Securities Law Alert
In This Edition:• First Circuit: Reverses Dismissal of Action Claiming Investors Were Misled About a New—AllegedlyNon-Functional—Product• Seventh Circuit: Reverses Bylaw-Based Dismissal of a Derivative Suit Under Section 14(a) of theExchange Act• Court of Chancery of Delaware: Applies Entire Fairness Standard to De-SPAC Merger
January 2022

First Circuit: Reverses
Dismissal of Action Claiming
Investors Were Misled Abouta New—Allegedly NonFunctional—ProductSimpson Thacher
Names Lynn K. Neuner
Co-Chair of Global
Litigation Department-Click here to learn more

On December 22, 2021, the First Circuit
reversed the dismissal of a securities fraudclass action under Section 10(b) alleging thata software company and certain of its officers
misled investors by touting a new databackup product that they knew did not work.
Constr. Indus. & Laborers Joint Pension
Tr. v. Carbonite, 2021 WL 6062622 (1st Cir.
2021) (Kayatta, J.). On the issue of scienter,the court held that the complaint alleged facts
raising a strong inference that the CEO andCFO either inquired about the new productbefore deciding to promote it to investors or
were reckless in failing to do so.

Background and Procedural History
Following the 2018 launch of its new databackup product, the CEO stated in a call withinvestors and analysts that the new product“significantly improves our performance forbacking up virtual environments and makes
Simpson Thacher & Bartlett LLP

us extremely competitive going after thatmarket.” Weeks later, the company’s CFO
stated at an investor conference that “[t]hisis a market that we haven’t been particularly
strong in, in the past, we’ve been okay. I think
we have completely overhauled the productand we have put something out that we thinkis just completely competitive and just a
super strong product[.]” However, plaintiff
alleged that throughout this time the newproduct never worked and the company had
set up an internal “tiger team” focused on
fixing the product. In July 2019, the company
announced reduced 2019 full-year revenue
projections and that the product would be
withdrawn from the market, after which there
was a stock drop.

Plaintiff Alleged Facts Raising a
Strong Inference of Scienter
The First Circuit disagreed with the district
court that plaintiff failed to successfully plead
scienter. The court determined that plaintiff
alleged facts raising a strong inference that
the CEO and CFO either inquired about theproduct before deciding to promote it toinvestors or were reckless in failing to do so.
Specifically, plaintiff asserted that defendants

must have known that the product did notwork because its professed importance to thecompany strongly implied that senior officers
were following it closely and were aware of its
failings. Plaintiff alternatively asserted that
defendants were at least highly reckless inpromoting the product because, if they were
not aware of the issues, “then they repeatedlyand with apparent premeditation promoted it
as important to the company without at least
checking that it had ever worked.”

Court Rejects Non-Culpable
Inference From Efforts to Remedy
the Product’s Issues
The court also rejected that the company’sefforts to remedy the issues with the productsuggested “a sincere belief that [the product]
could be made operational with enoughwork, such that [the company] believed [theproduct] was fixable.” The court pointed outthat the CEO’s and CFO’s statements wereframed in the present tense and, therefore,“were not projections of hoped-for futureperformance.” The court characterized thestatements as “flat-out claims about theproduct as it then stood.”

this derivative action asserting a claim thatis subject to exclusive federal jurisdiction.”
The court explained that if the bylaw wereso applied then plaintiff’s derivative action
could not be heard in any forum because theExchange Act gives federal courts exclusive
jurisdiction over actions under it. Further,
the court stated that this “result would becontrary to Delaware corporation law, whichrespects the non-waiver provision in Section
29(a) of the federal Exchange Act, 15 U.S.C.
§ 78cc(a).”Background and Procedural History
Following two fatal plane crashes involving
the same aircraft model, plaintiff filed thisderivative suit in 2019 under Section 14(a)of the Exchange Act in the Northern Districtof Illinois where the plane manufacturer
is headquartered. Plaintiff alleged that thecompany’s officers and directors madematerially false and misleading publicstatements about the development andoperation of this model in the company’s
proxy materials. Without addressing themerits, the district court dismissed on forum
non conveniens grounds after applying acompany bylaw1 requiring that any derivative
actions be filed in the Delaware Courtof Chancery.

Delaware Corporation Law and theExchange Act Bar Application ofthe Bylaw

Seventh Circuit: Reverses
Bylaw-Based Dismissal of a
Derivative Suit Under Section
14(a) of the Exchange Act
On January 7, 2022, a split Seventh Circuit
panel reversed a derivative suit’s dismissal
based on a company forum-selection bylaw
requiring derivative actions be filed in theCourt of Chancery of Delaware. Seafarers
Pension Plan v. Bradway, 2022 WL 70841(7th Cir. 2022) (Hamilton, J.). The court heldthat the “forum bylaw cannot be applied toThe court began by stating that the “moststraightforward resolution of this appeal
is under Delaware corporation law, which
we read as barring application of the[company’s] forum bylaw to this caseinvoking non-waivable rights under thefederal Exchange Act.” After noting thatplaintiff’s chosen forum in the federal district
where the company is headquartered “seemsappropriate” the court pointed out that if thebylaw is applied, it “will force plaintiff to raise
its claims in a Delaware state court, which is
not authorized to exercise jurisdiction overExchange Act claims.” The court observedthat it would be difficult to reconcile this
1. The bylaw provided in relevant part, “With respect to any
action arising out of any act or omission occurring after theadoption of this By-Law, unless the Corporation consents
in writing to the selection of an alternative forum, the Courtof Chancery of the State of Delaware shall be the sole andexclusive forum for . . . any derivative action or proceedingbrought on behalf of the Corporation . . . .”2result with Section 29(a) of the ExchangeAct, which deems void contractual waivers ofcompliance with the requirements of the Act.

would be denied relief, Judge Easterbrook
responded that “Delaware will provide
whatever substantive relief is appropriate[.]”After parsing the statutory text of Section
1152 of the Delaware General Corporation
Law, which addresses bylaws that impose
choices of forum for litigation involving
derivative claims, the court stated that
“we conclude that Section 115 does not
authorize use of a forum-selection bylaw
to avoid what should be exclusive federal
jurisdiction over a case, particularly under
the Exchange Act.” In particular, the court
focused on the “consistent with applicablejurisdictional requirements” phrase inSection 115. The court concluded that asapplied here, the company’s forum bylaw
violates Section 115 because it is inconsistent
with the jurisdictional requirements of theExchange Act.

Judge Easterbrook concluded that “if there
is no such thing as a derivative § 14(a)claim divorced from state corporate law,
if derivative suits are proper in state
courts, and if exclusivity under § 27(a) iswaivable—indeed, if any one of these three
propositions holds—then there is no problem
with litigating plaintiff’s claim in the courtsof Delaware.”Judge Easterbrook Dissents
While agreeing that Section 27(a) ofthe Exchange Act provides for exclusive
jurisdiction of claims arising under it and theSEC’s rules, Judge Easterbrook stated that,
however, “a derivative suit arises under state
law even if a federal issue may come to thefore eventually.” He also pointed out that inShearson/American Express v. McMahon,
482 U.S. 220 (1987), the Supreme Court
treated exclusivity under Section 27(a) as aright that may be waived. Writing in supportof the bylaw’s application, Judge Easterbrookdescribed it “just another forum-selectionclause.” In response to concerns that plaintiff
2. Section 115 provides that “bylaws may require, consistent withapplicable jurisdictional requirements, that any or all internal
corporate claims shall be brought solely and exclusively in anyor all of the courts in this State.” 8 Del. C. § 115.

Court of Chancery ofDelaware: Applies Entire
Fairness Standard toDe-SPAC Merger
On January 3, 2022, the Court of Chanceryof Delaware largely denied motions todismiss in a class action for breach offiduciary duties alleging that the directors,officers, and controlling stockholder of aSPAC (special purpose acquisition company)
withheld material information from thepublic stockholders, which allegedly impaired
their right to redeem their shares before thede-SPAC merger. In re MultiPlan S’holders
Litig., 2022 WL 24060 (Del. Ch. Ct. 2022)(Will, V.C.).3 The court held that: (i) plaintiffs
pleaded direct claims centering around thepurported impairment of their redemption
right; (ii) the entire fairness standard ofreview applied at the pleading stage; and(iii) plaintiffs had pleaded a non-exculpateddisclosure claim against the SPAC’s
controlling stockholder and former directors.

Background
The SPAC’s initial public stockholders
purchased IPO units consisting of one
common share and a fractional warrant for$10 per unit. The sponsor of the SPAC was
ultimately controlled by a sole stockholder(the “Controlling Stockholder”), who had
previously sponsored several SPACs. The
sponsor’s primary form of compensation was“founder” shares. If the SPAC entered into abusiness combination within two years, thefounder shares would convert into common
3. Simpson Thacher represents defendant MultiPlan Corp. f/k/a
Churchill Capital Corp. III in this action.
3shares. If no transaction was completed, theSPAC would liquidate, the public stockholders
would receive their investment back plus
interest and the founder shares would haveno value.
The SPAC entered into a merger witha healthcare data analytics firm and, in
September 2020, the SPAC issued a proxystatement that solicited stockholder votes
on the deal. The SPAC’s certificate ofincorporation established that the publicstockholders could either exercise theirredemption right (then equal to $10.04) heldby the SPAC trust or remain as investors in
the post-combination entity. In October 2020,
the SPAC’s stockholders “overwhelmingly”
voted to approve the business combinationand the de-SPAC merger was completed. InNovember 2020, a short-seller publisheda negative report alleging that the target’s
largest customer was building a competing
in-house product. The post-merger company’s
stock fell to a then-closing low of $6.27 thefollowing day.

board was conflicted either because thedirectors were self-interested or because they
lacked independence from the Controlling
Stockholder.
Noting that entire fairness was not triggeredby the mere presence of a controllingstockholder, the court explained thatplaintiffs must also adequately plead that
the Controlling Stockholder engaged ina conflicted transaction. Delaware courts
place conflicted controller transactions
implicating entire fairness into one of two
categories: “where the controller stands
on both sides”4 and “where the controller
competes with the common stockholders forconsideration.” As to the second category, thecourt explained that a controller competes
with common stockholders when he “receives
a unique benefit by extracting somethinguniquely valuable to the controller, even if
the controller nominally receives the sameconsideration as all other stockholders to
the detriment of the minority.”5 IRA Tr. FBO
Bobbie Ahmed v. Crane, 2017 WL 7053964(Del. Ch. 2017, revised 2018).

Procedural History
Plaintiffs alleged that the SPAC’s fiduciaries
omitted material information in the proxy.
Counts I, II, and III of the complaint weredirect claims for breach of fiduciary duty
against certain SPAC directors, officers, andthe Controlling Stockholder. Plaintiffs allegedthat defendants, putting their own financial
interests ahead of the public stockholders’interests, failed to disclose facts that impaired
the public stockholders’ informed exerciseof their redemption and voting rights.
Defendants moved to dismiss.

Plaintiffs Pleaded Facts Supportinga Reasonable Inference That Entire
Fairness Applies
An issue before the court was whether toapply the business judgment rule, whichis Delaware’s “default standard of review”
or entire fairness, which is Delaware’s“most onerous standard of review” to thede-SPAC merger. The court determinedthat plaintiffs pleaded facts supporting areasonable inference that entire fairness
applied on two independent bases. First,
plaintiff alleged that the de-SPAC merger wasa conflicted controller transaction. Second,plaintiff alleged that a majority of the SPAC

Plaintiffs Pleaded Facts Supportinga Reasonable Inference That theControlling Stockholder Received aUnique Benefit
Focusing on the period before the de-SPACmerger when the public stockholders held
redemption rights backed by the trust, thecourt determined that the allegations pleaded
facts supporting a reasonable inference that
4. The court found that the Controlling Stockholder did notstand on both sides of the de-SPAC merger as this was anarms-length transaction between two unaffiliated parties.
5. A controller also competes with common stockholders when
the controller “receives greater monetary consideration for its
shares than the minority stockholders” or “takes a different
form of consideration than the minority stockholders[.]”4

there was a unique benefit to the Controlling
Stockholder. The court pointed out thatthe merger had a value to the common
stockholders if shares of the post-merger
entity were worth $10.04, but that the merger
was valuable to the Controlling Stockholder“well below” $10.04 because the value of
the Controlling Stockholder’s compensation
would drop to zero if no merger occurred.
The court determined that “[t]he potential
conflict between [the Controlling Stockholder]and public stockholders resulting from theirdifferent incentives in a bad deal versus
no deal is sufficient to pass the ‘reasonably
conceivable’ threshold[ ]” found in
Rule 12(b)(6).

conflicts[ ]” and that the court’s “conclusion
does not address the validity of a hypotheticalclaim where the disclosure is adequate andthe allegations rest solely on the premisethat fiduciaries were necessarily interested
given the SPAC’s structure.” Indeed, thecourt stated that “[i]f public stockholders,in possession of all material information
about the target, had chosen to invest rather
than redeem, one can imagine a different
outcome.”Plaintiffs Pleaded Facts Supportinga Reasonable Inference That theStockholders’ Redemption Rights
Were Impaired Through Failure toDisclose Material Information
The court finally found that plaintiffs’ breachof fiduciary duty claims were reasonably
conceivable because they alleged that thedirectors “failed, disloyally, to disclose
information necessary for the plaintiffs toknowledgeably exercise their redemption
rights.” The court emphasized that “plaintiffs’
claims are [not] viable [ ] simply becauseof the nature of the transaction or resulting

This edition of theSecurities Law Alert was edited byPeter E. Kazanoff / +1-212-455-3525
pkazanoff@stblaw.com andLinton Mann III / +1-212-455-2654
lmann@stblaw.com5

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