricontinental
Indus., Ltd. v. PricewaterhouseCoopers, LLP,
475 F.3d 824 (7th Cir. 2007)). “The Second
Circuit applies a different, but heightened,
two-part test for loss causation, requiringthat plaintiffs show that the loss was bothforeseeable and caused by the materializationof the risk concealed by the fraudulent
statement” (citing ATSI Commc’ns, Inc.
v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir.
2007)). “The Fifth Circuit has concluded
that Rule 8(a) applies” to loss causation
allegations (citing Lormand v. U.S. Unwired,Inc., 565 F.3d 228 (5th Cir. 2009)). Finally,
the First Circuit “has only stated that it isunclear whether a plaintiff has to plead losscausation under Rule 8(a) or 9(b) (citing
Mass. Ret. Sys. v. CVS Caremark Corp., 716
F.3d 229 (1st Cir. 2013)).
The Ninth Circuit explained that it was“persuaded by the approach adopted in
the Fourth Circuit.” Courts in the Fourth
Circuit “review allegations of loss causationfor ‘sufficient specificity,’ a standard largely
consonant with [Rule] 9(b)’s requirement that
averments of fraud be pled with particularity.”
Penn. Nat’l Gaming, 637 F.3d 462.

Ninth Circuit Finds Plaintiffs Failed
to Plead Loss Causation Under
Either Rule 8(a) or Rule 9(b)Turning to plaintiffs’ loss causation
allegations in the case before it, the Ninth
Circuit found that plaintiffs did “not allege
specific statements made by the [d]efendants
that were made untrue or called into question
by subsequent disclosures.” The Ninth Circuit
determined that plaintiffs’ loss causation
allegations did not pass muster under either
Rule 8(a) or Rule 9(b), and therefore affirmed
dismissal of plaintiffs’ complaint.

Tenth Circuit Finds
Allegations of GAAP
Violations and Claims
That Defendants “MustHave Known” of the Fraud
Insufficient to Allege
Scienter Under the PSLRA’s
Heightened PleadingStandards
In a January 16, 2015 decision , the Tenth
Circuit affirmed dismissal of a securities fraud
action against Gold Resource Corporation
for failure to meet the heightened scienterpleading standards of the PSLRA. In re
Gold Resource Corp. Sec. Litig., 2015 WL
221614 (10th Cir. 2015) (Seymour, J.). The
Tenth Circuit held that plaintiffs’ allegationsof GAAP violations, standing alone, wereinsufficient to plead scienter. The court
further ruled that plaintiffs could not meetthe PSLRA’s scienter pleading requirements
merely by alleging that defendants “musthave known” of the alleged fraud or financial
discrepancy at issue.

Tenth Circuit Deems Allegationsof GAAP Violations Insufficientto Plead Scienter Absent
Particularized Facts Showing
Fraudulent Intent
The Tenth Circuit first addressed plaintiffs’
attempt to plead scienter by pointing to analleged GAAP violation concerning “thematerial overstatement of revenues.” The
Tenth Circuit explained that “allegationsof GAAP violations, standing alone, areinsufficient to state a securities fraud claim.”
Rather, such allegations may only “besufficient to state a claim” where they are“coupled with evidence that the violations
or irregularities were the result of the
defendant’s fraudulent intent to mislead
investors.”
The Tenth Circuit found that the allegationsof GAAP violations against Gold Resource
Corporation did not “come on top of … [any]other particularized facts showing fraudulent
intent” and were therefore inadequate
to plead scienter. Gold Resource, 2015
WL 221614.

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Tenth Circuit Finds Plaintiffs
Cannot Meet the PSLRA’s Scienter
Pleading Requirements Merely
by Asserting That Defendants“Must Have Known” of the Alleged
Financial Misstatements
The Tenth Circuit rejected plaintiffs’ assertion
that defendants “‘must have known’ of thealleged revenue misstatements at the timethey occurred” in view of “the small size of the
one-product company” and the fact that “theaccounting misstatements amounted to morethan sixteen percent of net income for the
first quarter of 2012.” The Tenth Circuit foundthat plaintiffs’ “view of the situation fail[ed] totake account of other plausible inferences” asrequired under the Supreme Court’s decisionin Tellabs, Inc. v. Makor Issues & Rights,
Ltd., 551 U.S. 308 (2007).
The alleged revenue misstatements stemmedin large part from a pricing discrepancy
involving one of the company’s two
customers. Applying the Tellabs standard,
the Tenth Circuit deemed it plausible thatlower-level employees at Gold Resource
Corporation might have delayed informing
senior executives of this pricing discrepancy
if they thought the “figures were wrong.” Gold
Resource, 2015 WL 221614. The Tenth Circuit
observed that “a prudent executive would
want to investigate and confirm a claimed
discrepancy before disclosing it publicly.”
In reaching this conclusion, the Tenth Circuit
found persuasive the Seventh Circuit’s
reasoning in Higginbotham v. Baxter
International, Inc., 495 F.3d 753 (7th Cir.
2007). There, the Seventh Circuit upheld
dismissal of a securities fraud action where
an executive learned of fraud at one of thecompany’s subsidiaries in May of 2004 but
did not publicly disclose the fraud until
July 2004. The Seventh Circuit found that“sometime during May 2004, [the executive]
learned enough to lead a reasonable person
to conduct an investigation.” However, theSeventh Circuit emphasized that “[k]nowing
enough to launch an investigation … is a very
great distance from convincing proof of intent
to deceive.”
The Tenth Circuit determined that “[t]hesame [analysis] is true in this case.” Gold
Resource, 2015 WL 221614. In the case athand, the Tenth Circuit found that“[d]efendants had every reason not to disclosethe [alleged pricing discrepancy] before thedispute was investigated and settled.” The
Tenth Circuit was “not persuaded [that] areasonable person would deem an inferenceof scienter more cogent or compelling than an
opposing inference of nonfraudulent intent
with respect to the misrepresentations” atissue, and therefore affirmed dismissal of
the complaint.

Delaware Supreme Court
Reaffirms Passive Market
Check May Satisfy Director
Revlon Duties and Provides
Guidance on “Blue Pencil”
Injunctions Modifying Merger
Agreements
In a December 19, 2014 decision written
by Chief Justice Strine in C&J Energy
Services, Inc., et al. v. City of Miami General
Employees’ & Sanitation Employees’
Retirement Trust, et al., 2014 WL 7243153(Del. 2014), the Delaware Supreme Court
reaffirmed that enhanced judicial scrutiny
under Revlon requires that directors ofa company make reasonable, but notnecessarily perfect, decisions in pursuing achange-of-control transaction; that a passive,
post-signing market check period may besufficient to satisfy directors’ Revlon duties;
and that “blue penciling” of an agreementby courts, to the detriment of the acquiror’s
rights under the agreement, should be limited
to instances where it is clear after trial (orbased on undisputed facts) that there was
misconduct by the acquiror, such as aidingand-abetting a breach of a fiduciary duty.

BackgroundThe case arose from the proposed merger,
announced on July 25, 2014, between C&J
Energy Services and a Bermuda-based
division of Nabors Industries, a competitor of
C&J. Among other benefits, the merger was
expected to produce substantial tax savings
from the re-domiciling of C&J from the U.S.
to Bermuda, provided that Nabors owned amajority of the combined entity.
The transaction was structured as a mergerof C&J with the Nabors subsidiary, with
Nabors receiving shares in the merged entity(new C&J) representing approximately 53%
7

of new C&J as well as approximately $938
million in cash. The existing C&J stockholders
would own the remaining minority stakein new C&J. In order to mitigate the publicstockholders’ loss of corporate control over
new C&J, the board of C&J negotiatedfor several corporate governance related
protections, including: (i) a bylaw providingthat all of the new C&J stockholders would
receive pro rata consideration in any saleof new C&J or its major assets, thereby
allowing for an equitable sharing of any“future control premium” that Nabors might
receive in a sale of its controlling stakein new C&J, (ii) the retention by C&J ofmanagement control of new C&J, and theright to nominate four directors, including
the chairman, to the seven director board of
new C&J, and (iii) a comprehensive, five-year“standstill” agreement from Nabors providing
for, among other restrictions, a prohibitionon the acquisition of additional shares andlimitations on the sale of its new C&J sharesto, for example, competitors and any person
or group that would own more than 20%
of new C&J. The merger agreement also
contained a broad fiduciary-out provisionthat permitted the C&J board to terminate
the proposed merger with Nabors if a morefavorable deal emerged for the sale of C&J,
a “modest” termination fee of 2.27% of thedeal value, and a lengthy pre-closing periodof approximately five months. The voting
agreement that C&J’s CEO entered into in
support of the merger would also terminate
upon a decision by the C&J board to exercise
its fiduciary out, leaving the CEO free to votein favor of a competing deal.
In a bench ruling issued on November 24,
2014, the Court of Chancery, while admittingthat its determination was a “very close call,”preliminarily enjoined for thirty days a voteby C&J stockholders on the merger, ordered
C&J to solicit alternative transactions to
the merger, and also provided that such
solicitation and any subsequent negotiation
by C&J of an alternative proposal would notconstitute a breach of the merger agreement.
The Court of Chancery based its decision andremedies on its determination of a “plausible”
violation by C&J’s board of its duty of care
under Revlon, citing the board’s failure toboth affirmatively shop C&J and have an“impeccable knowledge” of the value of C&J.

Delaware Supreme Court Analysis
In reversing the judgment of the Court ofChancery, the Delaware Supreme Court
assumed for purposes of its analysis that achange-of-control of C&J had occurred, thus
invoking enhanced judicial scrutiny of themerger under Revlon. In its analysis, theSupreme Court reiterated that Revlon does
not require a company to conduct an auction
or to follow any specific process. The Supreme
Court noted with approval Chancellor Allen’sreading of Revlon and its progeny to permit “aboard to pursue the transaction it reasonably
views as most valuable to stockholders,so long as the transaction is subject to aneffective market check under circumstancesin which any bidder interested in paying more
has a reasonable opportunity to do so.” In
its review of the factual record, the Supreme
Court noted possible deficiencies in the
C&J board sale process, including potential
conflicts involving its primary financial
advisor; limited direct board oversight andinvolvement in the merger negotiations; and“aggressive” compensation and severance
packages offered by Nabors to the C&J CEO
and other executives. On balance, however,the Supreme Court found that C&J’s
majority-independent and generally wellinformed board had met its Revlon duties bynegotiating “a logical strategic transaction
with undisputed business and tax advantages”
to its shareholders, a merger agreement that
contained a lengthy passive market check andonly modest deal protections, and a host of
bylaw protections that substantially mitigatedthe effects of the change-of-control of C&J,
while also providing C&J’s “stockholders witha fully informed, uncoerced opportunity tovote to accept the deal.” The Court also notedthat a private equity fund which owned 10% of
C&J’s stock was supportive of the transaction,and that when a large stockholder receiving
the same consideration as the otherstockholders is supportive of a transaction,that is normally evidence of its fairness.
The Supreme Court rejected the Court ofChancery’s comments that Revlon “required
impeccable knowledge” by the target’s boardof the company’s value, noting that the
C&J board was “well-informed” according
to the Court of Chancery decision. The
Supreme Court also emphasized several
times that Revlon and similar decisions arose
in situations in which a target board wasresisting takeover bids from a higher bidder,whereas in this transaction there were no8

other bidders and the C&J stockholders had
the right to vote down the proposed merger
with Nabors if they so chose.
The Supreme Court also held that the Courtof Chancery had misapplied the standardof review when granting a preliminary
injunction enjoining the merger. The Courtof Chancery erred when finding that theplaintiffs had shown “a plausible likelihoodof success on the merits as to a breach of
the duty of care” rather than requiring theplaintiffs to show “a reasonable probabilityof success on the merits.” Moreover, theSupreme Court suggested that an especiallystringent examination of plaintiffs’ claims
was warranted as “Delaware courts haveemphasized that in cases like this … theshowing of a reasonable probability of successmust be ‘particularly strong’ when ‘no otherbidder has emerged despite relatively mild
deal protection devices’.”The Supreme Court was also critical of
the Court of Chancery for its issuance ofa mandatory injunction requiring C&J tosolicit alternative proposals in violationof the merger agreement while expressly
providing that such a “go-shop” process
would not constitute a breach of the merger
agreement. In order to issue the unusual
remedy of a mandatory injunction “theCourt of Chancery must either hold atrial and make findings of fact or base an
injunction solely on undisputed facts.” In
this case, however, a number of important
factual disputes remained unresolved and,accordingly, the Court of Chancery erred in
issuing a mandatory injunction. Moreover,
the Supreme Court emphasized that even
“after a trial, a judicial decision holding aparty to its contractual obligations while
stripping it of bargained-for benefits should
only be undertaken on the basis that the
party ordered to perform was fairly required
to do so, because it had, for example, aided
and abetted a breach of fiduciary duty.” Forthese reasons, the Court of Chancery was
not entitled to “blue-pencil” the merger
agreement to “strip an innocent third
party [Nabors] of its contractual rights
while simultaneously binding that party toconsummate the transaction.”

New York Courts Reject
Disclosure-Only Settlementsof Merger Litigation
In two recent decisions, New York courts
have rejected disclosure-only settlementsof merger-related suits based on theimmateriality of the additional disclosures.
Gordon v. Verizon Communications, Inc.,
2014 WL 7250212 (N.Y. Sup. Ct. Dec. 19,
2014) (Schweitzer, J.); City Trading Fund v.
Nye, 46 Misc. 3d 1206(A) (N.Y. Sup. Ct. 2015)(Kornreich, J.).
On December 19, 2014, in an action arisingfrom Verizon Communication’s $130 billion
purchase of Vodaphone Group’s interest in
Verizon Wireless, the court denied approvalof a disclosure-only settlement based on
its finding that the additional disclosures“individually and collectively fail[ed] tomaterially enhance the shareholders’knowledge about the merger” and “provide[d]no legally cognizable benefit to theshareholder class.” Verizon Communications,2014 WL 7250212. The court explainedthat “[e]nhanced or corrected disclosure, tobe adequate to support a settlement, must
be a material improvement over what had
previously been disclosed.” For example, amaterial disclosure might “uncover conflicts”
or “correct material misstatements.”
On the other hand, “[m]erely providing
additional information—unless the additional
information offers a contrary perspective on
what has previously been disclosed—does
not constitute material disclosure.” The court
underscored that “divest[ing] [the class] ofvaluable rights in the form of a broad releaseof claims … cannot be justified by trivial
disclosure adjustments.” In so holding, thecourt observed that “[a] body of law meant
to protect shareholder interests from theabsence of due care by the corporation’s
managers has been turned on its head todiminish shareholder value by divesting themof valuable rights and imposing additional
gratuitous costs, i.e. attorneys’ legal fees on
the corporation.”
Several weeks later, in an action arising inconnection with Martin Marietta Materials’$2.7 billion acquisition of Texas Industries,
the court once again rejected a disclosureonly settlement based on its finding thatthe supplemental disclosures were “grossly
immaterial.” City Trading Fund, 46 Misc. 3d91206(A). The court explained that it “would
have approved the settlement” if “plaintiffs[had] alleged material omissions or settled
for material supplemental disclosures.”Given the “utterly immaterial” nature of
the supplemental disclosures, however,the court determined that “[a]pproving
the settlement would both undermine thepublic interest and the interests of [Martin
Marietta Materials’] shareholders.” The court
reasoned that allowing the settlement to go
forward “would incentivize plaintiffs to file
frivolous disclosure lawsuits shortly beforea [shareholder vote on a] merger, knowing
they will always procure a settlement andattorneys’ fees under conditions of duress—
that is, where it is rational to settle obviously
frivolous claims.”
Notably, the court emphasized that “extra
scrutiny is warranted when it appears
that the incentives of the proposed classrepresentatives diverge from those of theshareholders.” In the case before it, the court

found that the plaintiff was “essentially afictitious entity” that held a trivial number ofshares of Martin Marietta Materials as partof a strategy pursuant to which a generalpartnership affiliated with a plaintiffs’
firm would “purchase nominal amountsof shares in publicly traded companies”
and then bring suit whenever one of thosecompanies announced a merger. Because
the plaintiff had “no purposes for existingand no economic interests apart from thegeneration of attorneys’ fees,” the court foundthat plaintiff’s counsel had every incentive“to adopt inequitable litigation tactics andto advance meritless claims directed not at
vindicating the rights of real shareholders
but at maximizing the chance [the] litigation
will settle, resulting in awards of attorneys’
fees … wholly out of proportion to any real
benefit conferred on shareholders.” Thecourt observed that “[w]hen a proposed classrepresentative appears to be a fiction, thereis the concern that it has no accountability,
either to the class or to the court.”

The Securities Law Alertis edited by Paul C. Gluckow(pgluckow@stblaw.com/212455-2653), Peter E. Kazanoff(pkazanoff@stblaw.com/212-4553525) and Jonathan K. Youngwood(jyoungwood@ stblaw.
com/212-455-3539).

10

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