On The Case

How many investors does it take to screw up a deal? Judge questions M&A disclosure lawsuits

(Reuters) - Federal judges don’t have the authority to question settlements between individual shareholders and companies in the midst of M&A deals, according to an opinion issued Friday by U.S. District Judge Denise Cote of Manhattan.

Judge Cote had toyed with the idea that these individual shareholder settlements – which have become, as she noted, a distinct trend in securities litigation – might be subject to Rule 11 scrutiny under the Private Securities Litigation Reform Act. She concluded such settlements do not trigger the PSLRA’s Rule 11 strictures because the voluntary dismissal of an individual shareholder’s claim is not a final adjudication.

That’s an important holding for plaintiffs’ lawyers. But before the shareholder bar gets too excited, it should also note Judge Cote’s possibly ominous discussion of preliminary injunctions in deal litigation.

The judge spent a lot of time talking about the qualifications, or lack thereof, of the named plaintiffs who sued Time Inc, alleging insufficient disclosures about Meredith Corporation’s $2.8 billion acquisition of the company. One of the plaintiffs owned 100 shares in Time, worth less than $2,000. The other owned 8 shares, a stake of $200. Both are repeat securities class action plaintiffs. Judge Cote said their early motion to enjoin Meredith’s acquisition of Time is “an apt example of the dangers inherent in the pursuit of a putative class action challenging the adequacy of disclosures for an M&A transaction.”

Because this litigation was dismissed so quickly, the judge said, it didn’t give her an opportunity to delve into the possibility that shareholders abused the threat of a preliminary injunction to obtain worthless disclosures. But it sounds like Judge Cote is spoiling for a chance to rein in M&A shareholder class actions in federal court.

That’s certainly where the action is. As you know - and as law professors including Penn’s Jill Fisch documented in a 2018 paper, "The Shifting Tides of Merger Litigation," cited in Judge Cote’s opinion - shareholders suing over supposedly flawed M&A deals moved in droves to federal court after Delaware Chancery Court severely restricted fee awards for disclosure-only settlements in 2015 and 2016. These federal-court M&A lawsuits have followed a different path from the old-school Delaware class actions.

Delaware deal cases were typically settled as class actions, in which shareholders granted defendants broad releases and the Chancery judges set fees for plaintiffs' lawyers. By contrast, it’s rare for a shareholder M&A challenge in federal court to move forward as a class action. The cases are filed as class actions, to be sure, but they’re frequently dismissed voluntarily before class certification briefing (or much substantive litigation at all).

Sometimes shareholders’ lawyers just drop investors’ suits if defendants balk in early negotiations. But dozens of 2017 M&A challenges in federal court ended in the kind of settlement Judge Cote addressed in Friday’s opinion: Defendants agree to make additional disclosures in exchange for shareholders quickly dropping their suits.

These settlements don’t include broad shareholder releases, since they’re struck only with the investors who filed suit, not an entire class of shareholders. But they often do include fees for the shareholders’ lawyers who filed the suit: My analysis of the M&A cases filed in federal court in 2017 shows that defendants agreed to pay fees to shareholders’ lawyers in more than 70 cases, out of 200-plus cases. In at least 60 cases, those fees were not disclosed to the court.

We can debate forever the value of the additional disclosures shareholders obtain through M&A challenges. Delaware judges concluded that the vast majority of the disclosures obtained in shareholder M&A challenges are not material. The 7th U.S. Circuit Court of Appeals adopted Delaware’s tough standard in its 2016 decision in In re Walgreen Stockholder Litigation. Judge Cote is of the view that disclosure-only settlements “principally benefit plaintiff’s counsel.”

Other federal judges have approved fees for shareholders' lawyers who obtained only additional disclosures, including (in a case cited by Judge Cote), U.S. District Judge Thomas Schroeder of Greensboro, North Carolina, in 2017’s In re Hatteras Financial. In the Time case, said shareholder lawyer Carl Stine of Wolf Popper in an email, “Time disclosed important information related to the company’s projections, the process leading up to the transaction, and Time insiders’ and their banker’s potential conflicts of interest—all without the release of any class-wide claims.”

Stine said plaintiffs’ lawyers are earning reasonable mootness fees in disclosure-only, individual-investor settlements in federal court. I’ve found examples of mootness fees topping $300,000 in voluntarily dismissed, federal-court M&A challenges, but Stine said those fees came early in the wave. Fees have since leveled off at a much lower level, generally less than $125,000, according to Stine. “Nobody is getting rich off these cases,” he said. (Stine said Time paid a mootness fee in the case before Judge Cote but declined to say how much.)

Regardless of what judges think of disclosure-only settlements and mootness fees, Judge Cote said they’re outside of the court’s control under the PSLRA. But that’s why her skepticism about small-stake shareholders threatening to hold up billion-dollar transactions stood out to me. As Stine pointed out in his email statement about Cote’s opinion, it doesn’t really matter how many shares a lead shareholder owns. That’s the nature of class actions. And shareholders alone can’t block a transaction, Stine noted. “If Time had not made these disclosures, the judge, not the plaintiff shareholders, would have decided whether to enjoin the transaction,” he wrote in his email.

Judge Cote’s musing about the power of the threat of an injunction by shareholders with only a minuscule stake in the deal, in other words, was extraneous. But that’s what made it particularly pointed. “The time frames in which an M&A transaction must close usually discourages defendants from attempting to defeat pre-merger litigation on the merits, even when that litigation is abusive,” the judge wrote. “If a preliminary injunction against the closing of the tender offer had been granted, two plaintiff shareholders with minimal stakes in the litigation would be holding up a multi-billion-dollar transaction, with potentially enormous consequences for all shareholders.”

I have to read that passage of Judge Cote’s opinion as a warning: Woe to the small-time shareholder who actually tries to enjoin an M&A deal in her courtroom. If I were a defendant facing an M&A disclosure suit in a case before Judge Cote, I’d think hard about settling, even if the cost of settlement is only $125,000 and some additional disclosures.