June 30, 2020

M&A Disclosure Claims: Somebody Actually Litigated One!

Post-Trulia, most M&A disclosure lawsuits have been brought in federal court and have alleged violations of Section 14(a) & Rule 14a-9 under the Exchange Act. Those cases usually settle, often for a combination of supplemental disclosures and the payment of a mootness fee.  But this Cleary Gottlieb blog says that somebody recently litigated a case involving federal disclosure claims – and the result was interesting:

In Karp v. SI Financial Group, Inc., No. 3:19-cv-001099 (MPS), 2020 WL 1891629 (D. Conn. Apr. 16, 2020), however, the defendants chose not to follow the usual playbook and actually litigated the plaintiff’s Section 14 claim. And on April 16, 2020, the district court granted the defendants’ motion to dismiss, ruling that the plaintiff had failed to plead that any statement in the proxy was rendered false or misleading by the omissions of facts the plaintiff alleged were material and not disclosed.

In so ruling, the court highlighted a fundamental difficulty plaintiffs in such strike suit merger cases often have in successfully pleading a Section 14 claim: Unless a plaintiff can show that the proxy statement omitted a fact required to be disclosed by SEC regulations (which is often a tall task), the plaintiff must plead that some omitted fact renders a statement in the proxy materially misleading.

Importantly, unlike Delaware duty-of-disclosure claims, the omission of a material fact alone is not enough to state a Section 14 claim. Instead, the plaintiff must plead – with particularity, not merely with conclusory allegations – how the allegedly omitted fact renders the proxy statement disclosures materially misleading. But without knowing the facts that have been omitted – and because of the discovery stay imposed by the Private Securities Litigation Reform Act (“PSLRA”) – plaintiffs will have difficulty obtaining such facts at the pleading stage, particularly since there is no equivalent tool to a Section 220 books and records claim under the federal proxy rules.

Although the case highlights the challenges plaintiffs face in bringing federal disclosure claims, the blog speculates that the decision won’t have much practical impact in the current environment, and that most defendants will continue to opt for settlements.  However, it points out that settling out may not always be the best approach, and that the SI Financial decision may be a useful one for defendants to keep in mind if they’re inclined to fight.

John Jenkins