All posts by Ben Chapple

25th Annual Ruby R. Vale Interschool Corporate Moot Court Competition

Benjamin P. Chapple

Widener’s Institute of Corporate & Business Law, in partnership with the law school’s Moot Court Honor Society, hosted the 25th Annual Ruby R. Vale Interschool Corporate Moot Court Competition.  This year’s competition included a geographically diverse set of competitors, hailing from twenty different law schools.  The competition lasted four days, with the final round on March 17, 2013, judged by Delaware Supreme Court Justice Jack Jacobs, Justice Joseph Walsh (retired), Vice Chancellor J. Travis Laster, Vice Chancellor Sam Glasscock, and Judge Jed S. Rakoff of the United States District Court for the Southern District of New York.  We are extremely thankful for their generous participation.  Judge Rakoff also provided a Distinguished Scholar Lecture, in which he discussed the International Court of Commerce of Iraq and the heroism of the judges of that court who do their part to promote economic stability despite daily threats of assassination.  A summary of this year’s moot court problem and a list of award recipients are provided below.

The case appealed from involved the use of a “Don’t Ask, Don’t Waive” standstill agreement in the context of the sale of an entire company, Callison Inc., that is controlled by its 72% stockholder, Allen.  Because Allen needed funds to purchase another business—which it is contractually obligated to buy—it became interested in monetizing its 72% stake in Callison.   Allen approached Callison’s board of directors, expressing its interest in selling its holding through a sale of the entire company, and the Board—after forming an independent special committee—initiated a sale process for the Company that involved a private canvassing of the market of likely potential suitors.  Of the suitors identified, only six agreed to sign a DADW standstill.  Each of these six suitors was afforded a one-time opportunity to submit their highest and best bid to acquire the entire Company; however, each was contractually prevented—as a result of the DADW—from (1) making any further offers and (2) asking Callison’s Board for permission to do the same.

As a result of the bidding process, Vicente emerged as the highest bidder.  The Board and Vicente entered into a merger agreement that provided for a market check, but notably excluded the five unsuccessful bidders from participating in the market check.  One of these five unsuccessful bidders, Galena, approached Callison’s Board and privately requested that it waive the DADW provision so as to permit Galena to make a topping bid.  The Board, after consulting legal counsel, however, held firm to the DADW and rejected Galena’s offer.  As a result of this rejection, Galena took two actions.  First, it filed suit challenging the validity of the DADW standstill agreement, in which Galena sought a preliminary injunction to prevent Callison and/or Callison’s Board from attempting enforcement.  Second, on the same day, Galena launched a tender offer for $35.50—which is $1.50 more than the Vicente offer, representing a premium in excess of $120 million—conditioned on, inter alia, the judicial invalidation of the DADW standstill agreement. ­

In the hypothetical moot court problem, the Court of Chancery found the challenged DADW provision to be unenforceable under the Revlon/QVC “range of reasonableness” standard—thereby enjoining enforcement of the provisions.  Accordingly, it was unnecessary for the Court of Chancery to consider Galena’s argument that the more exacting entire fairness should apply.  The Delaware Supreme Court accepted an interlocutory appeal from the preliminary injunction order.   The appeal implicated two principal issues relating to the fiduciary duties of the directors of a Delaware corporation in relation to the sale of the company.  Both issues arose from the Board’s decision to accept Vicente’s indisputably lower offer in reliance upon the DADW agreement.

The first issue was the validity of the DADW standstill agreement as a matter of Delaware law.  Previous decisions of the Court of Chancery have examined this question, and concluded that these provisions are highly problematic.  In these prior decisions, the view has been that DADW standstill agreements “collectively operate to ensure an informational vacuum,” and prevent the board of directors from satisfying their duty to take care and remain informed of all material information reasonably available.  Additionally, past decisions have found that DADW provisions prevent the board from satisfying its ongoing statutory and fiduciary obligation to provide a current, candid, and accurate merger recommendation to the shareholders.  Notably, however, the Court of Chancery’s most recent decision that addressed the question—In re—made clear that (1) these provisions are not per se invalid, and (2) the Court is “not prepared to rule out that [these provisions] can’t be [properly] used for value-maximizing purposes.” In re Transcript, at 23.

Competitors, particularly in the final rounds, focused on Supreme Court precedent.  Appellants, on the one hand, argued that the Court has made clear that there is no single “blueprint” for the board to follow to satisfy Revlon‘s value maximization directive.  Additionally, Appellants stressed that the Appellee is a sophisticated party that knowingly entered into the DADW standstill.  Furthermore, Appellants argued the DADW standstills, here, were used in a value-maximizing manner, because the bidders were encouraged to put their best foot forward up front, thus preventing a costly protracted auction.  Appellees, on the other hand, argued that, although there is no single blueprint, Revlon and its progeny make clear that the Board’s role is to obtain the highest value reasonably available.  To that end, Appellees argued that the Callison Board’s decision to accept Vicente’s offer, which was more than $120 million less than the opposing offer, is clearly not value maximizing.  In response to Appellants’ reliance on the DADW standstill, Appellees argued contracts cannot limit a board’s fiduciary duties.  This issue, in large part, comes down to balancing two concepts: one, the Revlon/QVC directive that the target board must maximize shareholder value; and two, how much flexibility will the Court allow target boards in creating a value-maximizing sales process to satisfy this directive.

The second issue—whether the more exacting entire fairness standard should apply—arose because Callison’s majority shareholder, Allen, would incur $60 million in liquidated damages if he failed to close an independent business acquisition.  Relying on McMullin v. Beran, Appellee argued a conflict of interest was present because Allen (1) has an independent need for quick liquidity and (2) appointed all of Callison’s Directors.   Furthermore, Appellee argued that Allen dominated the sales process, making the special committee a “rubber stamp.”  Appellee’s argument, thus, implicates the duty of loyalty.  Appellants denied there was any disqualifying conflict.  They emphasized that under the Vicente offer Allen would be receiving the identical consideration (on a per share basis) as the minority, in a transaction that resulted from a deliberative process, involving a well-functioning independent special committee, which included an effective market check that allowed other topping bids to come forward to ensure value maximization.  Appellees cogently argued, however, that the market check was illusory because it excluded those most likely to making a topping bid—the DADW-bidders.

Although there were many great competitors at this year’s competition, we would like to specifically recognize:

1st Place 

Georgetown University Law Center 

Jeffrey DeSousa

Allyson Poulos

2nd Place

Brooklyn Law School

Andrew Ceppos

Tricia Lyon

The Donald E. Pease Best Brief Award

Michigan State University College of Law

Jeffrey Hayden

Jeffrey Mann

William Selesky

Best Oral Advocate

Georgetown University Law Center

Jeffrey DeSousa


SCOTUS Concludes Proof of Materiality is Not a Prerequisite to Certification of a Securities-Fraud Action Alleging Violations of §10(b) and Rule 10(b)–5

Benjamin P. Chapple

On February 27, 2013, the United States Supreme Court, in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, a 6-3 decision, concluded that proof of materiality is not a prerequisite to certification of a securities-fraud action that alleges violations of §10(b) or Rule 10b–5.  Below is a summary of the Court’s decision.

In all private securities-fraud actions brought under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b–5, the plaintiff must prove, inter alia, that it relied on a misrepresentation or omission of material fact that was made by the defendant.  In Basic v. Levinson, the United States Supreme Court concluded “requiring proof of direct evidence ‘would place an unnecessarily unrealistic burden on [a] plaintiff who has traded on an impersonal market.'” Slip Op. at 1 (quoting Basic).  In order to facilitate the certification of securities-fraud class actions, the Court in Basic fashioned the fraud-on-the-market (“FOTM”) theory.  The premise of this theory is that the price of a security that is traded in an efficient market will reflect all publicly available information about a company; therefore, one who purchases a security that trades in an efficient market will be presumed to have relied on that information in purchasing the security.  Additionally, “because immaterial information, by definition, does not affect the market price, it cannot be relied upon indirectly by investors who, as the [FOTM] theory presumes, rely on the market price’s integrity.” Slip Op. at 10.  As a result, the FOTM theory is inapplicable absent a showing that the misrepresentation or omission was in fact material.

Invoking the FOTM theory, Connecticut Retirement Plans and Trust Funds (“Plaintiff”) sought certification of a securities-fraud class action under Federal Rule of Civil Procedure 23(b)(3) against biotechnology company Amgen Inc. and several of its officers (collectively, “Amgen”).  The Plaintiff claims that Amgen violated §10(b) and Rule 10b–5 when it made material misrepresentations and misleading omissions regarding the safety, efficacy, and marketing of two of Amgen’s flagship drugs.  As a result of these alleged misrepresentations and omissions, the Plaintiff contends that the price of Amgen’s stock was artificially inflated, until “the truth came to light” and the Plaintiff, among others, suffered financial losses.  The district court certified the class, and the Court of Appeals for the Ninth Circuit affirmed.  Amgen appealed, and the Supreme Court granted certiorari and heard oral argument on November 5, 2013.  The Court issued a 6-3 opinion, with Justices Thomas, Scalia, and Kennedy dissenting.

Because Amgen conceded (1) the efficiency of the market for the securities at issue, (2) the public character of the allegedly fraudulent statements on which the Plaintiff’s complaint is based, and (3) that the Plaintiff satisfied all of the class-action prerequisites stated in Rule 23(a), the issue presented to the Court concerned the requirement stated in Rule 23(b)(3) that “the questions of law or fact common to class members predominate over any questions affecting only individual members.” Put differently, as the Court stated, “the pivotal inquiry in this case is whether proof of materiality is needed to ensure that the questions of law or fact common to the class ‘will predominate over any questions affecting only individual members’ as the litigation progresses.”  Amgen claimed that to meet the predominance requirement, the Plaintiff must do more than “plausibly plead that Amgen’s alleged misrepresentations and misleading omissions materially affected Amgen’s stock price.”  According to Amgen, certification must be denied unless the Plaintiff proves materiality, because immaterial misrepresentations or omissions, by definition, would have no impact on Amgen’s stock price in an efficient market.  To this end, Amgen claimed the key question in this case was whether materiality is an essential predicate of the FOTM theory.

Although agreeing with Amgen that “materiality is an essential predicate” of the FOTM theory, the Court explained that the “pivotal inquiry” in this case is whether proof of materiality is needed to ensure that the questions of law or fact common to the class will “predominate over any questions affecting only individual members” as the litigation progresses. Slip Op. at 10 (citing Fed. R. Civ. P. 23(b)(3)).  The Court answered this question in the negative for two reasons; thereby holding that proof of materiality is not a prerequisite to  class certification.  First, because the question of materiality is judged according to an objective standard, viewing the significance of an omitted or misrepresented fact from the purview of a reasonable investor, materiality can be proved through evidence common to the class.  As a result, the Court concluded, materiality is a common question for Rule 23(b)(3). Slip Op. at 11 (quoting Basic, where the Court listed “materiality” as one of the questions common to the Basic class members).   Second, because materiality is an essential element of a Rule 10b–5 claim, if the Plaintiff fails to present sufficient evidence of materiality, individual reliance questions will not overwhelm the questions common to the class.  Instead, the Court concluded, if the Plaintiff failed to establish materiality, whether upon summary-judgment or at trial, it “would end the case for one and for all; no claim would remain in which individual reliance issues could potentially predominate.” Id.

As is usual with most recent decisions from the United States Supreme Court, the conclusion that proof of materiality is not a prerequisite to class certification was not unanimous.  However, before turning to the dissenting views of Justices Thomas, Kennedy, and Scalia, attention should be paid to Justice Alito’s concurring opinion.  Although brief, Justice Alito explains: “As the dissent observes, more recent evidence suggests that the [FOTM] presumption may rest on a faulty economic promise.  In light of this development, reconsideration of the Basic presumption may be appropriate.” Alito, J. Concurring Op. at 1.

 Justice Thomas dissented, with Justice Kennedy joining fully, and Scalia joining only in part.  Justice Thomas explained:

Without demonstrating materiality at certification, plaintiffs cannot establish Basic‘s fraud-on-the-market presumption.  Without proof of fraud on the market, plaintiffs cannot show the otherwise individualized questions of reliance will predominate, as required by Rule 23(b)(3).  And without satisfying Rule 23(b)(3), class certification is improper.  Fraud on the market is thus a condition precedent to class certification, without which individualized claims of reliance will defeat certification.

Moreover, Justice Thomas stated that the majority opinion “transform[ed] the predicate certification inquiry into a novel either-or inquiry occurring much later on the merits.”  To this end, he explained:

According to the [majority], either (1) plaintiffs will prove materiality on the merits, thus demonstrating ex post that common questions predominated at class certification, or (2) they will fail to prove materiality, at which point they will learn ex post that certification was inappropriate because reliance was not, in fact, a common question.  In the [majority’s] second scenario, fraud on the market was never established, reliance for each class member was inherently individualized, and Rule 23(b)(3) in fact should have barred certification long ago.  The [majority] suggests that the problem created by the second scenario is excusable because the plaintiffs will lose anyway on alternative grounds, and the case will be over.  But nothing in logic or precedent justifies ignoring at certification whether reliance is susceptible to Rule 23(b)(3) classwide proof simply because one predicate of reliance—materiality—will be resolved, if at all, much later in the litigation on an independent merits element.

In addition to joining in Justice Thomas’s dissent, Justice Scalia also wrote a separate dissenting opinion, which in part stated that he views the FOTM theory as governing not only the question of whether class certification is proper, but also the question of substantive liability. But see Thomas, J. Dissenting Op. at 11 (“The result [of the majority’s error] is that [it] effectively equates §10(b) materiality with fraud-on-the-market materiality and elides reliance as a §10(b) element.”).  In accord with Justice Thomas’s dissenting opinion, Justice Scalia wrote that, in his view, “it makes no sense to ‘presume reliance’ on the misrepresentation merely because the plaintiff relied on the market price, unless the alleged misrepresentation would likely have affected the market price—that is, unless it was material.”  Scalia, J. Dissenting Op. at 2.  Finally, recognizing the practical import of the majority’s decision, Justice Scalia explained how “[c]ertification of the class is often, if not usually, the prelude to a substantial settlement by the defendant because the costs and risks of litigating further are so high.”

Celera: New Uncertainty in Settlement in Class Action Deal Litigation?

Professor Lawrence A. Hamermesh

The Delaware Supreme Court handed down an interesting decision on December 27, 2012 in the Celera merger class action litigation.  The underlying litigation was a challenge to a squeeze-out tender offer and merger, and involved some hot button issues (“don’t ask/don’t waive” standstill agreements and a top-up option), but the opinion wasn’t really about them.

The Supreme Court’s opinion instead reviewed a decision by the Court of Chancery to approve a class action settlement without opt-out rights.  The original plaintiff, New Orleans Employee Retirement System (NOERS), had owned 10,000 Celera shares, which it sold in the market (at a price slightly higher than the $8.00/share deal price) before the second-step merger was completed.  The settlement, reached a year or so after that merger, when any possibility of injunctive relief was pretty much history, would as usual have barred all other stockholders from pursuing further litigation challenging the deal.

That bar would have affected BVF Partners, which owned over 5% of the stock when the deal was announced, and 24.5% by the time of the merger. BVF objected to the settlement on a variety of grounds, including the lack of opt-out rights in the settlement.

As is common in Delaware in this sort of litigation, the Court of Chancery certified a class, for settlement purposes, under Court of Chancery Rules 23(b)(1) and (b)(2), under which opt-out rights aren’t required.  The Supreme Court didn’t find fault with that certification; it didn’t reverse the determination to accept the settlement; and it didn’t accept BVF’s arguments that NOERS lacked standing because it sold its shares before the merger, or that NOERS was an inadequate class representative because it was a “frequent filer,” a term that the Supreme Court said it has not yet even recognized.

What the Supreme Court reversed was the determination not to require opt out rights.  In the following short analysis, the Court found that determination to have constituted an abuse of discretion:

The court could not deny a discretionary opt-out right where the policy favoring a global settlement was outweighed by due process concerns. Here, the class representative was “barely” adequate, the objector was a significant shareholder prepared independently to prosecute a clearly identified and supportable claim for substantial money damages, and the only claims realistically being settled at the time of the certification hearing nearly a year after the merger were for money damages. Under these particular facts and circumstances, the Court of Chancery had to provide an opt-out right.

What’s intriguing–and perhaps unsettling–about this brief analysis is whether it has logical limits in future litigation challenging mergers that are consummated after the litigation begins. If there were “due process concerns,” why should it matter that the objector was a “significant shareholder?” Are those concerns less pressing when the objector has only 100 shares? Why so, when even a 100-share holder can hire effective class counsel who could pursue the litigation effectively? Is adequacy a sliding scale? If so, what are the measuring marks on that scale, if, as the Court held, NOERS clearly had standing because it held shares when the merger was approved?

And most important, what do future settlement hearings now have to evaluate? Before denying opt-out rights, will the court have to examine the size of shareholdings of unrepresented class members in order to determine whether any of those stockholders own enough shares so that due process rights are offended?  Or does this responsibility arise only when an objection to the settlement is lodged?

The result in this case may have been the right one:  with the no opt-out condition of the settlement no longer satisfied, I imagine that the case will now proceed, perhaps to a revised settlement with BVF, or perhaps to full-blown litigation.  And there surely was something unseemly about a holder of 10,000 shares that weren’t even directly affected by the challenged transaction being able to achieve preclusion of the claims of a 24.5% stockholder.  But in achieving what may have been a good result, the Court has perhaps created an element of uncertainty over how to handle settlements in common deal litigation.

Widener Law Students Place Highly in Nationwide Online Transactional Law Competition

Three Widener Law students on the Transactional Law Competition Team recently placed highly in a nationwide online competition hosted by LawMeets.

Over 800 registered participants, ranging from law students at schools such as Berkeley and John Marshall, to practicing attorneys and even a group of investment bankers from one of the big investment banks participated in the LawMeets course, which consisted of four exercises over two intensive weeks. The results of those exercises were then peer-reviewed and ranked.

Second-year student Deniz Uzel placed 9th in “the anatomy of an acquisition agreement” and an astonishing 1st in the “due diligence” assignment, bringing her overall rank to 20th place. Second-year student Randy MacTough placed 13th and 21st in two of the online assignments: “the anatomy of an acquisition agreement” and “indemnification.” Second-year student Amber Marsano placed 4th in the “indemnification” assignment.

LawMeets is an educational program founded by by Professor Karl Okamoto, the Director of the entrepreneurship law program at Drexel University’s Earle Mack School of Law. LawMeets offers students an opportunity to improve their lawyer-client skills by addressing hypothetical client problems with short video responses that are voted on by their peers. Legal experts then offer critiques of the highest rated student responses.

The entire Widener Law community congratulates Deniz, Randy, and Amber on their impressive work!


Delaware Supreme Court’s Latest Non-Pronouncement on Fiduciary Duties in Limited Liability Companies

Professor Luke M. Scheuer

The Delaware Supreme Court’s November 7 opinion in Gatz Properties, LLC v. Auriga Capital Corp. has left open the question of whether the Delaware’s Limited Liability Company Act (the “LLC Act”) imposes default fiduciary obligations on a limited liability company’s (an “LLC”) managers.  In Gatz, the Supreme Court affirmed the Court of Chancery’s opinion and held that a company’s manager had breached its contractual fiduciary duties to minority members under the company’s LLC agreement.  However, in a blistering rebuke, the Supreme Court rejected as “dictum without any precedential value” the Court of Chancery’s conclusion that the manager had breached default fiduciary duties under the LLC Act.  The Court further “decline[d] to express any view regarding whether default fiduciary duties apply as a matter of statutory construction.”

The decision is problematic for practitioners and investors who have assumed that in the LLC context, fiduciary obligations exist unless they are disclaimed in a company’s LLC agreement.  Going forward, attorneys will undoubtedly inform their business clients (both managers and investors) that any fiduciary obligations should be addressed in an LLC agreement.  However, unrepresented investors may be caught off-guard because fiduciary duties are a basic element of all other business forms.  As the LLC becomes the default form for new businesses (including small businesses that are often formed without legal counsel), many less well advised investors may assume that managers have a minimum level of responsibility and not realize that they are required to include language in the LLC agreement to create such obligations.

The ruling is also part of a line of cases that contrasts the high standard historically required for those managing business entities with the low modern standard.  The great Benjamin Cardozo articulated fiduciary duties in the following high minded terms: “[n]ot honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior . . . the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd.”  In the intervening 80 years, fiduciary duties have been watered down to the point where they are bare minimal standards that can be waived (or might not even exist as a default) for LLCs.  The Court may be correct that the Delaware legislature is the best group to decide the default fiduciary duty issue.  Until they do, Delaware is placing LLC investors at risk for the benefit of managers, and is encouraging the degradation of business culture.

A blog entry on the oral argument before the Supreme Court was previously posted to this site by Ben Chapple (Widener Law ’13).


A Summary of the 28th Annual Francis G. Pileggi Distinguished Lecture in Law “Unsettled and Unsettling Issues in Corporate Law”

On November 9, 2012, the Delaware Journal of Corporate Law, with the Institute, hosted the 28th Annual Francis G. Pileggi Distinguished Lecture in Law. This year’s lecturer was Professor Lyman P.Q. Johnson. Professor Johnson has taught at Washington and Lee University School of Law since 1985—holding the Robert O. Bentley Professorship since 1995—and beginning in 2008, he was appointed to the faculty of the University of St. Thomas School of Law in Minneapolis, where he currently serves as the LeJeune Distinguished Chair in Law. Professor Johnson’s lecture was titled Unsettled and Unsettling Issues in Corporate Law. The lecture revisited two fundamental issues in corporate law: (1) the central role of the business judgment rule (BJR) in fiduciary litigation, and (2) whether there is a mandated corporate purpose. The majority of the lecture was devoted to the former issue, but Professor Johnson discusses both issues in great detail in his forthcoming article that will be published in Volume 38 of the Delaware Journal of Corporate Law.

Following an introduction by Delaware Supreme Court Justice Henry duPont Ridgely, the lecture began with Professor Johnson acknowledging that the law surrounding the BJR is “seemingly settled,” in that it is clear that the rule applies to directors. He went on to note, however, that it is less clear whether the BJR applies to officers or controlling shareholders. Professor Johnson continued by discussing how this deeply entrenched rule has evolved over the last three decades through the decisions in Sinclair (1971), Aronson (1984), and Cede (1991). The professor argued that it is inappropriate to adhere to a rule of law simply because it has been used for a long period and has proposed a rethinking of the BJR, ultimately arguing that the rule is unnecessary and should be deemphasized.

Professor Johnson articulates six reasons in support of this thesis. First, he argues that the BJR is under inclusive, so it should not serve as a “unified vessel.” Further to this point, he stated that fiduciary duties are broader in scope, and therefore are the more appropriate focus. Second, he asserts that the BJR is a maxim of historical accident that grafted the duty of care into the BJR framework. Professor Johnson believes that this fiduciary duty should be showcased, not engrafted with the BJR. Third, the professor contends that emphasizing fiduciary duties over the BJR still provides ample deference to the directors. To this end, he argues that there is no need for an Aronson or Sinclair presumption because ample deference and business latitude remains by maintaining the gross negligence standard. Fourth, he believes that elevating the focus to fiduciary duties streamlines the analysis and rationales with other areas of law; he cited, for example, agency law where you would only need to ask two questions: (1) did a fiduciary duty exist?, and (2) if so, was that duty breached? Fifth, Professor Johnson asserts that emphasizing the BJR “hinders optimal conduct” through depriving directors of having an affirmative duty because the rule presumes that the director complied with his or her fiduciary duties. Sixth, and perhaps closely tied to his fourth point, he argues that elevating fiduciary duties over the BJR will facilitate a better understanding of corporate law for those who do not specialize in the subject matter, i.e. law students and many out-of-state practitioners who practice Delaware corporate law.

To put it modestly, some of those in attendance were a bit taken aback by Professor Johnson’s proposal, particularly the part relating to removing the presumption afforded by the BJR. One attendee of note, former-Vice Chancellor Stephen Lamb, expressed concern that denying directors the presumption will increase the number of meritless suits, and then proceeded to ask if the professor had considered this effect, and if so, whether a heightened pleading standard would be an appropriate solution. Professor Johnson acknowledged that he did not take into account these considerations, but stated that he will consider the implication before his forthcoming article goes to press. The Institute’s director, Professor Lawrence Hamermesh, also asked Professor Johnson what, if any, past decisions would have a different outcome under his proposed model that elevates fiduciary duties over the BJR. Professor Johnson responded that he could not think of a case where the result would be altered; however, the process to reach the result would be more streamlined under his proposed approach.

Susan Lyon Helps Readers Understand New SEC Whistleblower Program: Breaking Down the Largest Whistle-Blowing Rewards in U.S. History

Back in August, Professor Scheuer discussed the first whistleblower award issued by the SEC here. Following a recent whistleblower award development, Susan Lyon from NerdWallet authored a blog post titled, Understanding the New SEC Whistleblower Program: Breaking down the Largest Whistleblowing Rewards in U.S. history. In this post, Susan discusses how the IRS recently paid a former UBS banker Bradley Birkenfeld $104 million for his role as a whistleblowing informant, who provided the IRS with valuable insider information, resulting in a giant settlement with UBS. Susan explains,

The Dodd-Frank Act’s whistleblower program, established under the SEC, is the most recent attempt at strengthening and speeding up federal whistleblower programs.  While the DOJ, SEC, and IRS continue to push forth their own whistleblowing programs, the debate concerning proper retribution and consequences for such informants rages on.

Susan turned to five experts with the question: Is the SEC’s new program working, and is it better than the old IRS program? One expert—Institute Director and Professor of Corporate and Business Law Lawrence Hamermesh—provided the following insight:

“Clearly the one thing that Congress saw and wanted to fix was an insufficient incentive system for whistleblowers who had witnessed corporate misconduct.  So they decided to effectively hold out a ‘carrot’ – a portion of the money recovered as a result of any information the whistleblower provided.

The big question is how this will interact with internal corporate grievance and reporting programs already in place.  Firms were afraid the SEC program would take the wind out of their sails, but instead the program may actually bolster internal practices because the same person can now both report internally and to the SEC.  The commission did an admirable job setting up a reasonable balance between them to harmonize the two mechanisms.  We’ve now seen two claims addressed but the SEC can’t say much more about how well the program is working without threatening whistleblower anonymity.”

The remaining four experts include: (1) Tom Devine, Legal Director of the Governmental Accountability Project, who explains how the SEC has implemented the gold standard of whistleblower programs by protecting the whistleblower from industry retaliation; (2) Eva Marie Carney, Partner at RK&O LLP and former Assistant General Counsel at the SEC, who highlights the advantages of being able to anonymously report fraud to the SEC; (3) Professor Richard Moberly, Associate Dean at the University of Nebraska School of Law, who notes the unique aspects of the SEC program set up by Dodd-Frank in providing both strong retaliation protection as well as financial incentives; and (4) Professor Geoffrey Rapp, the Harold A. Anderson Professor of Law and Values at the University of Toledo College of Law, who draws attention to the key differences between SEC, IRS and FCA whistleblower programs.

To review Susan’s post and view the experts’ commentary, please visit here.


A Report on Oral Argument in Gatz Properties v. Auriga Capital Corp.

Ben Chapple (Widener Law ’13) attended the oral argument on September 19, 2012, before the Delaware Supreme Court in Gatz Properties v. Auriga Capital Corp.  (No. 148, 2012).  This is the case in which Chancellor Strine’s opinion concluded, following a lengthy analysis, that members and managers of a Delaware LLC owe fiduciary duties to the LLC by default, and that such duties exist unless excluded by the LLC agreement.

Ben files the following dispatch, and makes two predictions about the outcome:  (1) the Court may avoid deciding what standard of judicial review applies in the case, by holding that the result would be unaffected even if the entire fairness standard does not apply; and (2) the Court will likely determine that the defendant contractually owed fiduciary duties under the LLC agreement, and therefore it is unnecessary to decide whether such duties exist by default.

*          *          *

In the opinion below, the Court of Chancery held that a majority owner and manager of a LLC (“Gatz”) breached his fiduciary duties when he attempted to obtain ownership interests of the minority members in bad faith.  In deciding the case, Chancellor Strine found that traditional fiduciary duties of care and loyalty apply to LLCs unless the parties contract them away; thus, it was held that there are “default” fiduciary duties. As a result of this holding, many academics and practitioners have closely followed this appeal, anticipating that the Supreme Court will finally weigh in on this interesting issue, which was the subject of an online symposium here late last year. What follows is a brief overview of the oral argument and a couple predictions about the Court’s holding.

Defendant’s Arguments

On appeal, Gatz argued that LLCs are creatures of contract, not common law, and the LLC agreement at issue was unambiguous in its terms that certain conflict transactions were appropriate. Gatz further argued that the Court of Chancery implicitly applied the entire fairness standard, and that decision was contrary to terms of the LLC agreement. Justice Ridgely responded by asking Gatz’s counsel, “Wouldn’t the case be the same even without the entire fairness standard?” Counsel replied that the “prism” through which one views the facts makes a considerable difference, and the burden shift associated with the entire fairness standard was devastating to Gatz’s case.  To this end, Gatz argued that because Chancellor Strine turned a “safe harbor” provision—section 15 of the LLC agreement[1]—into an entire fairness provision, the legal prism should be corrected. Gatz asserted that reading entire fairness into section 15 is inappropriate because if the parties intended to limit transactions they would have done so contractually, which, Gatz contends, they did not. Gatz explained that although the LCC agreement imposed fiduciary duties—for example, as a result of section 15—section 16[2], as written, should have prevented the application of those duties in present case. Gatz argued that although the LLC agreement does not explicitly state that no fiduciary duties apply to certain conflict transactions, under Delaware law the applicable standard that is contractually identified should be enforced and respected by the courts. At the end of Gatz argument, Justice Jacobs stated, “Since [Gatz] conceded that some fiduciary duties apply, to that extent it was unnecessary for the trial court to interpret the LLC statute about default fiduciary duties.” Gatz responded, briefly, by reiterating his previous point that although the LLC agreement imposed fiduciary duties, section 16 of the agreement prevented the application of the duties in the case sub judice.

Plaintiffs’ Arguments

The appellee, Auriga Capital Corp. (“Auriga”), focused its portion of the argument on the contention that Gatz waived the claim that fiduciary duties did not apply—by default or otherwise. Auriga asserted that Gatz repeatedly admitted, throughout pre-trial stages, that fiduciary duties applied and it, like Chancellor Strine, relied on these representations. Auriga asserted that fiduciary duties, whether based on contract or common law, are the same—(1) the duty of loyalty, and (2) the duty of care—and based on the facts of the case, the Court does not need to address whether duties exist by default because they existed by contract, namely as a result of section 15. Additionally, Auriga stated that the “law review” portion of the trial court’s opinion—relating to whether fiduciary duties exist by default—was not addressed by the parties below, and therefore the Court should not decide this issue because it was not “vigorously debated” at trial.

Two Predictions

(1) Based on Justice Ridgely’s question—”Wouldn’t the case be the same even without the entire fairness standard?”—the Court may avoid deciding this issue by holding that the result of the case is unaffected regardless of whether the entire fairness standard applies; and (2) the Court, consistent with avoiding this issue, will likely limits its analysis by determining that Gatz contractually owed Auriga fiduciary duties as a result of section 15 of the LLC agreement, and therefore it is unnecessary to decide whether they exist by default.


[1] Section 15 of the agreement provides, in pertinent part,

Neither the Manager nor any other Member shall be entitled to cause the Company to enter . . . into any additional agreements with affiliates on terms and conditions which are less favorable to the Company than the terms and conditions of similar agreements which could be entered into with arms-length third parties, without the consent of a majority of the non-affiliated Members (such majority to be deemed to be the holders of 66-2/3% of all Interests which are not held by affiliates of the person or entity that would be a party to the proposed agreement

[2] Section 16 of the agreement provides,

No Covered Person [defined to include, “the Members, Manager, and the officers, equity holders, partners, and employees of such of the foregoing”] shall be liable to the Company, [or] any other Covered Person or any other person or entity who has an interest in the Company for any loss, damage or claim incurred by reason of any act or omission performed or omitted by such Covered Person in good faith in connection with the formation of the Company or on behalf of the Company and in a manner reasonably believed to be within the scope of the authority conferred on such Covered Person by this Agreement, except that a Covered Person shall be liable for any such loss, damage, or claim incurred by reason of such Covered Person’s gross negligence, willful misconduct, or willful misrepresentation.

Professor Barnett on SEC’s Recent No-Action Letter to Linn Energy, LLC

 Linn Energy, LLC, SEC No-Action Letter (publicly available Aug. 30, 2012),

 2012 SEC No-Act. Lexis 428, 2012 WL 3835914

Professor Larry D. Barnett

In Linn, a Delaware limited-liability company (company #1) that had issued NASDAQ-listed securities to raise capital for its business operations[i] created a separate Delaware limited-liability company (company #2) that would also issue NASDAQ-listed securities.  Tax-exempt entities, as well as persons located outside the United States, were deterred by U.S. tax law from investing in the securities of company #1 because under U.S. tax law the company was deemed a partnership.  The tax disincentive would not exist for these entities/persons if they invested in the securities of company #2, however, because company #2 would be classified as a corporation.  Company #2 would sell its securities publicly and use the money received from the sale to acquire newly issued securities of company #1, thereby enlarging the investor base of company #1 and providing company #1 with additional capital.  Company #2 would have no long-term assets other than securities issued by company #1, and its short-term assets would be cash or cash-equivalents.  The raison d’etre of company #2, therefore, was to provide a conduit for investments in company #1:  Through ownership of the securities of company #2, persons disadvantaged by U.S. tax law when they directly owned the securities of company #1 could indirectly own the securities of company #1 and avoid the tax consequences of direct ownership.  Because the arrangement had specific features that attempted to equalize the governance and economic positions of investors in the two companies, the position of investors in company #1 and the position of investors in company #2 would differ mainly in terms of U.S. tax law.

An issuer of securities that qualifies as an investment company is required by § 7(a) of the Investment Company Act (“Act”) to register with the Securities and Exchange Commission.  Company #2, as an issuer of securities that invested in securities, evidently satisfied § 3(a)(1) of the Act, the section that specifies the activities and assets that define an investment company.  The request for a no-action letter submitted to the Commission thus focused on whether company #1 was an investment company under § 3(a)(1) and argued that it was not.  However, in responding to the request, the S.E.C. Division of Investment Management exempted not only company #1 but also company #2 from § 7(a).[ii]  Regrettably, the Division only provided assurance that it would not recommend enforcement action under the Act.  No explanation of pertinent law was explicitly given.  Indeed, the Division pointed out that it was not “express[ing] any legal or interpretive conclusion on the issues presented.”

Law-specific reasoning for a resolution of an issue of law under the Investment Company Act is typically absent from no-action letters written by the Division of Investment Management.  In this regard, then, Linn is not unusual.  However, the reply of the staff is notable for what the Division asserted in a footnote.  Specifically, the footnote stated that the position taken by the Division in the instant case applied to, and only to, company #1 and company #2.  Warning that “no other entity may rely on this position,” the Division observed that the two companies and their proposed arrangement were involved in a situation that had a “very fact-specific nature.”  In the view of the Division, its decision dealt with a situation that had unique attributes and hence could not — and should not — be generalized to other settings.

The warning given by the Division should be considered in conjunction with the omission by the Division of its reasoning on whether § 3(a)(1) applied to company #1.  The request for a no-action letter had presented a detailed analysis in support of the contention that company #1 was not an investment company.  According to the request, company #1 did not meet the criteria established either by § 3(a)(1)(A) or by § 3(a)(1)(C).  When it exempted company #1 from § 7(a), did the Division believe that company #1 failed to satisfy one or more of the criteria in each of these sections and hence was not an investment company?  Or did the Division think that company #1 qualified as, or might qualify as, an investment company under § 3(a)(1)(A) or § 3(a)(1)(C) but conclude that the proposed arrangement did not undermine the purposes of the Act?  One of two routes could thus have been taken in reaching the conclusion that enforcement action was unnecessary under § 7(a) with respect to company #1.  Although the route that the Division actually followed is unknown, the warning given by the Division in its reply may be evidence that the second route was chosen, i.e., that the staff thought that company #1 was or might be an investment company, but on policy grounds ruled that the two companies were entitled to an exemption from § 7(a).  Such a warning has traditionally been uncommon in no-action letters,[iii] and its inclusion in the instant letter is plausibly an indicator that the staff anticipated that the purposes of the Act would be subverted if the position it took could be widely followed by investment companies.

If the above reasoning is correct, what might explain the concern of the staff?  In granting the request of the two companies, the Division exempted from registration not just company #1, but also company #2.  Company #2, however, seems to have been an investment company.  Therefore, company #2, like company #1, was able to avoid the obligations that the Act imposes on a registered investment company, and company #1 was not subject even to the restrictions that the Act places on an affiliate of a registered investment company.

Vehicles for collective investments in securities became much more numerous in the United States during the past three decades, as seen in the graph in the Appendix infra,[iv] and they are now of inestimable significance to the U.S. financial system.[v]  As a result, the formulation of law on investment companies can have major consequences for the country — consequences that are economic and, at least as importantly, consequences that are social.[vi]  Unless exemptions from the registration requirement of the Act are granted sparingly, the goals that Congress established for the Act are unlikely to be achievable.  With this in mind, the staff may have placed the warning in the reply because it harbored doubts, or at least was uncertain, about the contention that company #1 was not an investment company.[vii]  Company #1, therefore, may have been an investment company, as was company #2.  If so, the exemption of both companies from registration as investment companies could have been prompted by a pair of specific considerations that alleviated the concern of the staff — the securities issued by company #1 had already been sold publicly, and company #2 would be an alter ego of company #1.[viii]  Assuming that the exemption was based on these considerations, the grounds for the exemption were indeed narrow, and Linn is likely to have helped the Act maintain its social productivity, the main function of law in a democracy.[ix]



[i] Company #1 purchased and developed properties that contained substantial reserves of oil and natural gas.  All of its current property holdings were in the United States.

[ii] Even if it was not an investment company, company #1 would have been subject to § 17(d) of the Act and Rule 17d-1(a) under the Act as long as company #2 was an investment company and was required to register.  Joint undertakings by a registered investment company and its first- and second-tier affiliates are covered by § 17(d) and Rule 17d-1(a) when the affiliates are principals in the undertakings.  Because company #2 was controlled by company #1 and would own more than 5% of the outstanding voting securities of company #1, company #1 would be a first-tier affiliate of an investment company (company #2) pursuant to § 2(a)(3)(B) and § 2(a)(3)(C) of the Act.

[iii] In a search done on September 8, 2012 of the Lexis database of SEC no-action letters, I looked for the warning in letters that were issued under the Investment Company Act from calendar year 2000 onward.  The warning was not found before 2007, and of the 70 no-action letters that carried the warning, fully 90% appeared in 2008 and 2009.  Before and after 2009, consequently, few no-action letters issued under the Act included the warning.

[iv] The graph is limited to mutual funds, because as measured by assets under management, mutual funds are currently the most important type of U.S. investment company.  Infra note v.  The graph was prepared from data in Investment Company Institute, 2012 Investment Company Fact Book 134, 138 (52d ed. 2012), (last visited  Sept. 9, 2012).

[v] The latest data on the number and net assets of U.S. investment companies are given below by type of investment company.  The data in the columns and in the rows of the table are drawn from different points in time, but all of the time points are within the period from December 31, 2011 to July 31, 2012.

  Type of investment company            Number          Net assets
   Mutual funds             7,637

$12.340 trillion

   Closed-end funds             634       $ 0.250 trillion
   Exchange-traded funds            1,228       $ 1.192 trillion
   Unit investment trusts            6,022       $ 0.060 trillion


Source:  Investment Company Institute, and (last visited Sept. 8, 2012).

[vi] Larry D. Barnett, The Place of Law: The Role and Limits of Law in Society 49–63, 121–22 (2011).

[vii] The subsidiaries of company #1 were wholly owned, not majority-owned.  See §§ 3(a)(24), 3(a)(43) of the Act (defining “majority-owned subsidiary” and “wholly-owned subsidiary”).  The conclusion that company #1 was an investment company could thus have been based on § 3(a)(1)(C) of the Act, which requires inter alia that, to be an investment company, an entity must own, hold, or trade “investment securities.”  Under § 3(a)(2) of the Act, “investment securities” include securities issued by wholly owned subsidiaries.

Although an entity that qualifies as an investment company under § 3(a)(1)(C) may have an exemption from the status of investment company through § 3(b) of the Act, neither the incoming letter nor the staff reply mention, let alone discuss, § 3(b).

[viii] Being exchange-listed, the securities issued by company #2, as well as the securities issued by company #1, were by definition available to the public.

[ix] Barnett, supra note vi, at 198–204.


Why (Not) Chapter 9 Bankruptcy?

This post is authored by Benjamin Chapple.

On September 6, 2012, Institute Professor Juliet Moringiello gave a CLE presentation titled “Why (Not) Chapter 9?“.  Professor Moringiello explained that in the past two years there have been a number of notable Chapter 9 bankruptcies, involving municipalities such as: Central Falls, Rhode Island, Harrisburg, Pennsylvania, Jefferson County, Alabama, and Mammoth Lakes, California.

The professor explained that Chapter 9 bankruptcies are rarely filed in large part for two reasons: (1) a paucity in case law creates uncertainty regarding how the bankruptcy will result; and (2) the statutory eligibility requirements of 11 U.S.C. § 109(c). One eligibility requirement to note is that the municipality must be specifically authorized by state law, or by a competent state government official or organization before it can file for bankruptcy.  While twenty four states have no authorizing legislation, and one state—Georgia—has legislation prohibiting Chapter 9 bankruptcies, the level at which the remaining twenty five states are authorized varies. It was explained that this authorization requirement is in place to address Tenth Amendment concerns, because a municipality is a creature of its states and entering bankruptcy places the municipality under the jurisdiction of the federal government.

Professor Moringiello’s presentation also identified and explained the delicate constitutional balance that exists between the federal and state government—specifically as a result of the Tenth Amendment, Contracts Clause, and Bankruptcy Clause. After addressing the constitutional implications of Chapter 9 bankruptcies, non-bankruptcy debt collection alternatives were discussed.

Professor Moringiello explained throughout her presentation that most interested parties advocate for either state or federal control; thus, finding that there cannot be state and federal cooperation. Professor Moringiello discussed the deficiencies of relying on Chapter 9 alone, and concluded that currently Chapter 9 is an incomplete rehabilitation tool.  Chapter 9 is incomplete because (1) Code sections outside of Chapter 9 apply in Chapter 9 only if included under § 901, and therefore Chapter 9 does not incorporate all of the provisions of Chapters 1, 3 and 5; (2) in Chapter 9 bankruptcies the municipality (debtor) maintains exclusive control over its filing, plan, and use of its assets; and (3) unlike other types of bankruptcy, there is no possibility that a trustee or examiner will be appointed.

Professor Moringiello concluded that the optimal approach is for state and federal cooperation because state involvement, she argues, can ameliorate some of the Chapter 9 deficiencies noted above. Specifically, the professor advocates that states could, and should serve as a check on its municipality’s behavior since a trustee cannot be appointed.

 For information about future Institute Presentations, please visit the Events page.