Securities Law Alert
In This Edition:• Supreme Court: Grants Certiorari to Determine Whether the SEC May Seek and Obtain Disgorgement in
Civil Enforcement Proceedings• Supreme Court: Hears Oral Argument on Whether Plaintiffs Can Satisfy Fifth Third’s “More Harm ThanGood” Pleading Standard by Alleging That Delaying an Inevitable Disclosure Results in Greater Stock
Price Harm
• District of New Jersey: American Pipe Tolling Does Not Apply to Untimely Opt-Out Individual Actions
Brought Prior to a Decision on Class Certification• Western District of Kentucky: Financial Projections That Assumed No Future Acquisitions Were Not
Misleading, Where the Proxy Statement Included a Disclaimer and Adequately Disclosed the Company’s
Growth Plans• Delaware Supreme Court: Generalized Allegations of a Controller’s Need for Liquidity Do Not, Standing
Alone, Warrant Application of the Entire Fairness Standard of Review• Delaware Supreme Court: Plaintiffs Failed to Allege That Venture Capital Investors Who Collectively
Controlled 60% of a Company’s Shares Constituted a “Control Group”
October/November 2019

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Simpson Thacher & Bartlett LLPSupreme Court: Grants
Certiorari to Determine
Whether the SEC May Seek
and Obtain Disgorgement in
Civil Enforcement Proceedings
On November 1, 2019, the Supreme Court
granted certiorari to consider whether the
SEC may seek and obtain disgorgement incivil enforcement proceedings. Liu v. SEC,
No. 18-501. The SEC is statutorily authorized
to seek and obtain injunctive relief, equitablerelief and civil monetary penalties in civil
enforcement proceedings. See 15 U.S.C.
§§ 77t(b), (d), 78u(d)(1), (3), (5). The statutory
scheme does not specifically empower the

SEC to seek and obtain disgorgement in civil
enforcement proceedings.1
All of the circuit courts have either explicitly
held, or simply assumed, that courts mayorder disgorgement in SEC enforcement
proceedings as part of their broad authority toaward equitable relief. See SEC v. Cavanagh,
445 F.3d 105 (2d Cir. 2006) (holding that“contemporary federal courts are vested withthe . . . authority by the Constitution and
the Judiciary Act” to order disgorgementin SEC enforcement proceedings); SEC v.
1. The SEC is, however, statutorily authorized to seek and obtaindisgorgement, among other remedies, in SEC administrative
proceedings. See 15 U.S.C. § 78u-2(e) (permitting the SEC
to “enter an order requiring accounting and disgorgement,
including reasonable interest”).

Maxxon, 465 F.3d 1174 (10th Cir. 2006)(“Disgorgement is by nature an equitable
remedy as to which a trial court is vested
with broad discretionary powers.”); SEC v.
Blavin, 760 F.2d 706 (6th Cir. 1985) (“Oncethe [SEC] has established that a defendant
has violated the securities laws, the district
court possesses the equitable power to grantdisgorgement . . . .”).2
But in Kokesh v. SEC, 137 S. Ct. 1635 (2017),
the Supreme Court held that “[d]isgorgementin the securities-enforcement context is a‘penalty’” subject to the 5-year statute oflimitations set forth in 28 U.S.C. § 2462.3
The Court rejected the SEC’s contention
that disgorgement is remedial rather thanpunitive in nature. The Court observed that
“SEC disgorgement sometimes exceeds the
profits gained as a result of the violation” and“sometimes is ordered without considerationof a defendant’s expenses that reduced
the amount of illegal profit.” The Court
noted that, “[i]n such cases, disgorgement
does not simply restore the status quo; itleaves the defendant worse off.” Notably,
the Kokesh Court stated that “[n]othing in[its] opinion should be interpreted as an
opinion on whether courts possess authority
to order disgorgement in SEC enforcement
proceedings or on whether courts haveproperly applied disgorgement principles inthis context.”

2. See also SEC v. Happ, 392 F.3d 12 (1st Cir. 2004); SEC v.
Hughes Capital Corp., 124 F.3d 449 (3d Cir. 1997); SEC v.
Gotchey, 1992 WL 385284 (4th Cir. 1992); SEC v. Huffman,
996 F.2d 800 (5th Cir. 1983); SEC v. Lipson, 278 F.3d 656(7th Cir. 2002); SEC v. Ridenour, 913 F.2d 515 (8th Cir.
1990); SEC v. Rind, 991 F.2d 1486 (9th Cir. 1993); SEC v.
Calvo, 378 F.3d 1211 (11th Cir. 2004); SEC v. First City Fin.
Corp., 890 F.2d 1215 (D.C. Cir. 1989).

Ninth Circuit Rejects the Argument
That Kokesh Precludes Courts
From Ordering Disgorgementin Excess of Net Profits in SEC
Enforcement Proceedings
In SEC v. Liu, 754 F. App’x 505 (9th Cir.
2018), the Ninth Circuit affirmed a district
court decision ordering disgorgement of thefull amount of the funds defendants raised
from investors (over $26 million) for a projectthat violated federal securities laws, withno deduction for expenses (approximately$16 million). The district court ordereddisgorgement in addition to millions ofdollars in civil penalties.
The Ninth Circuit rejected the argumentthat under Kokesh, the district court was
not permitted to order disgorgement in an
amount that exceeded defendants’ net profits.
The Ninth Circuit reasoned that “Kokesh
expressly refused to reach this issue . . .
so that case is not ‘clearly irreconcilable’
with [its] longstanding precedent” ondisgorgement orders in SEC enforcement
proceedings. Defendants successfully
petitioned the Supreme Court for certiorari.
On November 5, 2019, several days after theSupreme Court granted certiorari to address
the question of whether district courts mayorder disgorgement in SEC enforcement
proceedings, the Fifth Circuit rejected theargument that Kokesh “necessarily decided
that disgorgement is no longer an equitable
remedy.” SEC v. Team Res., 2019 WL
5704525 (5th Cir. 2019) (Duncan, J.). The
Fifth Circuit stated that it was “not convincedthat Kokesh quietly revolutionized SEC
enforcement proceedings while at the sametime explicitly stating it was not doing so.”

3. 28 U.S.C. § 2462 establishes a five-year statute of limitations
for “an action, suit or proceeding for the enforcement of any
civil fine, penalty, or forfeiture, pecuniary or otherwise.”
Please click here to read our discussion of the Supreme Court’s
decision in Kokesh.

2Potential Implications

BackgroundShould the Supreme Court rule against the
SEC in Liu, we expect some measure of shortterm disruption to the SEC’s enforcement
program. But we anticipate that Congress
would act to provide express statutory
authority for disgorgement—and there are infact two draft bills advancing in Congress—
in a manner that may actually extend thestatutory limitations period for disgorgement
to as long as ten years. And in the interim,
the SEC could be expected to pursue
more cases in an administrative forum,
where it has express statutory authority to
pursue disgorgement.

In Fifth Third Bancorp v. Dudenhoeffer, 573
U.S. 409 (2014), the Supreme Court held thatin order “[t]o state a claim for breach of the
duty of prudence” against ESOP fiduciaries“on the basis of inside information, a plaintiff
must plausibly allege an alternative actionthat the defendant could have taken thatwould have been consistent with the securities
laws and that a prudent fiduciary in the same
circumstances would not have viewed as more
likely to harm the fund than to help it.”4

The Supreme Court will hear and rule on
Liu v. SEC later this Term; a date for oral
argument has not yet been set.

Supreme Court: Hears Oral
Arguments on Whether
Plaintiffs Can Satisfy Fifth
Third’s “More Harm ThanGood” Pleading Standard
by Alleging That Delaying
the Inevitable Disclosure ofan Alleged Fraud Results inGreater Stock Price Harm
On November 6, 2019, the Supreme Court
heard oral arguments in Retirement Plans
Committee of IBM v. Jander, No. 18-1165.
At issue is whether plaintiffs can satisfy Fifth
Third’s “more harm than good” pleading
standard for inside information-based ERISA
claims against the fiduciaries of an employee
stock ownership plan (“ESOP”) by alleging
that delaying an inevitable disclosure ofan alleged fraud results in greater stock
price harm.

In Jander v. Retirement Plans Committeeof IBM, 910 F.3d 620 (2d Cir. 2018), theSecond Circuit held that Fifth Third’s “moreharm than good” pleading standard was met
where plaintiffs alleged that the disclosureof the overvaluation of one of the company’sbusiness divisions was “inevitable, because[the company] was likely to sell the business
and would be unable to hide its overvaluationfrom the public at that point.” The court
found plaintiffs adequately alleged that “theeventual disclosure of a prolonged fraudcauses ‘reputational damage’ that ‘increases
the longer the fraud goes on.’” The court
determined that “when ‘a drop in the valueof the stock already held by the fund isinevitable’ . . . it is far more plausible that a
prudent fiduciary would prefer to limit theeffects of the stock’s artificial inflation on
the ESOP’s beneficiaries through prompt
disclosure.” Defendants petitioned theSupreme Court for a writ of certiorari toreview the Second Circuit’s decision. The
Court granted defendants’ petition on June
3, 2019.

Justices Grapple with the Questionof Whether Claims Against ESOP
Fiduciaries for Failure to Disclose
Inside Information Should Be
Brought Under the Securities Laws
During oral argument, petitioners’ counsel
argued that “ESOP fiduciaries do not havea fiduciary obligation to use information
gained in a corporate capacity or to use theregular corporate channels of disclosure forthe benefit of plan participants.” Petitioners’
counsel further contended that in every case,plaintiffs could plead “generic allegations”
that “it is prudent to disclose early”
because “no fraud lasts forever, disclosure’s
4. Please click here to read our discussion of the Supreme Court’s
decision in Fifth Third.
3

inevitable, and the harms of concealment
only grow over time.” He asserted that
permitting such allegations to satisfy Fifth
Third is “fundamentally inconsistent” withthe “objective reality that if you disclose
negative inside information to the market,
it’s going to have a negative impact on thevalue of the stock, which is all an ESOP
holds.” Petitioners’ counsel argued that Fifth
Third therefore requires something “veryspecific” and “very different” that would
cause a prudent fiduciary to determinethat “committing this immediate harm isnonetheless prudent.”
Justice Sotomayor stated that “[t]he economic
principle” that the harm of an inevitabledisclosure increases over time “is both
logical and supported by the literature.”
She questioned what was “missing fromthe specifics” of the complaint, other than
the theory that this “economic principle
shouldn’t exist at all.” Justice Sotomayor
asked whether petitioners’ counsel could“really be saying that it’s a fiduciary duty
to help sellers promote fraudulent conduct
by avoiding losses for people.” Petitioners’
counsel responded that such disclosure-based
claims against ESOP fiduciaries who are also
company insiders should be brought under
the securities laws, rather than ERISA. Justice
Sotomayor stated that this was “not what you
asked for cert on.” Justice Breyer raised thesame concern, and suggested that the Court
should “just stick to the question on which
we granted cert.” He stated that plaintiffs’
allegations concerning the increased
stock price harm resulting from a delayed
disclosure were “fairly specific” and “seem[]adequate.” Justice Breyer questioned, “What’s
wrong with [the complaint]?”
Counsel for the United States, as amicus
curiae supporting neither party, positedthat the securities laws should exclusively
govern a company’s disclosure obligations.
He asserted that “it would undermine theobjectives of the securities laws to impose
an additional disclosure regime based on
the ad hoc balancing of a single ERISA
fiduciary.” Justice Ginsburg observed that
this “theory” was “nowhere aired below.”Counsel for the United States explained that
he was trying to “be useful to the Court by
discussing the objectives of the securities
laws” and highlighting the quandary faced by
ESOP fiduciaries, who are prohibited under
the securities laws from making a selective
disclosure only to plan participants. JusticeAlito seemed persuaded, and noted that the“more harm than good” standard asks the”fiduciary . . . to make a very complicatedcalculation” about whether and when todisclose adverse inside information, by
trying to anticipate what the situation
would be “at some point in the future when
the information will inevitably come out.”
Justice Kagan noted that “it does soundlike you want us to scrap [Fifth Third] andstart all over again.” Counsel for the UnitedStates responded that Fifth Third requires
courts to consider “whether a[n] ERISAbased obligation to disclose . . . would beinconsistent with the objectives of . . . thesecurities laws.” He asserted that “in almost
every case it would be.”Justice Gorsuch questioned respondents’counsel why the securities laws would not“be a really good place to start and maybe
finish in assessing what [the] long-term
overall health of the corporate interests might
be?” He stated, “I mean, isn’t that what the
securities laws are all about? It’s . . . ensuring
the markets function on a net basis with asmuch transparency and efficiency as we canmuster, subject to . . . imposing reasonable
costs and duties on people?” Justice Gorsuch
observed that if the fiduciary is supposed
to consider “the general interests . . . of theplan as a whole,” he “would have thought the
securities laws would have been a really goodproxy for the duties we’d expect a fiduciary to
abide.”
Respondents’ counsel argued that thecase before the Court was among the “rareexception[s]” in which ESOP fiduciaries wererequired to make a disclosure because of theunique circumstances at issue. He explainedthat the case involved “fiduciaries who
happen to be insiders . . . who happen to be
involved in the thing that is alleged to haveinflated the stock price, who happen to havedirect knowledge of that, and who happen
to have responsibility for the accounting ofthat, and, therefore, are in a position to know
about it.” Justice Kavanaugh observed, “Thatdoesn’t seem rare at all. That seems fairly
commonplace.” During rebuttal, petitioners’
counsel reiterated that “[t]he allegations here
are generic allegations that could be made in
every stock drop case.”
The Court will issue a decision in Retirement
Plans Committee of IBM v. Jander later
this Term.
4

District of New Jersey:
American Pipe Tolling
Does Not Apply to Untimely
Opt-Out Individual Actions
Brought Prior to a Decision
on Class Certification
On September 10, 2019, the District of New
Jersey held that plaintiffs who file optout actions after the statute of limitations
has expired, but before a decision on classcertification has been issued, are not entitledto the benefit of American Pipe tolling.
Northwestern Mut. Life. Ins. Co. v. Valeant
Pharm. Int’l, 2019 WL 4278929 (D.N.J. 2019)(Shipp, J.).5 The court explained that holding
otherwise would “encourage future plaintiffs
to sit back, await developments in the caseas the strength of the parties’ positions aretested through Rule 12 motion practice,and if there are favorable determinations,file an otherwise untimely action that issaved by the American Pipe doctrine.” Thecourt determined that “[s]uch a result does
not support the efficiency and economy oflitigation” that underpins the American
Pipe doctrine.

Background
In American Pipe & Construction Co. v. Utah,
414 U.S. 538 (1974), the Supreme Court heldthat “the commencement of a class actionsuspends the applicable statute of limitations
as to all asserted members of the class who
would have been parties had the suit been
permitted to continue as a class action.” The
Supreme Court subsequently “clarified” that“[t]he rule is not dependent on intervening
in or joining an existing suit; it applies aswell to putative class members who, after
denial of class certification, ‘prefer to bring an
individual suit rather than intervene . . . oncethe economies of a class action [are] no longer
available.’” China Agritech v. Resh, 138 S. Ct.
1800 (2018) (quoting Crown, Cork & Seal Co.
v. Parker, 462 U.S. 345 (1983)).
In China Agritech, the Supreme Court heldthat “American Pipe does not permit themaintenance of a follow-on class action past
expiration of the statute of limitations.”
Prior to the China Agritech decision, “theSecond[,] Tenth, and Ninth Circuits each held
5. Simpson Thacher represents Valeant Pharmaceuticals
International Inc. in this matter.

that a putative class member who brings anindividual action prior to class certification
would receive the benefit of American Pipetolling,” while the Sixth Circuit reached the
opposite conclusion.6 Northwestern Mut.
Life. Ins. Co., 2019 WL 4278929. The Third
Circuit has not ruled on this issue, nor has any
circuit court addressed this question since theSupreme Court’s decision in China Agritech.

Applying American Pipe Tollingto Untimely Opt-Out Actions
Filed Prior to a Decision on
Class Certification Would Not
Promote Efficiency and Economy
of Litigation“To resolve th[e] issue” of whether a plaintiff
who brings untimely opt-out claims prior toa decision on class certification is entitledto the benefit of the American Pipe tolling
doctrine, the Northwestern Mutual court“consider[ed] the history and purpose of theAmerican Pipe doctrine.” The court explainedthat “the American Pipe doctrine encourages
efficiency and economy of litigation because
without the doctrine potential class members
would be induced to file protective motions tointervene or join.” The court also noted that it“protect[s] the interests of putative unnamed
class members who ha[ve] not received
notice and were unaware of the pending classaction.”The court found that “the expansion of
the American Pipe doctrine here would
not promote efficiency and economy oflitigation,” as it would “encourage additional
individual actions to be brought prior to classcertification” and could require the court to“deal with dispositive motions rehashing legal
and factual issues [it] previously addressed.”
The court also found it significant that theplaintiff in the case before it was “not aputative unnamed class member who neverreceived notice of this action and must relyon the protection of the American Pipe
doctrine.” Moreover, the court observedthat the plaintiff could “hardly qualify as
diligent in asserting claims and pursuing
relief” given that the plaintiff “wait[ed] morethan two years after the filing of the” classaction complaint to bring suit. The court
6. Compare In re WorldCom Sec. Litig., 496 F.3d 245 (2d Cir.
2007); State Farm Mut. Auto. Ins. Co. v. Boellstorff, 540
F.3d 1223 (10th Cir. 2008); and In re Hanford Nuclear
Reservation Litig., 534 F.3d 986 (9th Cir. 2008); with WyserPratte Mgmt. Co. v. Telxon Corp., 413 F.3d 553 (6th Cir.
2005).
5

“conclude[d] that application of the American
Pipe doctrine to [the plaintiff’s] federal law
claims would not further the purposes of thedoctrine,” and dismissed the plaintiff’s claims
as untimely.

Western District of Kentucky:
Financial Projections
That Assumed No Future
Acquisitions Were Not
Misleading, Where theProxy Statement Included aDisclaimer and Adequately
Disclosed the Company’s
Growth Plans
On September 24, 2019, the Western Districtof Kentucky dismissed a securities fraud
action alleging that financial projections
that assumed no future acquisitions by
the company rendered a proxy statement
misleading, in violation of Section 14(a) of the
Securities Exchange Act of 1934 and SEC Rule
14a-9 promulgated thereunder. Laborers’
Local #231 Pension Fund v. PharMerica
Corp., 2019 WL 4645583 (W.D. Ky. 2019)(Jennings, J.).7 The court rejected plaintiffs’
contention that the financial projections
and other statements in the proxy statement“would cause an investor to believe thatthe [c]ompany’s future business plan only
included organic growth” and not growththrough acquisitions. The court emphasizedthat the proxy statement “contains an
express disclaimer that warns stockholders
not to make assumptions . . . based on
the [p]rojections,” as well as “statements
explicitly stating that future acquisition
remains part of the [c]ompany’s growthplans.” The court determined that “noreasonable stockholder would construe” thestatements at issue concerning the financial
projections “to imply that [the company’s]
growth plan only contemplated organic
growth,” because the proxy statement “all but
explicitly told the stockholder not to makesuch an inference.”
The court found Laborers’ Local #231
Pension Fund v. Cowan, 300 F. Supp.
3d 597 (D. Del. 2018), instructive. There,
7. Simpson Thacher represents PharMerica Corporation andKohlberg Kravis Roberts & Co. in this matter.

plaintiff “claimed that financial forecasts
in the proxy statement . . . were misleading
because those forecasts failed to accurately
portray [the company’s] acquisition strategy.”
PharMerica, 2019 WL 4645583 (discussing
Cowan). But the proxy statement specifically“cautioned” stockholders “not to place undue,
if any, reliance on the forecasts. The Cowan
court found that the proxy’s disclaimer
effectively prevented the financial forecasts
from affirmatively misleading stockholders
about [the company’s] future actions,
including potential future acquisitions.”

As in Cowan, the financial projections at
issue in the proxy statement in PharMerica
did not account for future acquisitions.
The proxy statement included a disclaimer
specifically warning that “the projections
are not to be relied on as indicative of future
events,” and the company’s “SEC filings andother public statements explicitly state[ed]that the [c]ompany’s plans included futureacquisition.” Given this “context,” the court
found that it would be “unreasonable” forstockholders to conclude, based on thefinancial projections, that the company’s“growth plan at the time of the merger only
included organic growth.”
The court also found that the financial
projections could not be “materially false”
for assuming no future acquisitions, because
the projections “on their face unambiguously
disclose that assumption to stockholders.”
The court further found that the financial
projections could not be rendered misleading
because they relied on what plaintiffs
characterized as an “incorrect” assumption.
The court explained that “assumptions andinputs in financial forecasts are immaterial,
and therefore not misstatements under
Section 14(a), when disclosed, because once
disclosed the stockholder[s] [are] free todetermine for themselves whether suchassumptions and inputs are appropriate.” The6

court concluded that plaintiffs failed to state aclaim under Section 14(a) and Rule 14a-9.

Delaware Supreme Court:
Generalized Allegations of aController’s Need for Liquidity
Do Not, Standing Alone,
Warrant Application of the
Entire Fairness Standard of
Review
On November 1, 2019, the Delaware Supreme
Court affirmed the dismissal of a shareholder
class action alleging that a company’scontrolling stockholder “orchestrated a saleof the company [to a third party] for lessthan fair value to address a personal needfor liquidity prompted by his retirement as
the company’s CEO.” English v. Narang,
2019 WL 1300855 (Del. Ch. Mar. 20, 2019),
aff’d, 2019 WL 5681416 (Del. Nov. 1, 2019)(Vaughn, Jr., J.). The Chancery Court foundplaintiffs alleged “no concrete facts fromwhich it can reasonably be inferred that [theCEO] had an exigent or immediate need for
liquidity” that created a disabling conflictof interest with respect to the transaction.
Because the court found the transaction wasapproved by a majority of the company’s
uncoerced and fully-informed stockholders,the court determined that “the [t]ransaction
is governed by the business judgment rule
under Corwin and its progeny” rather thanthe entire fairness standard of review.8
Plaintiffs alleged that when the CEO “decided
to retire in mid-2015 at seventy-three yearsof age, he needed to liquidate his positionas part of his estate planning and wealthmanagement strategy because his [company
stock] holdings accounted for nearly all of
his net worth.” English, 2019 WL 1300855.
Plaintiffs relied on N.J. Carpenters Pension
Fund v. infoGROUP, 2011 WL 4825888(Del. Ch. Sept. 30, 2011, revised Oct. 6,
8. In Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del.
2015), the Delaware Supreme Court held that “when atransaction not subject to the entire fairness standard
is approved by a fully informed, uncoerced vote of thedisinterested stockholders, the business judgment rule
applies.” The Corwin rule also applies when a majority ofdisinterested stockholders tender their shares in the firststep of a two-step merger under 8 Del. C. § 251(h). See In re
Volcano Corporation Stockholder Litig., 143 A.3d 727 (Del.
2016). Please click here to read our discussion of the Delaware
Supreme Court’s decision in Corwin, and here to read our
discussion of the Chancery Court’s decision in Volcano.

2011). There, the Chancery Court foundplaintiffs adequately alleged that a controllingstockholder “forced” the sale of a company“at an inopportune time and utilizing a flawed
and inadequate sales process,” so that thecontroller “could obtain desperately needed
liquidity.” infoGROUP, 2011 WL 4825888.
The infoGROUP plaintiffs alleged that thecontroller had over $25 million in debts atthe time the complaint was filed, and had
not received a salary since the controller was
pushed out of his role as the company’s CEO.
Defendants in English argued that the
Chancery Court’s decision in In re Synthes
Shareholder Litigation, 50 A.3d 1022 (Del.
Ch. 2012), provided a closer analogy. There,
the court declined to apply the entire fairness
standard of review to a transaction that
was allegedly motivated by a controllingstockholder’s need for liquidity. The Synthes
court found that “a controlling stockholder’s
immediate need for liquidity” might“constitute a disabling conflict of interest”
only in “very narrow circumstances.” Synthes,
50 A.3d 1022. The court stated that “[t]hose
circumstances would have to involve a crisis,
fire sale where the controller, in order tosatisfy an exigent need (such as a margin callor default in a larger investment) agreed to asale of the corporation without any effort” toprovide “logical buyers” with the opportunity
to “make a bid that would reflect the genuine
fair market value of the corporation.” The
Synthes court dismissed the complaint
because there were “no well-pled facts tosuggest that [the CEO] forced a crisis sale of[the company] . . . to satisfy some urgent needfor cash.”
In English, the Chancery Court found theallegations “similar to those pled in Synthes”
and “dramatically different than the situation
in infoGROUP.” 2019 WL 1300855. The
court noted that plaintiffs had “not identified
any allegations of fact . . . about [the CEO’s]
estate planning or wealth management
strategy to support the inference that hewas seeking to liquidate his shares quickly.”Moreover, the court found the complaint“devoid of any facts suggesting” that the
CEO had “debt obligations, needed to exit
his position [at the company] in order topursue a new business venture, or had
admitted to others a need for liquidity.”
The court also deemed it significant thatthe company engaged in a lengthy sales
process that included outreach to “numerous
7potential buyers.” The court concluded thatplaintiffs “failed to plead facts to supporta reasonable inference that [the CEO’s]
retirement . . . posed some sort of exigency
or emergency where he needed liquidity fast
so as to create a disabling conflict of interest
with respect to the [t]ransaction.” The court
therefore found that “no basis exists tosubject the [b]oard’s consideration of the[t]ransaction to entire fairness review,” anddismissed the complaint based on applicationof the business judgment rule.
The Delaware Supreme Court affirmed thedismissal of the complaint “on the basis ofand for the reasons assigned by” the Chancery
Court. English, 2019 WL 5681416.

legally significant way, either before or during
the allegedly dilutive actions.”
The court explained that Delaware law“recognizes that multiple stockholders
together can constitute a control groupexercising majority or effective control, witheach member subject to the fiduciary duties
of a controller.” The stockholders must be“connected in some legally significant way—such as by contract, common ownership,
agreement, or other arrangement—to work
together toward a shared goal.” The “mereconcurrence of self-interest among certain
stockholders” is not sufficient to establish
the existence of a control group. “Rather,
there must be some indication of an actual
agreement, although it need not be formal or
written.”

Delaware Supreme Court:
Plaintiffs Failed to Allege That
Venture Capital Investors
Who Collectively Controlled
60% of a Company’s Shares
Constituted a “Control Group”
On October 4, 2019, the Delaware Supreme
Court affirmed the dismissal of a shareholder
action premised on the legal theory thatseveral venture capital firms constituted a“control group” that breached its fiduciary
duties in connection with allegedly dilutive
financing transactions and a subsequentacquisition. Sheldon v. Pinto Tech. Ventures,2019 WL 4892348 (Del. 2019) (Valihura, J.).9
Plaintiffs alleged, inter alia, that the venture
capital firms (1) collectively controlled over
60% of the company’s shares, (2) were parties
to a voting agreement that provided themwith the right to appoint three directors,
who in turn chose two additional directors;and (3) had a history of investing together.
The Delaware Supreme Court found these
allegations insufficient to demonstrate thatthe venture capital firms “were connected in a
9. Plaintiffs argued that their failure to make a demand or
plead demand futility did not mandate the dismissal of
their claims because their claims were partially direct under
Gentile v. Rosette, 906 A. 2d 91 (Del. 2006). In Gentile, theDelaware Supreme Court recognized that a claim may be“both derivative and direct in character” if “(1) a stockholder
having majority or effective control causes the corporation
to issue ‘excessive’ shares of its stock in exchange for assetsof the controlling stockholder that have a lesser value; and(2) the exchange causes an increase in the percentage of theoutstanding shares owned by the controlling stockholder, anda corresponding decrease in the share percentage owned by
the public (minority) shareholders.”

Plaintiffs argued that their allegations weresimilar to those in In re Hansen Medical
Stockholders Litigation, 2018 WL 3025525(Del. Ch. June 18, 2018). There, the Chancery
Court held that plaintiffs adequately pled theexistence of a “control group” by alleging,inter alia, that the stockholders had (1)coordinated their investments for twenty-one
years, (2) declared themselves as a “group of
stockholders” to the SEC; and (3) were “theonly participants in a private placement thatmade them the largest stockholders of” thecompany at issue. But the Chancery Courtin Sheldon found that plaintiffs’ allegations
more closely paralleled those at issue in van
der Fluitt v. Yates, 2017 WL 5953514 (Del. Ch.
Nov. 30, 2017). In van der Fluitt, the court
held plaintiffs failed to plead the existenceof a “control group” where the defendant
stockholders were not the only signatoriesof the relevant investor rights agreement,
and that agreement did not concern thechallenged transaction.
In Sheldon, the Delaware Supreme Court“agree[d] with the Court of Chancery that it is8not reasonably conceivable that the [v]enture[c]apital [f]irms functioned as a control
group.” 2019 WL 4892348. The Delaware
Supreme Court noted that the voting
agreement “bound all of [the company’s
stockholders]” and “was unrelated” to theallegedly dilutive transactions. Moreover,the court observed that the agreement “onlygoverns the election of certain directors
to [the company’s board]” and “does not
require [the stockholders] to vote together
on any transaction.” The Delaware Supreme
Court found similarly “unavailing” plaintiffs’
allegations concerning the venture capital

firms’ prior investments. Plaintiffs pointed tofour companies in which “two or more” of theventure capital firms “invested in the samefinancings.” The court observed that plaintiffs
did “not identify any instance in which all
three [v]enture [c]apital [f]irms participatedin any investment,” or “allege that they held
themselves out as a group of investors or thatthey reported as such to the SEC.” Instead,the “allegations merely indicate that venture
capital firms in the same sector crossed paths
in a few investments.”

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

Cheryl J. Scarboro
cscarboro@stblaw.com / +1-202-636-5529,
and George S. Wang
gwang@stblaw.com / +1-212-455-2228.

9

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
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

Hong Kong
Adam Goldberg
Counsel+852-2514-7552
adam.goldberg@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.
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11