August 2009
Authors: Irwin A. Kishner, Daniel A. Etna
DelawareChancery Court Clarifies Directors Duties In a Sale of Control Transaction
In the first decision applying the recent Delaware Supreme Court decision in Lyondell Chemical Co. v. Ryan (as reported on in our April 2009 Corporate Quick Hit), the Delaware Court of Chancery reaffirmed that it "will not second guess the business decision of the board" in a sale of control context.
The complaint challenged the conduct of directors in negotiating and approving the sale of a majority of the company's voting stock. In particular, it was alleged that the outside directors comprising the committee that approved the transaction breached their Revlon duty of good faith by allowing two other directors, who were also managers, to lead negotiations despite a potential conflict of interest.
In dismissing the complaint, the Delaware Court of Chancery relied on the Lyondell decision in which the Delaware Supreme Court ruled that directors cannot be held liable for breach of the duty of good faith in sale of control transactions unless they "knowingly and completely failed to undertake their responsibilities" by "utterly fail[ing] to attempt to obtain the best sale price." The Delaware Court of Chancery found that no such failure had occurred. In support of its finding, the Delaware Court of Chancery noted that the directors created a special committee, regularly met and consulted with advisors, reviewed financial reports and analyses, and properly supervised members of management who were involved in the sale of control transaction.
This decision highlights that there is no "blueprint" to follow in a sale of control transaction. Rather, the business judgment rule will shield the directors' decision from scrutiny so long as a reasonable sale process drove the decision.
Wayne County Employees' Retirement Systems v. Corti, C.A. No. 3534-CC (Del. Ch. July 24, 2009).
SEC Seeks Ban on "Flash Orders"
The SEC announced that it is initiating efforts to crack down on "flash orders," a high-speed trading technique. Flash orders allow investors with certain electronic trading capabilities to buy or sell orders a few milliseconds before they are routed to the entire market. The SEC argues that flash orders give investors with access to the requisite technology an unfair advantage over other participants in the market.
Growth in computerized trading has led to a steep increase in trading volume in recent years, with stock exchanges indicating that between 50-70% of all trades are now executed by high frequency traders using high-speed technology. Notwithstanding, it is reported that flash orders comprise only a small percentage of high frequency trades.
Following the SEC's announcement, both NASDAQ and BATS announced that they would no longer offer flash orders starting on September 1, 2009.
The SEC is also reviewing its rules governing "dark pools," private electronic trading networks that pair buyers and sellers of securities anonymously. The SEC has indicated that it is considering requiring dark pool operators to disclose post-trade information to give the public a better sense of the liquidity and size of specific operators. The SEC is concerned about transparency issues with dark pools, and the resulting risk of speculation from non-participants resulting in market fluctuations. We will update you on this topic in future alerts.
SEC Proposes Rule to Prevent "Pay to Play" Practices by Investment Advisers
The SEC has proposed a new rule under the Investment Advisers Act of 1940, as amended, that would prohibit an investment adviser from providing advisory services for compensation to a government client for two years after the investment adviser, its executives or employees make a contribution to elected officials or candidates. The proposed rule would also prohibit an investment adviser and its employees from soliciting another person or a political action committee to make a contribution to an elected official to influence the selection of the investment adviser. The proposed rule, however, would permit an executive or an employee of an investment adviser to make a contribution of up to $250 per election per candidate if the contributor is entitled to vote for the candidate.
To prevent an investment adviser from skirting around the proposed rule, an investment adviser and its employees would be prohibited from paying a third party, such as a solicitor or a placement agent, to solicit a government client on behalf of the investment adviser. The prohibition would also extend to contributions by spouses, lawyers or companies affiliated with the investment adviser if the conduct would violate the rule had the investment adviser directly engaged in the conduct.
SEC Rel. No. IA-2910 (Aug. 3, 2009).
SEC Temporarily Expands Authority of the Division of Enforcement
The SEC has temporarily delegated its authority to issue formal investigation orders to the Director of the Division of Enforcement for one year. As a result, the SEC enforcement staff may issue subpoenas as part of any federal securities law investigation without having to obtain prior approval from the SEC commissioners. This delegation of authority is expected to greatly expedite future enforcement investigations.
SEC Rel. No. 34-60448 (Aug. 5 ,2009).
SEC Brings First "Naked" Short Selling Enforcement Action
The SEC has brought its first enforcement action for abusive "naked" short selling in violation of Regulation SHO against two broker-dealer firms and their options traders, charging them with violating the "locate" and "close-out" requirements of Regulation SHO.
Regulation SHO requires broker-dealers to locate a source of borrowable shares prior to selling short and to deliver securities sold short by a specified date. The SEC contended that the firms and traders improperly claimed that they were entitled to an exemption to the locate requirement and engaged in transactions that created the appearance that they were complying with the close-out requirement, but were not. The firms and traders agreed to settle the SEC's charges without admitting or denying the SEC's findings.
SEC Admin. Proceeding Rel. Nos. 34-60440 (TJM) & 34-60441 (HCM).
Delaware Chancery Court Refuses to Block Advancement of Legal Expenses and Indemnification Rights
The Delaware Court of Chanceryruled that a private equity fund was not entitled to deny advancement of legal expenses and indemnification rights to its personnel who served as officers and directors of one of its failed portfolio companies. The portfolio company was a maker of car parts in which the fund held a majority interest. The portfolio company, after announcing that it had corrected "certain historical accounting errors" resulting from an internal management review, filed for bankruptcy shortly thereafter. This announcement triggered a multitude of lawsuits naming its personnel, among others, as defendants.
The heart of the parties' dispute over the advancement of legal expenses involved the fund's partnership agreement requirement that "[n]o advances shall be made by the [fund] . . . without the prior written approval of the [g]eneral [p]artner." The fund argued that the plain meaning of the prior written approval requirement is that the general partner has discretion to deny that approval, otherwise there would be no point in requiring prior approval. The personnel successfully countered that the language providing that "[e]xpenses reasonably incurred by an [i]ndemnitee . . .shall be advanced by the [fund]" makes advancement mandatory, and the written approval requirement serves the more ministerial purpose of ensuring that the requirements set forth in the advancement provision (that the expenses be reasonably incurred and the indemnitee provide an undertaking to repay non-indemnifiable expenses) have been met before the money is advanced.
With respect to the indemnification claim, the fund argued that, under its partnership agreement, it was the personnel's burden to plead and ultimately demonstrate that they did not breach their duties to the fund; did not knowingly violate applicable law; and did not act with scienter. In ruling for the personnel, the Delaware Court of Chancery stated that the personnel were not required to make allegations about their conduct to state a claim for indemnification. Nor were they required to prove that their conduct met the standard of the fund's partnership agreement at a trial on the merits were the matter to proceed further. In so ruling, the Delaware Court of Chancery reasoned that acceptance of the fund's argument would be counterproductive to Delaware's policy goal of assuring indemnitees "that their reasonable expenses will be borne by the corporation they have served if they are vindicated."
Stockman v. Heartland Indus. Partners LP, C.A. No. 4227-VCS (Del. Ch. July 14, 2009); Stepp v. Heartland Indus. Partners LP, C.A. No. 4427-VCS (Del. Ch. July 14, 2009).
Recent Amendments to the Delaware General Corporation Law
Several noteworthy amendments to the Delaware General Corporation Law regarding stockholder access to proxy solicitation materials, proxy solicitation expense reimbursement, record dates for voting, indemnification and advancement of expenses to directors and judicial removal of directors became effective on August 1, 2009. For more information on these amendments, please click here.
For more information please contact Irwin A. Kishner at (212) 592-1435 or ikishner@herrick.comorDaniel A. Etnaat (212) 592-1557 ordetna@herrick.com.
Copyright © 2009 Herrick, Feinstein LLP. Corporate Quick Hit is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
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