March 2, 2009

Madden v. Cowen & Co.: SLUSA’s “Delaware Carve-Out” Applies to Suit Against M&A Financial Adviser

– by John Jenkins, Calfee Halter & Griswold

In Madden v. Cowen & Co. (C.A.9 (Cal.)) (2/11/09), the Ninth Circuit held the “Delaware carve out” contained in the Securities Litigation Uniform Standards Act of 1998 applied to disclosure claims brought against an investment banking firm that rendered a fairness opinion to the board of a seller’s subsidiary in connection with a merger transaction. The case appears to be the first in which a court has extended the Delaware carve-out to shareholder claims made against persons other than officers or directors of the company in which they owned stock.

SLUSA preempts certain state-law based securities fraud class actions involving “covered securities” under the Private Securities Litigation Reform Act of 1995. Before SLUSA’s enactment, plaintiffs had used state-law based class actions to avoid the heightened pleading requirements and other procedural impediments imposed on federal securities class actions by the PSLRA. Under SLUSA, federal claims are generally the only ones permitted to be made for class actions involving securities traded on a national securities exchange, and federal court is the only forum in which those claims may be brought.

SLUSA contains several important exceptions to its preemption of state law shareholder class actions. These include derivative actions and actions based on the law of the issuer’s state of incorporation. These two exceptions have come to be known as the Delaware carve-out. In order for a non-derivative claim to fall within the scope of the Delaware carve-out, it must involve either:

– the purchase or sale of securities by the issuer or an affiliate of the issuer exclusively from or to holders of equity securities of the issuer; or

– a recommendation, position, or other communication with respect to the sale of the issuer’s securities that is made by or on behalf of the issuer or its affiliate to equity holders, and concerns the equity holders’ decisions with respect to voting their securities, responding to a tender or exchange offer, or exercising dissenters’ or appraisal rights.

The second bulleted exception has been used to preserve state law fiduciary duty of disclosure-based claims against directors. See, e.g, Alessi v. Beracha, 244 F. Supp. 2d 354 (D. Del. 2003). However, courts have traditionally declined to extend the carve-out for disclosures made “by or on behalf of an issuer” to disclosure based claims involving communications from persons other than the corporation or its officers and directors. See e.g. Greaves v. McAuley, 264 F. Supp. 2d 1078, 1083-84 (N.D. Ga. 2003) (holding that fiduciary duty claims by former shareholders against the company and its board members were covered by the Delaware carve-out but that claims against the buyer were not).

In Madden, the Ninth circuit rejected contentions by the investment bank that its communications were not made “on behalf of” the issuer. In making this argument, the bank pointed out that it did not serve as the financial adviser to the company in which the plaintiffs were shareholders. Instead, the bank was retained to render a fairness opinion to the board of directors of that company’s majority-owned subsidiary.

Nevertheless, the court noted that the complaint alleged that investment bank’s fairness opinion “was provided to the shareholders of St. Joseph with Cowen’s consent and that the shareholders relied on the opinion when voting in favor of the merger.” Accordingly, the court held that the complaint sufficiently alleged that the bank’s communication was “on behalf of” St. Joseph for purposes of the Delaware carve-out, regardless of whether Cowen addressed its letter only to the subsidiary’s board.