Tuesday, February 13, 2018

Court denies settlement that secured ‘utterly useless’ disclosures

By Anne Sherry, J.D.

In a sometimes scathing opinion that could serve as a primer for the policy reasons against disclosure-only settlements in the M&A context, a New York state court rejected such a settlement. The court admonished plaintiffs’ counsel for conflating cases involving management projections (material) with those involving, as in the instant case, analyst projections (immaterial). “This case is not a close call,” the court wrote. “All of the supplemental disclosures are utterly useless to the shareholders” (City Trading Fund v. Nye, February 8, 2018, Kornreich, S.).

Disclosure settlement. In early 2015, the court denied preliminary approval of the settlement, calling it “disturbing” and highlighting “the modus operandi” of the plaintiffs and their counsel, the Brualdi Law Firm, of purchasing nominal amounts of shares in public companies and then suing when one of the companies announces a merger. City Trading Fund was an E*Trade brokerage account that owned 10 shares of Martin Marietta Materials, Inc., prior to the company’s merger with Texas Industries, Inc. To settle the disclosure lawsuit, MMM made some additional disclosures and agreed to pay Brualdi a $500,000 fee. As the 2018 decision explains, many shareholders vociferously opposed the settlement.

Delaware and New York authority. In the intervening three years following the 2015 decision, the Delaware Court of Chancery cracked down on disclosure-only settlements in Trulia and other decisions, while the Appellate Division of the New York Supreme Court adopted a more lenient settlement approval standard in Gordon v. Verizon Communications, Inc. Unlike Trulia, Gordon does not require the plaintiff to rule out all doubts as to the materiality of the new disclosures. Instead, in factoring in the best interests of the class, Gordon requires that the supplemental disclosures provide “some benefit” to shareholders. Whether or not Gordon was intending to mirror the Delaware standard for mootness fees, the only reasonable interpretation of “some benefit” is that the disclosures would aid a shareholder’s voting decision.

“Utterly useless” disclosures. In the end, however, the court’s task was made easier by the fact that it was not a close case; all of the supplemental disclosures were “utterly useless to the shareholders.” The new information comprised terse “tell me more” disclosures, third-party projections, disclosures of positions in Texas Industries held by large-bank shareholders, and a disclosure that MMM’s president and CEO could see a bump in compensation after the merger.

Notably, in this case, a supplemental disclosure was of analyst projections, unlike the management projections that the Delaware chancery court has held to be material. The court admonished plaintiffs’ counsel for “a deceptive portrayal of the law” by simply referring to the importance of “financial projections” when discussing the authority. “While counsel is not wrong to assume that Delaware courts know more about these issues than this court, … it is deceptive to leverage that perceived ignorance by not accurately portraying the law,” the court wrote. “Such conduct is particularly egregious in a situation where, as here and at the appellate level, there is no adversarial briefing.”

With regard to the banks’ holdings, the court noted that most large banks prior to the Volcker Rule had proprietary trading desks that had positions in virtually every public company, and this practice continues today. Given the walls between research and trading divisions at large banks, there is no reason to believe that the incentives of bankers who had influence in the merger were affected by their colleagues on the trading desk. And if the banks had net long positions in Texas Industries, it would make even less sense to believe they would recommend an unwise merger, because the market would react and the stock price would fall.

The court also observed that it was rational for the company to settle the disclosure lawsuit. However, it emphasized that this question should not be conflated with the question of whether the settlement was in the best interest of the company and its shareholders.

The case is No. 651668/2014.