Securities Law Alert
In This Edition:• Third Circuit: Nonvoting Board Observers Affiliated With an Issuer’s Placement Agent Are Not Subject
to Liability Under Section 11 of the Securities Act of 1933
• Third Circuit: Company’s Comprehensive Disclosures Defeated an Inference of Scienter• Southern District of New York: Second Circuit’s Decision in Singh v. Cigna Does Not Stand for the
Proposition That a Company Can Never Face Securities Fraud Liability for Statements in a Corporate
Code of Conduct• Southern District of New York: A Company Has No Duty to Disclose Uncharged, UnadjudicatedWrongdoing Unless There Is a “Direct Nexus” Between the Alleged Wrongdoing and the Company’s
Statements• Eastern District of New York: (1) Statements Concerning a Mutual Fund’s Investment Goals Were
Inactionable, But (2) Loss Causation Requirement Does Not Preclude Securities Act Claims Against
Mutual Funds• Delaware Supreme Court: Reverses Dismissal of Caremark Claim Where the Directors Allegedly MadeNo Effort to Establish a Board-Level Monitoring and Reporting System
July 2019

Simpson Thacher’s“very experienced andknowledgeable” securities
litigation team has an“extensive track recordof success.”–Legal 500

Simpson Thacher & Bartlett LLP

Third Circuit: Nonvoting
Board Observers AffiliatedWith an Issuer’s Placement
Agent Are Not Subject toLiability Under Section 11 of
the Securities Act of 1933
On July 23, 2019, the Third Circuit held that“a nonvoting board observer affiliated with
an issuer’s placement agent” is not subject toliability under Section 11 of the Securities Act
of 1933 as a person who “‘perform[s] similarfunctions’” to a “‘director.’” Obasi Inv. Ltd.
v. Tibet Pharm., 2019 WL 3294888 (3d Cir.
2019) (Hardiman, J.) (quoting 15 U.S.C.
§ 77k(a)(3)).

Background
Plaintiffs brought Section 11 claims against
two nonvoting board observers who
were chosen by the placement agent andnamed with their consent in a registration
statement. The registration statement notedthat although the board observers had noformal authority or responsibilities, “theymay nevertheless significantly influence theoutcome of matters submitted to the Board of
Directors for approval.” Plaintiffs contended
that defendants were subject to Section 11
liability pursuant to 15 U.S.C. § 77k(a)(3),
which provides that Section 11 claims may
be brought against “every person who, withhis consent, is named in the registration
statement as being or about to become adirector, person performing similar functions,or partner.”
The district court found that there was “agenuine issue of material fact as to whether[the board observers] could be viewed
as . . . people performing similar functions
to a director.” Dartell v. Tibet Pharm., 2017
WL 1944106 (D.N.J. May 10, 2017). The
district court noted that “[a]ccording to thedescription” in the registration statement,
the “[b]oard [o]bservers could influence theentire board.” The district court reasoned thatthe “[b]oard [o]bservers arguably had more
influence than any individual board member,
who could only cast a single vote.” The district
court subsequently certified the following
question for an interlocutory appeal:
Can Defendants be potentially liable
under Section 11 of the Securities Act
of 1933, each as a ‘person performing
similar functions’ to a director, in lightof Defendants’ role as board observers
who could (but did not necessarily haveto) significantly influence the outcomeof matters submitted to the board of
directors for approval?
Obasi, 2019 WL 3294888.

Third Circuit Holds Nonvoting
Board Members Affiliated With an
Issuer’s Placement Agent Do Not
Perform “Similar Functions” toDirectors as a Matter of Law
On appeal, the Third Circuit held that“deciding whether a person is a proper§ 77k(a)(3) defendant . . . is a question of law
for the court, not a question of fact for thejury.” The court further held that the inquiry
is limited to a review of “the description
provided” in the registration statement of
the person’s role, and does not extend to
extrinsic evidence concerning the person’s
actual functions. The Third Circuit foundthat holding otherwise “would excise thephrase ‘named in the registration statement
as’ altogether and rewrite § 77k(a)(3) to say‘every person who, with his consent, is or
is about to become a director [or] person
performing similar functions.” The court
further reasoned that “the requirementof consent to be named . . . confirms that[the court’s] inquiry stops at the text of theregistration statement.” The court noted that“[i]t is hard to see how this consent could be

informed if a person’s status (and potential
liability) were speculative and mutable basedon facts and events beyond the text of theregistration statement.”
Turning to the question of whether the
nonvoting board members affiliated with
the issuer’s placement agent could face
Section 11 liability pursuant to § 77k(a)(3),
the Third Circuit held that defendants
were not “performing similar functions” todirectors based on the description of theirrole in the registration statement. The courtemphasized that defendants “cannot votefor board action” and thus have no “ability
to manage the company’s affairs,” which is
the “directors’ most basic power.” The court
also found it significant that defendants were
“aligned with the placement agent” rather
than the company. The court explainedthat defendants’ “loyalties aren’t with[the company’s] shareholders—and loyalty
to the shareholders is as vital to directorshipas the power to manage.” Finally, the court
noted that defendants’ “tenures are set toend automatically, with no opportunity [forshareholders] to vote them out.” The court
found that these “[t]hree features differentiate[defendants] from directors.”
The Third Circuit deemed defendants’“influence” insufficient to render themsimilar to directors. The court observed thata well-regarded analyst “might also enjoy
special access to the issuer’s board andmanagement,” and may also have the “power
to influence the issuer’s board.” The court
explained that “no one would argue that [this]hypothetical analyst is any meaningful way‘similar’ to a board member.”
The Third Circuit also rejected plaintiffs’
contention that “a broad construction” of§ 77k(a)(3) “is necessary to hold wrongdoers
accountable.” The court noted that “Section
11 imposes near-strict liability for untruths
and omissions made in a registration
statement,” as “a § 11 plaintiff need not allege
scienter, reliance, or loss causation.” Thecourt explained that “[b]ecause § 11 is suchstrong medicine, . . . it applies only to limited
and enumerated categories of defendants.”
The court pointed out that “Section 11 isbut one part of an overlapping web of civil
liability provisions,” many of which could
be used to seek redress against nonvoting
board members appointed by the issuer’s
placement agent.
2

In a dissenting opinion, Judge Robert
Cowen expressed his view that the majority
had applied an unduly narrow definitionof the term “similar,” and failed to adhere
to the Supreme Court’s instruction thatfederal securities fraud laws “should beconstrued . . . flexibly to effectuate theirremedial purposes.” Id. (quoting Herman& MacLean v. Huddleston, 459 U.S. 375(1983)). Judge Cowen opined that “a person
may be named as performing similarfunctions to a director even if he or she does
not possess the directors’ formal power todirect and manage a corporation, and the
responsibilities and duties that accompany
those powers.”

Third Circuit: Company’sComprehensive Disclosures
Defeated an Inference of
Scienter
On June 20, 2019, the Third Circuit affirmed
dismissal of a securities fraud action alleging
that a company “fraudulently lauded
its financial health and misrepresented
that its distributions were funded fromthe performance of the business.” Fan v.
StoneMor Partners, 2019 WL 2529250 (3dCir. 2019) (Restrepo, J.). The Third Circuit
found that “for each category of alleged
misstatements, [the company] disclosed
sufficient information to render them
immaterial.” The court further held that thecompany’s comprehensive disclosures belied
any inference of scienter.

made after the end of the quarter . . . lesscash reserves.” The court determined thata reasonable investor would have known
from this definition that the company’s“distributions were funded by more thanjust its operating revenue.” The court
also found it significant that the company
included in its annual reports both “GAAPand non-GAAP financials side-by-side,which demonstrated the mathematicalreality that [the company] was not able tofund its distributions primarily from its
day-to-day operations because much ofthat cash was being held in state trusts andwas unrecognized by GAAP.” The court
determined that these disclosures refuted
plaintiffs’ allegation that the company“fraudulently concealed the fact that its
distributions were not funded primarily fromthe current operating revenue.”
The court further found that the company’s“disclosures do not demonstrate an intent
to defraud—rather, they accurately show
how [the company] leveraged its assets inorder to maximize its distributions despite
the state trust requirements” that limited its
ability to recognize proceeds as revenue under
GAAP. The court explained that although thecompany “may have been caught by the risk
inherent in its business strategy, . . . thoserisks were disclosed” to investors and thus
“the pleadings do not demonstrate scienteras the [Private Securities Litigation Reform
Act] requires.”

As to alleged misstatements concerning thecompany’s financial health, the court foundthat the company “repeatedly disclosed therisks it faced in its business.” For example, thecompany cautioned that its “substantial levelof indebtedness could materially adversely
affect its ability to generate sufficient cash
for distribution to its unitholders, to fulfill its
debt obligations and to operate its business.”
The court determined that these types of
disclosures “alert[ed] reasonable investors” tothe company’s downside potential.
With respect to statements concerning thesource of the company’s distributions, thecourt noted that the company’s Form 10-Ks
defined “Available Cash as consisting of cashon hand at the end of that quarter, plus cashon hand from working capital borrowings
3Southern District of New York:
Second Circuit’s Decisionin Singh v. Cigna Does Not
Stand for the Proposition Thata Company Can Never Face
Securities Fraud Liability forStatements in a Corporate
Code of Conduct
On June 11, 2019, the Southern District of
New York held that the Second Circuit’s
decision in Singh v. Cigna Corporation,
918 F.3d 57 (2d Cir. 2019), did not entitle
defendants to judgment on the pleadings in asecurities fraud action alleging misstatementsin the company’s Codes of Conduct and Ethics
concerning its policies on sexual harassmentand merit-based advancement.1 In re Signet
Jewelers Ltd. Sec. Litig., 2019 WL 2428529(S.D.N.Y. 2019) (McMahon, J.). The court
found that Cigna “did not announce a newlegal rule . . . deeming an entire category ofstatements—those contained in a company’scode of conduct—per se inactionable.”

In Cigna, the Second Circuit determined that“general declarations about the importanceof acting lawfully and with integrity” set
forth in a company’s Code of Ethics were
“textbook example[s] of puffery.” The Second
Circuit explained that “general statements
about reputation, integrity, and compliancewith ethical norms are inactionable puffery,
meaning that they are too general to cause areasonable investor to rely on them.”
The Signet court rejected defendants’contention that “Cigna wrought a sea change
in the doctrine of puffery.” The court found
1. Please click here to read our discussion of the Second Circuit’s
decision in Cigna.

that “Cigna did not purport to change thewell-established law regarding materiality,”nor did it “rule . . . that all statements in codesof conduct qualify as puffery.” The court
observed that “the Cigna court expressly
stated that context bears on materiality.”
The Signet court recognized that “[w]here astatement is located is one factor (of several)
relevant to materiality; that was the law
before Cigna, and it remains the law afterit.” However, the court reasoned that “it does
not follow from Cigna that a securities fraudclaim can never rest on statements containedin a public company’s code of conduct.”
The Signet court pointed out that in Indiana
Public Retirement System v. SAIC, 818
F.3d 85 (2d Cir. 2016), the Second Circuitspecifically “eschewed laying down a brightline rule . . . that would categorize allstatements located in a company’s code of
conduct as immaterial puffery as a matterof law.” Signet, 2019 WL 2428529. The
SAIC court noted that “statements about acompany’s reputation for integrity or ethicalconduct . . . may amount to more than puffery
and may in some circumstances violate thesecurities laws.” 818 F.3d 85. The SAIC court
offered as examples “a company’s specificstatements that emphasize its reputation
for integrity or ethical conduct as central
to its financial condition or that are clearly
designed to distinguish the company fromother specified companies in the same
industry.”
The Signet court found that the facts allegedin the case before it “differ starkly from thosealleged in Cigna.” Unlike the “exceptionallyvague and aspirational” statements theSecond Circuit deemed inactionable in Cigna,
the statements at issue in Signet specifically“touted how the company makes decisions
based solely on merit, disciplines misconduct,
and provides a safe and anonymous meansfor employees to report misconduct without
retaliation.” The court found these allegedly
misleading statements were designed “toreassure the investing public that [thecompany] did not, in fact, have a toxic
workplace” at a time when the company faced
accusations of a culture of sexual harassment.
The court held that these statements wereactionable because a reasonable investor“would be concerned about how grave
allegations concerning rampant sexual
misconduct might affect her investment in[the company].”4Southern District of New
York: A Company Has No
Duty to Disclose Uncharged,
Unadjudicated Wrongdoing
Unless There Is a “Direct
Nexus” Between the Alleged
Wrongdoing and theCompany’s Statements
On July 12, 2019, the Southern District of
New York dismissed a securities fraud action
alleging that a multinational conglomerate“fraudulently failed to disclose [an] alleged
bribery scheme.” Schiro v. Cemex, S.A.B.
de C.V., 2019 WL 3066487 (S.D.N.Y. 2019)(Caproni, J.). The court underscored that “acompany has a duty to disclose uncharged,
unadjudicated wrongdoing” only if there is “adirect nexus between the alleged wrongdoing
and the company’s statements.” The court
further held that the scienter of the officersof one of the company’s subsidiaries officers
could not be imputed to the company because
there were no allegations that the officers
served as proxies for the company, or that thecompany “possessed some degree of control
over, or awareness about, the fraud.”

A Duty to Disclose Uncharged,
Unadjudicated Wrongdoing
Does Not Arise Merely Becausea Criminal Conviction Would
Adversely Impact the Company
The court explained that the duty to disclose
uncharged, unadjudicated wrongdoingarises only if there is “a connection between
the illegal conduct and the misleadingstatements beyond the simple fact that acriminal conviction would have an adverse
impact upon the company’s operations ingeneral or the bottom line.” For example, thecourt recognized that “[a] duty to disclose
uncharged wrongdoing may . . . arise when acorporation puts the reasons for its success
at issue, but fails to disclose that a material
source of its success is the use of improper orillegal business practices.”
The court held that statements “attribut[ing]the [c]ompany’s growth to broad trends andcorporate strengths, without pointing to
any specific factors or sources of revenue,”
did not trigger a duty to disclose the alleged
bribery scheme because the statements were

“far too generic to be actionable under the
securities laws.” The court similarly foundthat statements concerning the company’s
Code of Ethics and its anti-bribery policies
were “classic puffery.” The court noted that“[m]any of the statements were precededby explicitly aspirational language (e.g.,‘committed to’; ‘tr[ies] to ensure’), thus
unmistakably signaling that they werestatements about goals, not statements offact.” The court also found inactionable
statements concerning the company’s internal
controls because the company “did notstate that the [c]ompany’s internal controls
were effective” but “only that management
had concluded as much.” The court also
held that the company had no duty todisclose the alleged bribery payment in its
financial statements because “a violation offederal securities laws cannot be premised
upon a company’s disclosure of accurate
historical data.”
The court did, however, find that thecompany’s statements concerning litigation
over rights to a Columbian plant triggereda duty to disclose the company’s alleged
payment of a bribe to acquire the plant’s
assets. The court determined that “[t]healleged bribery scheme bears a direct nexus”
to the company’s statements concerning
the litigation. The court reasoned that “inthe mind of a reasonable investor, both thescheme and the proceeding could have raised
serious doubts about” the legal enforceabilityof the company’s rights to the plant’s assets.

Plaintiffs’ Allegations Were
Insufficient to Impute the Scienterof the Subsidiary’s Officers to
the Company
The court held that plaintiffs did notadequately allege that the scienter of officersof the company’s subsidiary should be
imputed to the company. The court explainedthat “[t]he mere existence of a parentsubsidiary or affiliate relationship is not on
its own sufficient to impute the scienter ofthe subsidiary to the parent or its affiliate.”
The court found that the subsidiary’s officers“were not sufficiently senior within [theparent company] to serve as a proxy forthe [c]ompany.” Moreover, there were no
allegations that the officers “participated in
the overall management of the [c]ompany,
reported directly to [the company’s] senior
managers, or otherwise served as proxies for5the [c]ompany.” The court found it significant
that the subsidiary “comprises less than 6
percent of the total assets, and less than 13
percent of the total net sales” of the company.
“Given the tiny share of [the company’s]
business that [the subsidiary] comprises,” thecourt held that “the scienter of officers of [thesubsidiary] cannot, without more, be fairly
attributed to” the company.

Eastern District of New York:(1) Statements Concerninga Mutual Fund’s Investment
Goals Were Inactionable,
But (2) Loss Causation
Requirement Does Not
Preclude Securities Act Claims
Against Mutual Funds
On June 25, 2019, the Eastern District of New
York dismissed with prejudice a securities
fraud action alleging misrepresentations in amutual fund’s offering documents in violationof Sections 11 and 12(a)(2) of the Securities
Act. Emerson v. Mutual Fund Series Trust,2019 WL 2601664 (E.D.N.Y. 2019) (Spatt,J.). The court held plaintiffs failed to allege
any material misstatements or omissions, andspecifically found that statements concerning
the fund’s investment strategy were
inactionable. However, the court rejected
defendants’ contention that plaintiffs could
not satisfy the loss causation requirement for
Securities Act claims because a mutual fund’s
misstatements or omissions do not directly
affect the fund’s net asset value (“NAV”).
The court held that plaintiffs can rely on
the “materialization of the risk” framework
discussed in the Second Circuit’s decision in
Lentell v. Merrill Lynch & Co., 396 F.3d 161(2d Cir. 2005), to demonstrate loss causationin Securities Act claims against mutual funds.

Statements Concerning theFund’s Investment Goals
Were Inactionable
Plaintiffs alleged that “[d]efendants
misrepresented the [f]und as a low-risk
investment” by describing the fund’sinvestment objectives as “capital
appreciation and capital preservation in
all market conditions” and characterizing

the fund’s investment strategy as “market
neutral.” Plaintiffs contended that these
representations were misleading in view of“the [f]und’s significant investment in naked
call options, which rendered the [f]undsusceptible to large losses in rapidly risingmarkets.” The court found these statements
inactionable “because they merely articulate
the goals of the [f]und, rather than promisea particular investment strategy.” The court
observed that the fund’s stated objectives
were “to generate returns on investments
while avoiding losses—the aspiration ofnearly all mutual funds.” The court reasoned
that it could not “fathom how any mutualfund could escape liability if such vacuous
pronouncements became actionable simply
because the [f]und suffered losses against its
best wishes.”

A Reasonable Investor Considers
the “Totality of the Disclosures”
and Conducts Basic Mathematical
Analyses of Financial Data
Plaintiffs also claimed that defendants
misleadingly “conveyed that the [f]und did
not write uncovered call options.” The court
found that the statements at issue were
not misleading “when read in conjunction
with the totality of the disclosures in theOffering Documents.” The court noted thatthe offering documents were “replete withdisclosures regarding the [f]und’s investment
in uncovered call options and the associatedrisks.”
The court found it particularly significant thatthe fund “publish[ed] an itemized list of every
single investment and option in the [f]und’s
portfolio” on a quarterly basis. The court
concluded that “a reasonable investor would
have determined that the [f]und did not coverits written options with purchased options
by simply comparing the two numbers” in6the itemized list. The court explained that“[p]laintiffs cannot allege the [f]und failed
to disclose its investment in uncovered call
options when it could have ‘discovered’ thetruth purely through simple arithmetic.” Thecourt emphasized that “the Securities Act
creates liability for misleading statements,
not statements that an investor simply
misunderstood.” The court observed that the“disclosure requirements are not intended toattribute to investors a child-like simplicity.
Rather, investors are presumed to have theability to be able to digest varying reports
and data.”
The court found that disclosures concerning
the fund’s writing of uncovered call
options put plaintiffs on inquiry notice of
their alleged claims for purchases mademore than one year before they broughtsuit. Plaintiffs argued that the accrual of
their claims was delayed by defendants’reassurances concerning the fund’s capitalpreservation and risk mitigation strategies.
But the court explained that “an investor
may not reasonably rely on words of
comfort from management when there are
direct contradictions between defendant’srepresentations and the other materials
available to plaintiffs regarding the possibilityof fraud.” The court also found meritlessplaintiffs’ argument that “determining
whether a plaintiff had sufficient facts to place
it on inquiry notice is often inappropriate forresolution on a motion to dismiss.” The court
noted that the Second Circuit has “statedthat courts can readily resolve the issue ofinquiry notice as a matter of law on a motion
to dismiss . . . where the facts needed for
determination of when a reasonable investorof ordinary intelligence would have beenaware of the existence of fraud can be gleaned
from the complaint and papers . . . integral tothe complaint.”

Plaintiffs Cannot Assert a
Securities Fraud Claim Based
Solely on the Ineffectiveness of Risk
Mitigation Strategies
With respect to plaintiffs’ claims basedon the fund’s risk management-related
statements, the court found “the [f]und’s
representations merely announced the goalof mitigating losses, rather than providing
a guarantee that the [f]und would, in fact,
avoid such losses.” The court explained that“[n]o reasonable investor would consider
such an abstract promise to mitigate losses,
untethered from any specific form of hedging,material to their investment decision” inlight of the fund’s other disclosures. The
court reasoned that plaintiffs “could perhaps
allege a misrepresentation if the fund did
not actually use” the risk management
techniques it claimed to employ. But plaintiffs“cannot . . . recover simply because thosemethods failed to actually minimize losses tothe [p]laintiffs’ satisfaction.”

Plaintiffs May Recover Losses in
Mutual Fund Shares Under the
Securities Act
The court then addressed the “economic
reality” that “any decline in a mutual fund’s
NAV would result solely from changes inthe value of the mutual fund’s underlying
investments, as opposed to any of thefund’s statements or omissions.” The court
considered “what effect this economic reality
has on a plaintiff’s ability to recover for
Securities Act violations by mutual funds that
implicate the principle of loss causation.”
In In re State Street Bank and Trust Co.
Fixed Income Funds Investment Litigation,
774 F. Supp. 2d 584 (S.D.N.Y. 2011), thecourt dismissed Securities Act claims against
a mutual fund for failure to plead losscausation. The court noted that Sections 11
and 12(a)(2) of the Securities Act “tie therecovery of a potential plaintiff to the valueof a security.” The State Street court foundthat plaintiffs’ claims under Sections 11 and
12(a)(2) must be dismissed because “the NAV
does not react to . . . any misstatements in the[f]und’s prospectus” and thus “no connection
between [an] alleged material misstatement
and a diminution in the security’s value ha[d]been or could be alleged.”

7

The Emerson court was “unwilling toconcur with State Street” because the State
Street court “effectively found mutual
funds categorically exempt from liability
for misrepresentations under the SecuritiesAct.” 2019 WL 2601664. The court explainedthat “[i]f Congress intended such a sweeping
loophole, it would have said so directly.” The
Emerson court determined that “the mostcoherent way to address loss causation in thecontext of mutual funds would be throughthe ‘materialization of the [concealed] risk’framework discussed in Lentell.” The court
found that in the case before it, plaintiffs had
adequately alleged “an at least plausible basis
for defeating loss causation” by pleading that“the mutual fund issuer misrepresented thecomposition of the portfolio, concealing thefact that it had potentially unlimited exposure
to rapid upward swings in the S&P 500.” Thecourt explained that it could not say that “therevelation of the [f]und’s overinvestment in
naked call options had no causal connection
to decline in the [f]und’s NAV.”

Delaware Supreme Court:
Reverses Dismissal ofCaremark Claim Where the
Directors Allegedly MadeNo Effort to Establish a
Board-Level Monitoring andReporting System
On June 19, 2019, the Delaware Supreme
Court reversed dismissal of a derivative suitalleging that the directors of an ice cream
manufacturing company “breached their
duty of loyalty under Caremark” by failing tooversee the company’s operations.2 Marchandv. Barnhill, 2019 WL 2509617 (Del. 2019)(Strine, C.J.) (Marchand II). The Supreme
Court held that the plaintiff adequately
pled a Caremark violation by alleging“particularized facts that support a reasonable
inference that the [company’s] board
failed to implement any system to monitor[the company’s] food safety performance or
2. In In re Caremark International Derivative Litigation, 698
A.2d 959 (Del. Ch. 1996), the Delaware Chancery Court statedthat “where a claim of directorial liability for corporate loss ispredicated upon ignorance of liability creating activities within
the corporation . . . only a sustained or systemic failure of theboard to exercise oversight—such as an utter failure to attempt
to assure a reasonable information and reporting system
exists—will establish the lack of good faith that is a necessary
condition to liability.”

compliance.” The court further found that theplaintiff adequately alleged demand futility
with respect to breach of fiduciary duty claims
against the company’s officers.

BackgroundIn early 2015, an outbreak of listeria“caus[ed] the company to recall all of its
products, shut down production at all of
its plants, and lay off over a third of its
workforce.” The listeria outbreak resulted
in the death of three consumers of thecompany’s ice cream products, and alsoprecipitated a major liquidity crisis for thecompany.
One of the company’s stockholders filed abooks and records request pursuant to 8 Del.
C. § 220 to investigate the board’s oversightof the company’s food safety practices.
The stockholder subsequently brought a
Caremark claim alleging that that the board“had no committee overseeing food safety”
or “reporting system in place about foodsafety,” and “did not discuss food safety at its
regular board meetings.” The plaintiff further
alleged that the lack of a reporting system wasevidenced by management’s failure to reportlisteria issues to the directors until a crisis
erupted, even though management allegedly
had “two years of evidence that listeria wasa growing problem for [the company].” Theplaintiff also asserted breach of fiduciary duty
claims against the company’s CEO and one
other officer. Defendants moved to dismissthe complaint.
The Chancery Court found that “there
was a monitoring system in place” in viewof the company’s “compliance with FDA
regulations, ongoing third-party monitoringfor contamination, and consistent reporting8

by senior management to [the company’s]board on operations.” Marchand II, 2019
WL 2509617. The Chancery Court held thatthe plaintiff failed to state a Caremark claim
because he was not challenging “the existenceof monitoring and reporting controls, but theeffectiveness of monitoring and reporting
controls in particular instances.” Id. (quoting
Marchand v. Barnhill, 2018 WL 4657159(Del. Ch. 2018) (emphasis in original)).
The Chancery Court also ruled that theplaintiff was one director short of alleging thata majority of the board could not impartiallyconsider a demand with respect to breach offiduciary duty claims against the company’sCEO. The plaintiff alleged, inter alia, that the
CEO’s family had made donations totaling$450,000 to a university building named
in honor of the dispositive director. The
Chancery Court nevertheless found that thedirector was independent of the CEO andhis family because the director had voted infavor of separating the CEO and Chairman
positions—which the CEO strongly opposed.
The plaintiff appealed.

Caremark Imposes a “BottomLine” Requirement of a Board-Level
Oversight System
On appeal, the Supreme Court recognized that
“Caremark is a tough standard for plaintiffs
to meet” and imposes an “onerous pleading
burden.” The court noted that “directors
have great discretion to design context- andindustry-specific approaches tailored to theircompanies’ businesses and resources” whenestablishing a board-level oversight system.
The court also observed that Delaware“case law gives deference to boards and has
dismissed Caremark cases even when illegal
or harmful activities escaped detection” by
the board’s oversight system. However, theSupreme Court underscored that Caremark
imposes a “bottom-line requirement” that
directors must at least “try . . . to put in placea reasonable board-level system of monitoring
and reporting.”
The Supreme Court held that “the complaint
supports an inference that no system ofboard-level compliance monitoring andreporting existed at [the company].” Thecourt found the company’s “nominal[ ]”compliance with FDA regulations insufficient
to demonstrate “that the board implementeda system to monitor food safety at theboard level.” The court reasoned that “thesetypes of regulatory requirements, although
important, are not typically directed at
the board.” The court explained that thecompany’s compliance with regulatory
requirements “does not rationally suggest thatthe board implemented a reporting system
to monitor food safety or [the company’s]
operational performance.”
The Supreme Court further found that thedirectors could not avoid Caremark liability
merely because “management regularly
reported to them on ‘operational issues.’”
The court noted that “[a]t every board
meeting of any company, it is likely thatmanagement will touch on some operational
issue.” The court reasoned that “Caremark
would be a chimera” if the board’s oversight
responsibilities could be satisfied bymanagement’s discretionary discussions withthe board concerning the company’s general
operations.

Director’s Vote Against the CEO
on a Corporate Governance Matter
Did Not Establish the Director’sDisinterestedness to Consider aSuit Against the CEO
The Supreme Court also found the Chancery
Court erred in determining that one of thedirector’s ties to the CEO’s family “did not
matter” because the director voted against the
CEO on a corporate governance matter. The
court explained that “the decision whether
to sue someone is materially different andmore important than the decision whether
to part company with that person on a voteabout corporate governance.” The Supreme
Court stated that the Chancery Court was“bound to accord the plaintiff the benefit of
all reasonable inferences, and the pled facts
fairly support the inference that [the director]
9

owes an important debt of gratitude to the[CEO’s] family for giving him his first job,nurturing his progress from an entry level
position to a top manager and director, andhonoring him by spearheading a campaign toname a building at an important community
institution after him.” The court explainedthat Delaware “law has recognized that deepand longstanding friendships are meaningful
to human beings and that any realistic

consideration of the question of independence
must give weight to these important
relationships and their natural effect on theability of the parties to act impartially toward
each other.” The Supreme Court held that theplaintiff had adequately pled demand futility
by alleging that a majority of the board could
not impartially consider demand as to theclaims against management, and reversed
dismissal of these claims.

This edition of the
Securities Law Alert was edited by
Susannah S. Geltman
sgeltman@stblaw.com / +1-212-455-2762,
Paul C. Gluckow
pgluckow@stblaw.com / +1-212-455-2653,
Linton Mann III
lmann@stblaw.com / +1-212-455-2654,
and Jonathan K. Youngwood
jyoungwood@stblaw.com / +1-212-455-3539.

10

New York

Los Angeles

Brooke E. Cucinella+1-212-455-3070
brooke.cucinella@stblaw.com

Lynn K. Neuner+1-212-455-2696
lneuner@stblaw.com

Michael D. Kibler+1-310-407-7515
mkibler@stblaw.com

Paul C. Curnin+1-212-455-2519
pcurnin@stblaw.com

Michael J. Osnato, Jr.
+1-212-455-3252
michael.osnato@stblaw.com

Chet A. Kronenberg+1-310-407-7557
ckronenberg@stblaw.com

Stephen M. Cutler+1-212-455-2773
stephen.cutler@stblaw.com

Mark J. Stein+1-212-455-2310
mstein@stblaw.com

Palo Alto

Michael J. Garvey+1-212-455-7358
mgarvey@stblaw.com

Alan C. Turner+1-212-455-2472
aturner@stblaw.com

Susannah S. Geltman+1-212-455-2762
sgeltman@stblaw.com

Craig S. Waldman+1-212-455-2881
cwaldman@stblaw.com

Paul C. Gluckow+1-212-455-2653
pgluckow@stblaw.com

George S. Wang
+1-212-455-2228
gwang@stblaw.com

Nicholas S. Goldin+1-212-455-3685
ngoldin@stblaw.com

Jonathan K. Youngwood+1-212-455-3539
jyoungwood@stblaw.com

Peter E. Kazanoff+1-212-455-3525
pkazanoff@stblaw.com

David Elbaum
Senior Counsel+1-212-455-2861
david.elbaum@stblaw.com

Joshua A. Levine+1-212-455-7694
jlevine@stblaw.com
Linton Mann III+1-212-455-2654
lmann@stblaw.com
Joseph M. McLaughlin+1-212-455-3242
jmclaughlin@stblaw.com

Janet A. Gochman
Senior Counsel+1-212-455-2815
jgochman@stblaw.com

Stephen P. Blake+1-650-251-5153
sblake@stblaw.com
Alexis S. Coll-Very+1-650-251-5201
acoll-very@stblaw.com
James G. Kreissman+1-650-251-5080
jkreissman@stblaw.com
Simona G. Strauss
Senior Counsel+1-650-251-5203
sstrauss@stblaw.com

Washington, D.C.
Jeffrey H. Knox
+1-202-636-5532
jeffrey.knox@stblaw.com
Cheryl J. Scarboro+1-202-636-5529
cscarboro@stblaw.com
Peter C. Thomas+1-202-636-5535
pthomas@stblaw.com

The contents of this publication are for informational purposes only. Neither this publication nor the
lawyers who authored it are rendering legal or other professional advice or opinions on specific facts
or matters, nor does the distribution of this publication to any person constitute the establishment of an
attorney-client relationship. Simpson Thacher & Bartlett LLP assumes no liability in connection withthe use of this publication. Please contact your relationship partner if we can be of assistance regardingthese important developments. The names and office locations of all of our partners, as well as ourrecent memoranda, can be obtained from our website, www.simpsonthacher.com.
11SimpsonThacherWorldwide

UNITED STATESEUROPE

SOUTH AMERICANew York
425 Lexington Avenue
New York, NY 10017+1-212-455-2000

LondonCityPoint
One Ropemaker Street
London EC2Y 9HUEngland+44-(0)20-7275-6500

São Paulo
Av. Presidente Juscelino
Kubitschek, 1455
São Paulo, SP 04543-011
Brazil+55-11-3546-1000

Houston
600 Travis Street, Suite 5400
Houston, TX 77002+1-713-821-5650
Los Angeles
1999 Avenue of the Stars
Los Angeles, CA 90067+1-310-407-7500
Palo Alto
2475 Hanover Street
Palo Alto, CA 94304+1-650-251-5000
Washington, D.C.
900 G Street, NW
Washington, D.C. 20001+1-202-636-5500

ASIA

Beijing
3901 China World Tower A
1 Jian Guo Men Wai Avenue
Beijing 100004
China+86-10-5965-2999
Hong Kong
ICBC Tower
3 Garden Road, Central
Hong Kong+852-2514-7600
Tokyo
Ark Hills Sengokuyama Mori Tower
9-10, Roppongi 1-Chome
Minato-Ku, Tokyo 106-0032
Japan+81-3-5562-6200

12