Litigation Archives - That's Not Market

Monster Books and Records; Unrequited Demands and Other Lessons for Startups and Seasoned Companies

Everyone from startups to seasoned companies and their shareholders can take a lesson from the Monster books and records demand debacle.

I know what you’re thinking: “How lucky am I to have two books and records articles in two weeks!”

Monster Worldwide (of job board fame) was acquired and merged out of existence. A shareholder had made a books and records demand prior to the merger but did not bring suit to enforce it until after the merger. The demand letter said it would assume Monster would not take certain actions unless Monster said otherwise by a deadline. Monster did nothing. Former shareholder loses.

Here’s a timeline that will be helpful:

August 8 – Monster and Acquiror enter into a merger agreement
September 6 – Acquiror commences a tender offer to Monster shareholders under the merger agreement
October 19 – Shareholder sends demand letter to Monster seeking access to books and records
October 26 – Monster rejects demand in current form but offers to cooperate on limited access
October 26 – Shareholder emails about the limited offer and stating that if the merger closes before he files a complaint, he expects that the company will refrain from asserting any argument that he lost standing to inspect documents because the merger closed before he filed his complaint. If the company will not refrain from making any such argument, please tell me by 10:00 a.m. Eastern time tomorrow.”
October 28 – Withdrawal rights for the tender offer expire; Monster responds to Shareholder refusing to refrain from anything
November 1 – Merger completed
November 4 – Monster notifies Shareholder that its request was moot since the merger occurred
November 22 – Shareholder files complaint

The Shareholder claimed he still had standing according to some policy arguments based on the timing of his demands to Monster, but the court noted that this was simple:

The language of Section 220(c) is plain and unambiguous. By requiring that a plaintiff under Section 220, to seek relief from this Court, demonstrate both that it “has”—past tense—complied with the demand requirement, and that it “is”—present tense—a stockholder, the legislature has made clear that only those who are stockholders at the time of filing have standing to invoke this Court’s assistance under Section 220.

Since the merger had occurred, the Shareholder was no longer a shareholder at the time of the complaint. Therefore, he did not have standing under DGCL Section 220(c) to file a suit to enforce his right to books and records.

As we mentioned in our previous post, all corporations are bound by the books and records requirements of their jurisdiction of incorporation. Startups are not exempt just because they like confidentiality and “stealth mode.”

Likewise, shareholders making a demand must conform to strict requirements of the statute. A company can refuse and delay access on the basis of an improper request.

–Joe Weingarten v. Monster Worldwide, Inc.

Monster denies books and records request since it doesn't really exist anymore in its old form. — Monster Worldwide – You can have our job listings, but not our books and records

Gibson Les Paul Sticks It To The Man With New Model

New Gibson Les Paul commemorates government raid and property seizure.

In August 2011, federal agents raided Gibson Guitar Corp.’s facilities SWAT-style. To seize wood. For alleged violations of foreign exporting laws that the foreign governments declared not a violation.

Some declared the raid to be a political hit job since Gibson’s CEO gives to Republicans while other CEOs of musical instrument purveyors support Democrats. Regardless, Gibson resolved the issue with a financial penalty and donation to a federal agency for some BS research project.

To commemorate the shakedown, Gibson has released the Government Series II Les Paul. The fingerboards on these guitars include wood returned to Gibson from the U.S. government after the resolution of the matter. The guitars also sport a distinctive “Government Tan” finish and a bald eagle graphic on the pickguard.

This is a topic near and dear to me as a Gibson Les Paul owner myself. I have a black 1986 Les Paul that I bought in high school. I bussed a lot of tables at a local restaurant to afford that guitar. It was my first professional grade guitar. It is still one of the best in my collection.

In the words of a musical group that does not use guitars:

Gibson USA: Government Series II Les Paul - Government Tan

Fight the Power!

SEC Files Fraud Charges Against Wing Chau, One of the CDO Managers Profiled in Michael Lewis’ “The Big Short”

This won’t be good for the Wing chau defamation suit against Michael Lewis.

Some readers may be familiar with “The Big Short: Inside the Doomsday Machine,” Michael Lewis’ chronicle of the run up to the financial meltdown. I strongly recommend it. It is a great read.

In the book, there was a discussion of Wing Chau, who helped create and, in theory, manage some disastrous CDOs. He was not portrayed like the brilliant hedge fund managers who cashed in on the crash of real estate-backed securities. He was portrayed like a fool. For this, he sued Lewis for defamation.

I’m not sure if that case is ongoing or not, but the SEC has weighed in. Verdict: fraud charges against Chau for misleading investors in a CDO and for breach of fiduciary duties.

The SEC’s claims that Chau and his firm, Harding Advisory LLC, compromised their independent judgment as collateral manager to a CDO in favor of a hedge fund firm. The hedge fund, the awesomely named Magnetar Capital LLC, had invested in the equity of the CDO. Merrill Lynch structured and marketed the CDO. Harding was collateral manager for the CDO.

Specifically, the SEC claims that Harding agreed to let the hedge fund help select the subprime mortgage-backed assets underlying the CDO. This was not disclosed to investors.

The SEC claims that the influence of the hedge fund led Harding to select assets that its own credit analysts disfavored. In the tradition of criminal geniuses everywhere, in accepting the bonds, Chau wrote in an e-mail to the head of CDO syndication at Merrill Lynch:

“I never forget my true friends.”

The SEC claims that Chau understood that Magnetar was interested in investing as the equity buyer in CDO transactions, and that Magnetar’s strategy included “hedging” its equity positions in CDOs by betting against the debt issued by the CDOs. Because Magnetar stood to profit if the CDOs failed to perform, Magnetar’s interests were not necessarily aligned with investors in the CDO debt, which depended solely on the CDO performing well.

A Simple Question: What Does “Annual” in “Annual Meeting” Mean?

According to the Massachusetts Supreme Court, the answer isn’t quite so simple.

Link: Brigade Leveraged Capital Stuctures Fund, Ltd. v. PIMCO Income Strategy Fund

“Annual” means “annual,” right? How hard could it be. Let’s allow some ambiguous drafting, course of dealing and New York Stock Exchange regulations make it complicated.

Background

PIMCO is a big fund company and Brigade is an investor in two of its funds, each of which is a Massachusetts business trust.

The funds sent notices to investors of their intent to hold annual meetings as usual. Brigade sent notice that it was going to nominate a trustee for election at the annual meetings. PIMCO rescheduled the meetings to the last day of its fiscal year.

The funds’ declarations of trust require annual meetings at least 15 months after the first sale of shares and thereafter as specified in the bylaws.

The funds’ bylaws provide that annual meetings shall be held, so long as common shares are listed for trading on the NYSE, on at least an annual basis.

The NYSE requires listed companies to hold an annual shareholders’ meeting during the fiscal year.

Brigade filed suit seeking an injunction requiring PIMCO to hold the annual meeting as soon as practical and a declaration that the bylaws require an annual meeting at least once within any twelve month period.

Brigade contends that the rescheduling to nineteen months after the last annual meeting does not count as “annual,” which means within twelve months of the last annual meeting. PIMCO says “annual” means “during the fiscal year.”

What the Court Says “Annual” Means

Interpretation of Governing Documents

The court noted that the reference to the NYSE clearly means that an annual meeting must be held, at the very least, once every fiscal year, even though the bylaws do not explicitly say that.

However, the court reviewed the bylaw provision for shareholder notices together with the annual meeting requirement.¹ It also noted that the bylaws provided for a special meeting in lieu of annual meeting, which may take place outside of the “annual period,” a thirty day window following the anniversary of the previous year’s annual meeting, which is not an “annual meeting,” but a “special meeting.”

The court also noted that this interpretation is consistent with how PIMCO historically scheduled its meetings and the usual meaning of “on an annual basis.”

There is more going on here than contract interpretation, and you may already know this if you have ever dealt with this issue before a court.

The Real Issue

Many courts don’t come out and say it, but the Brigade court did. Where the bylaws are ambiguous, it will construe them against the drafters, in other words, the company.

The upshot is that courts do not like it when companies try to escape the wrath of a shareholder vote. As the court said,

“Moreover, where “bylaw provision are unclear, we resolve any doubt in favor of stockholders’ electoral rights.””

The court went on to quote a variety of shareholder friendly cases for the proposition that voting in corporate elections is a fundamental right of shareholders, and the court will not interpret ambiguous governing documents to allow the company to postpone an election.

________
¹Bylaws Section 10(c):

“To be timely, the Shareholder Notice must be delivered to or mailed and received at the principal executive offices of the Trust not less than forty- five (45) nor more than sixty (60) days prior to the first anniversary date of the date on which the Trust first mailed its proxy materials for the prior year’s annual meeting; … provided, … however, if and only if the annual meeting is not scheduled to be held within a period that commences thirty (30) days before the first anniversary date of the annual meeting for the preceding year and ends thirty (30) days after such anniversary date (an annual meeting date outside such period being referred to herein as an “Other Annual Meeting Date”), such Shareholder Notice must be given in the manner provided herein by the later of the close of business on (i) the date forty-five (45) days prior to such Other Annual Meeting Date or (ii) the tenth (10th) business day following the date such Other Annual Meeting Date is first publicly announced or disclosed” (emphasis added).

Do Section 10(b) and Rule 10b-5 Apply Outside of the U.S.?

Spoiler Alert: No, and this applies to civil and criminal matters, according to the Second Circuit.

Link: U.S. v. Vilar

Amid a selection of evidentiary and litigation-y claims, the recent 2^nd Circuit case of U.S. v. Vilar did have some interesting nuggets for securities professionals. Looking at an open issue following the U.S. Supreme Court case of Morrison v. National Australia Bank Ltd., the court looked at whether criminal liability under the Securities Exchange Act of 1934 extended to conduct outside the U.S.

Morrison was a civil case that limited Exchange Act Section 10(b) and Rule 10b-5 to domestic transactions in securities.

Background

The defendants were investment managers and advisers managing up to $9 billion before the tech bubble burst. They offered select clients the opportunity to invest in securities that paid a high, fixed rate of interest, which were backed primarily by high quality, short-term deposits. However a portion was invested in publicly traded emerging growth stocks. See where this is going?

The bubble burst and the defendants were not able to meet the interest payments. They created another investment vehicle and sold it to an investor, using the proceeds to settle a portion of the previous securities and for various personal expenses. This investor complained to the SEC after demands to return her funds were met with questionable responses.

The defendants were convicted on a variety of securities, mail and wire fraud counts.

The Argument

Relying on Morrison, he defendants argued that their convictions should be reversed since their conduct was extraterritorial, or outside the U.S.

The court agreed and quoted Morrison for the proposition that when a statute gives no clear indication of an extraterritorial application, it has none. Although Section 10(b) clearly forbids a variety of fraud, its purpose is to prohibit crimes against private individuals or their property, which is the sort of statutory provision for which the presumption against extraterritoriality applies (responding to the government’s examples of cases broadly applying statutes extraterritorially where the victims were government actors). A statute either applies exterritorially or it does not, and once it is determined that a statute does not apply extraterritorially, the only relevant question is whether the conduct occurred in the territory of a foreign sovereign. In such a case, the court’s test is:

A securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States. More specifically, a domestic transaction has occurred when the purchaser has incurred irrevocable liability within the United States to take and pay for a security, or the seller has incurred irrevocable liability within the United States to deliver a security.

The Upshot

The conviction stands. The conduct at issue was conducted in the United States, with ties to New York and Puerto Rico, which counts for the court’s purposes.

The defendants claimed that they structured the transaction carefully to avoid U.S. jurisdiction. However, the court declined to “rescue fraudsters when they complain that their perfect scheme to avoid getting caught has failed.”

The Takeaway

The court summarized its conclusion on the relevant (to us) point as follows:

Section 10(b) and Rule 10b-5 do not apply to extraterritorial conduct, regardless of whether liability is sought criminally or civilly.
A defendant may be convicted of securities fraud under Section 10(b) and Rule 10b-5 only if he has engaged in fraud in connection with:

a securities listed on a U.S. exchange; or
a security purchased or sold in the United States.

Nasdaq Among The Targets of Hacking Spree, According to Indictment

Three of the five alleged hackers are at large as the DOJ issues indictments in what I referred to the “largest such scheme ever prosecuted in the United States.” The hackers, five Russian and a Ukrainian, stole more than 160 million credit card numbers from a number of payment processors, retailers and financial institutions.

Nasdaq was a target, but its trading platforms were not compromised.

Among the U.S. Attorneys mentioned in the article is Preet Bharara, who is having a big week. He is also involved in the SAC Capital insider trading case.

SEC Pounces on Bitcoin Ponzi Scheme – In Securities Fraud, Everything Old Is New Again

Movie critics would call the scheme cliched and hackneyed.
Link: SEC Charges Texas Man With Running Bitcoin-Denominated Ponzi Scheme

This week, the SEC charged McKinney, Texas-based Trendon T. Shavers with defrauding investors in a Ponzi scheme involving Bitcoin. He may have raised more than $4.5 million in the scheme, but due to the Bitcoin-denominated transactions and vague SEC release, it is hard to tell. The SEC also says that in more recent dollars, the 700,000 Bitcoin raised exceeds $60 million, which screams “We Want Headlines!!!!” to me.

Shavers’ vehicle was called Bitcoin Savings and Trust and he used the names “Pirate” and “pirateat40” to sell his dirty wares. Despite the scary name, Shavers is probably just a Jimmy Buffet fan.

Jimmy Buffet, A Pirate Looks At Forty

The SEC claims Shavers claimed that investors would have no risk and huge profits over the Internet. It appears that Shavers took in Bitcoin investments and then sent them out in withdrawals and interest payments while losing money in his investments and siphoning off funds for himself. This is classic Ponzi scheme. Nothing new or notable other than the Bitcoin angle, which isn’t that interesting considering other schemes that are far more imaginative.

Insider Trading – How Much Of A Factor Must The Material Non-Public Information Play In The Investment Decision?

Spoiler alert: Not much.

Link: United States v. Raj Rajaratnam

Raj Rajaratnam, former billionaire hedge fund manager, appealed his notorious insider trading conviction. If you recall, he was the founder of the Galleon Group hedge funds who received insider information from contacts at McKinsey, Intel, Goldman Sachs and other hedge funds.

Among the issues raised at trial was whether the fraud counts should be vacated because the court told the jury that it could convict Rajaratnam if the “material non-public information given to the defendant was a factor, however, small, in the defendant’s decision to purchase or sell stock. He claimed that this allowed to jury to convict without a causal connection between the inside information and the trade.

The court noted that under the misappropriation theory of insider trading, a person commits fraud “in connection with” a securities transaction in violation of Rule 10b-5 when he misappropriates confidential information for securities trading purposes in breach of a duty owed to the source of the information. The Supreme Court in the O’Hagan case enshrined/created this theory to “protect the integrity of the securities markets against abuses by ‘outsiders’ to a corporation” who have access to confidential information that will affect the corporation’s security price but otherwise owe no duty to the corporation’s shareholders.

The court in this case endorsed the “knowing possession” standard* that is consistent with the cardinal rule of insider trading:

If you have a fiduciary or other duty to the company and hold material non-public information, disclose or abstain.

On this basis, the appeals court said that the district court’s instruction was more favorable to Rajaratnam than the legal standard. Rather than merely be in possession of the information, the jury had to find that he used it in some manner to find him guilty of insider trading. As a result, the jury instruction satisfied the “knowing possession” standard.

*The knowing possession standard became the law in the 2nd Circuit in United States v. Teicher and United States v. Royer.

Sarbanes-Oxley Lowered Standard to Remove Someone From Acting as an Officer or Director of a Public Company, Court Says

Then explains the standards, which really aren’t standards.

The Set-Up

Bankosky was a senior official of a pharmaceutical company. He had inside information on potential deals, and he traded on them.

Aside: As a music student in college, I told my primary professor that I was quitting my music degree and changing my major to pursue a law degree. He replied, “It doesn’t surprise me that people sell out, but how cheaply they do.”

How is this relevant? Bankosky’s illicit trades yielded $63,000.

Among other sanctions, the SEC moved to bar Bankosky permanently from serving as an officer or director of a public company. The court said, “Yep. Sounds good to me.”*

The Arguments

On appeal, the court noted the non-exclusive factors from U.S. v. Patel useful in making an assessment of the offender’s fitness to serve as an officer or director of a public company based on Exchange Act Section 21(d)(2). However, this was before Sarbanes-Oxley, which lowered the standard from “substantial unfitness” to “unfitness.” Results: Fireworks.

Does this mean that Patel no longer applies, as the SEC asked as it was looking for what it considers a more stringent standard? Nope. The court said:

“Moreover, the Patel factors are neither mandatory nor exclusive; a district court may determine that some of those factors are inapplicable in a particular case and it may take other relevant factors into account as it exercises its “substantial discretion” in deciding whether to impose the bar and, if so, the duration, so long as any bar imposed is accompanied with some indication of the factual support for each factor that is relied upon.”

In other words, the court may or may not look at a standard that may or may not apply based on something or other that may have six or seven elements that are probably substantially similar in substance. The court has a lot of discretion when determining what factors to consider in barring someone from acting as a public company director or officer.

SEC v. Bankosky

*Not a direct quote.

Whirlpool’s Unforced Negotiating Errors Does Not Make Its Contracts Unenforceable

Whirlpool Corporation v. The Grigoleit Company

The delightfully named Grigoleit supplied knobs to Whirlpool for many years, and was the sole supplier for a particular line of washing machines and dryers. Whirlpool began to phase out these appliances.

As their arrangement became smaller, Grigoleit requested price increases. They later entered into an agreement for a smaller supply of knobs at a higher price, subject to volume and inventory issues, for which Whirlpool was financially on the hook.

Whirlpool then kicked Grigoleit to the curb, and Grigoleit issued a final invoice. Whirlpool refused to pay it and declared the agreement unconscionable.

In Michigan, a claim of unconscionability is subject to a procedural (What is the bargaining power of the parties?) and substantive (Is the challenged term reasonable?) analysis.

The court did not look at the substantive issue because it found no procedural issue.

“Although courts should not substitute their judgment for that of freely contracting parties, “[i]mplicit in the principle of freedom of contract is the concept that at the time of contracting each party has a realistic alternative to acceptance of the terms offered.””

The court noticed that Whirlpool was a large, sophisticated company and presumed it was capable of competent negotiation. The court also noted that unconscionability is rarely found in the commercial context.

And the kicker: the term that Whirlpool considered unconscionable was a term that was proposed by Whirlpool.

The court noted a few key points:

Grigoleit was the sole supplier in this case by Whirlpool’s own design. It was a cost-saving measure on their own part. It created the risk that a disagreement with its supplier would cause manufacturing disruptions.
An unfavorable contract term is not the same as an unconscionable contract term.
Whirlpool had the resources, experience and ability to look elsewhere for its parts.

Category: Litigation