Second Circuit Rejects SRO Immunity Defense and Revives “Flash Boys”-Type Suit Against U.S. Stock Exchanges

On December 19, 2017, the Second Circuit in City of Providence, et al., v. BATS Global Markets, Inc., et al., vacated a New York federal district court’s dismissal of a “Flash Boys”-inspired consolidated class action, reviving the multi-district litigation against several U.S. stock exchanges, including BATS Global Markets Inc., Chicago Stock Exchange Inc., Direct Edge ECN LLC, the Nasdaq Stock Market LLC, Nasdaq OMX BX Inc., New York Stock Exchange LLC, and NYSE Arca, Inc.  The institutional investor lead plaintiffs alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, promulgated thereunder, claiming that the exchanges misled them about products and services that the exchanges sold to high-frequency trading (“HFT”) firms, thereby manipulating market activity to the plaintiffs’ detriment. The crux of these lawsuits is that the exchanges provided proprietary data feeds, co-location services, and complex order types to HFT firms in exchange for high fees that an ordinary investor could not afford, which allegedly allowed the HFT firms to receive more information at a faster rate at the expense of pension funds, other large institutional investors, and the investing public. On August 26, 2015, Judge Jesse M. Furman of the Southern District of New York dismissed the complaint against the exchanges, determining both that the plaintiffs failed to state a claim for fraud under Section 10(b) and Rule 10b-5 and that the exchanges were immune from private lawsuits related to the proprietary data feeds and complex order types (but not the co-location services) as self-regulatory organizations. In an opinion authored by Judge John M. Walker, however, a panel of the Second Circuit vacated the district court’s dismissal of the claims, finding that the plaintiffs adequately pleaded their fraud claims against the exchanges and that the exchanges were not immune from suit as SROs. First, the Second Circuit determined that the defendant exchanges were acting in their commercial interests by selling the products and services to HFT firms, not in a regulatory capacity such that they were “stand[ing] in the shoes of the SEC,” and thus, they were not entitled to the same protections of immunity as the SEC.  In short, the exchanges were “acting as a regulated entity – not a regulator.” Second, the panel determined that the plaintiffs adequately pleaded that “the exchanges were co-participants with HFT firms in the manipulative scheme and profited by that scheme,” not simply that the exchanges aided and abetted the HFT firms’ manipulative scheme. Specifically, the Second Circuit noted that the plaintiffs pleaded that “the exchanges created a fraudulent scheme that benefited the HFT firms and the exchanges, sold the products and services at rates that only the HFT firms could afford, and failed to fully disclose to the investing public how those products and services could be used on their trading platforms.” Concurring in the judgment, Circuit Judge Raymond J. Lohier, Jr. wrote that the court could simply have deferred to the SEC’s position, as stated in its amicus brief, that the exchanges are not absolutely immune from conduct described in the consolidated class action.

Delaware Supreme Court Reverses Dell Appraisal Ruling, Emphasizing Importance of Deal Price in Assessing Fair Value

On December 14, 2017, the Delaware Supreme Court in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd. reversed the Chancery Court’s decision in the Dell appraisal action, which had determined that the “fair value” of the company’s shares exceeded the deal price by about $7 billion, holding that “the deal price deserved heavy, if not dispositive, weight.” The approximately $25 billion Dell buyout was led by Dell’s founder and CEO, Michael Dell, and affiliates of a private equity firm, Silver Lake Partners. Following the sale, former Dell stockholders requested appraisal under Section 262 of the Delaware General Corporation Law, seeking to receive the “fair value” of their shares as of the merger date rather than what they received in the deal price.  In May 2016, following an appraisal trial, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery found in favor of Dell stockholders and ruled that the fair value of Dell in the buyout was about $7 billion more than the deal price. Dell appealed the appraisal decision, arguing that the Chancery Court did not consider “all relevant factors” because it failed to take into account the deal price. The Delaware Supreme Court decided that, although the Court of Chancery considered all relevant factors, it nevertheless erred in assigning no mathematical weight to the stock price and the deal price, instead relying exclusively on its own discounted cash flow analysis. First, the Delaware Supreme Court rejected the Chancery Court’s determination that no weight should be afforded to Dell’s stock price because a “valuation gap” between Dell’s fundamental value and market prices showed that the market was inefficient. To the contrary, the Delaware Supreme Court stated that the efficient market hypothesis controls, and that “the evidence suggests that the market for Dell’s shares was actually efficient and, therefore, likely a possible proxy for fair value.” The court specifically noted that “analysts scrutinized Dell’s long-range outlook when evaluating the Company and setting price targets.” Second, the Delaware Supreme Court rejected the Chancery Court’s argument that the lack of strategic buyers in the Dell buyout pushed the deal price below fair value, determining instead that the Chancery Court’s assumption that more bidders existed was unfounded based on the record. The court stated that the “Court of Chancery ignored an important reality: if a company is one that no strategic buyer is interested in buying, it does not suggest a higher value, but a lower one.” Third, the Delaware Supreme Court rejected the Chancery Court’s finding that the nature of the deal as a management-led buyout lowered the deal price below the fair value. Instead, the Delaware Supreme Court held that the “prerequisite elements for problematic [management-led buyouts] did not exist,” where there was an extensive due diligence process that provided bidders with access to all of the necessary information. While this decision falls short of setting a bright-line rule that the deal price is dispositive of fair value under the Delaware appraisal statute, it nevertheless suggests that Delaware courts going forward will emphasize deal price in appraisal cases.

Delaware Supreme Court Affirms Dismissal of Breach of Duty Suit Against Duke Energy Board for Failure to Plead Demand Futility

On December 15, 2017, the Delaware Supreme Court in City of Birmingham Retirement and Relief System, et al. v. Good affirmed the dismissal of an investor breach of duty suit against the directors of Duke Energy. In a 4-1 split opinion, the Supreme Court held that the Court of Chancery was correct in dismissing the suit because the plaintiffs failed to show that a litigation demand on the board was futile. Stockholders of Duke Energy filed a derivative suit against certain directors and officers of the company, seeking to hold them liable for a toxic coal ash spill that contaminated the Dan River in North Carolina. The defendant directors moved to dismiss the complaint, arguing that the plaintiffs did not make a demand on the board of directors before filing suit, as required by Court of Chancery Rule 23.1. Although the plaintiffs argued that they were excused from making a demand because it was futile, the Court of Chancery found no reasonable inference that the directors acted in bad faith so as to excuse demand from the fact that the directors relied on a report from management when addressing the coal ash storage problems. The Chancery Court accordingly dismissed the complaint.  On appeal, the Delaware Supreme Court affirmed. Justice Collins J. Seitz, Jr., writing for the majority, determined that “the plaintiffs did not sufficiently allege that the directors faced a substantial likelihood of personal liability” to show demand futility. Justice Seitz agreed with the Chancery Court’s findings that the board presentations did not support an inference that the directors acted in bad faith and that the alleged facts did not support a reasonable inference that Duke Energy illegally colluded with regulators. Chief Justice Leo E. Strine, Jr. dissented from the majority’s decision, however, stating that the facts pleaded “raise a pleading stage inference that it was the business strategy of Duke Energy, accepted and supported by its board of directors, to run the company in a manner that purposely skirted, and in many way consciously violated, important environmental laws.”

Tennessee District Court Denies Motion to Dismiss Securities Class Action Against CoreCivic

On December 18, 2017, the U.S. District Court for the Middle District of Tennessee denied the defendants’ motion to dismiss in Grae v. Corrections Corp. of America, et al., finding that the plaintiffs had adequately pleaded an actionable misstatement, loss causation, and scienter. The class action plaintiffs alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against CoreCivic (formerly Corrections Corporation of America)—a publicly traded real estate investment trust that owns and operates correctional, detention, and residential re-entry facilities—and against certain CoreCivic executives. The plaintiffs alleged that CoreCivic and its executives mislead investors about its history of quality, cost-savings and compliance with particular standards at Federal Bureau of Prisons facilities in CoreCivic’s periodic SEC filings. Of particular note, the plaintiffs pointed to a Department of Justice Office of Inspector General review, published on August 11, 2016, which found that CoreCivic facilities experienced substantially higher rates, relative to BOP institutions, of inmate fights, inmate-on-inmate assaults, and suicide attempts, and to an August 18, 2016 memorandum issued by then-Deputy Attorney General Sally Q. Yates entitled “Reducing our Use of Private Prisons,” which specifically directed that, “as each [private prison] contract reaches the end of its term, the Bureau should either decline to renew that contract or substantially reduce its scope in a manner consistent with law and the overall decline of the Bureau’s inmate population.” In the wake of the OIG Review and the Yates Memorandum, CoreCivic’s stock price fell dramatically. The defendants moved to dismiss the complaint for failure to state a claim, arguing that the plaintiffs had failed to identify an actionable misstatement or omission, failed to plead loss causation, and failed to plead facts sufficient to support a strong inference of scienter. Judge Aleta A. Trauger denied that motion, holding that “[a] reasonable juror could conclude that CoreCivic’s statements, in context, were false or misleading because they ran directly counter to a wealth of available evidence establishing that its operations had pervasively failed to live up to the quality standards of the [BOP].” The court also determined that a reasonable investor could find it material, when valuing the company, that CoreCivic offered inferior services and that its relationship with its biggest client, the BOP, was deteriorating. The court also refused to dismiss the complaint on the basis of loss causation or scienter, finding that the plaintiffs had adequately alleged that CoreCivic’s misleading statements, and not the Yates Memorandum alone, caused the investors economic harm, and that the plaintiffs’ allegations that dozens of deficiencies were affirmatively brought to CoreCivic’s attention were sufficient to support a strong inference that CoreCivic and its executives acted knowingly.