United States: Calling For Judicial/Legislative Intervention In Unwarranted M&A Shareholder Litigation

Last year, shareholders filed lawsuits challenging nearly 95% of public company M&A deals -- a new high (or low) water mark and the fourth consecutive year where more than 90% of these deals wound up in court. These lawyer-driven strike suits have become numbingly familiar, and predictably generic. Not only do nearly all M&A deals wind up in court, but(i) most attract hopelessly redundant, copy-cat lawsuits (on average, more than 5 per deal), typically in multiple jurisdictions (over 60% in 2013); (ii) virtually all these suits settle fast for supplemental "disclosures" of dubious value (over 90% before the deal closes), with virtually none providing monetary relief to shareholders (only 2% last year); and (iii) the plaintiffs' lawyers who bring these cases receive cash "fees" averaging about $500K a throw -- in marked contrast to the "clients" whom they claim to represent (and who, again, almost never see a dime).

The conventional wisdom is that the M&A strike suit has metastasized into a permanent "deal tax," whereby proxies are re-written, and plaintiffs' lawyers paid off, with constructive deal-makers walking away holding their noses. So pervasive is the M&A strike suit that smart D&O insurers have essentially carved them out from their policies by setting special, very high deductibles. At the same time, economic consulting firms are chronically publishing studies to remind us how bad the problem has gotten. But -- behind all these consistent and scary statistics-- there is reason to believe that this vexatious litigation will decline; that the trend will soon correct itself; and that sophisticated courts and legislators can, should, and will intervene.

For starters, the need for change could not be more apparent. It simply cannot be that more than 90% of M&A deals in America are the product of flawed processes supervised by derelict corporate directors who flout their fiduciary duties. In fact, it is hard to find even isolated examples of a successful court challenge to a legitimately lousy deal -- or even to lousy disclosures in a good deal. Of the hundreds of cases filed last year, not a single one survived long enough to go to trial. And of the few cases that didn't immediately settle, the plaintiffs lost every time on the merits. Pragmatic business people typically settle such "nuisance" suits simply because doing so is cheaper and less annoying than litigating them to a win -- not because anyone believes that directors have actually done anything wrong.

Nor do the "settlements" reached in these M&A cases provide meaningful economic benefit to shareholders or even some broader social benefit. Virtually none of these settlements (precisely 1 in the last two years) directly provide any "bump-up" on the deal price paid to investors, even though virtually all involve cash payments to the lawyers who filed the case -- an enormous red flag. Instead, settlements typically call for "supplemental disclosure" on the theory that shareholders with more information will be able to vote for or against the deal on a more informed basis. But that theoretical benefit does not match the facts: disclosure-only settlements have no statistically significant impact on the outcome of shareholder votes on mergers, an ugly truth laid bare by some top academics in a forthcoming study in the Texas Law Review. (Nor is there any statistically meaningful relationship between fee awards to plaintiffs' counsel and the outcome of shareholder votes.) Bottom line: a settlement does not yield any benefit to investors if all they get is "supplemental" disclosure of information that they already have, that is obvious, and/or that doesn't otherwise change anyone's views on the deal.

Courts plainly have become impatient with these manufactured lawsuits, and increasingly intolerant of settlements that do not actually "create value." In Delaware, the epicenter of this litigation, the Chancery Court has very recently dismissed several high-profile strike suits, including one challenging the merger between Ramtron International and Cypress Semi- conductor. Jettisoning the case as no more than "ubiquitous shareholder litigation that immediately follows the announcement of any public company merger," the Court made clear that plaintiffs' boilerplate accusations were a far cry from the "extreme set of facts" necessary to show that the target's directors had actually "conscious[ly] disregard[ed]" their duties. Likewise, the Chancery Court recently refused to approve a negotiated settlement of a strike suit filed against Medicis Pharmaceuticals -- even after all involved agreed to terms at arms' length -- because the supplemental disclosures demanded by the plaintiffs' lawyers did not "change the game" by providing their shareholder clients with any new and relevant information about the merger. For essentially public policy reasons, the Court simply couldn't place its imprimatur on a superficial settlement of a lawsuit that, if litigated in the real world, stood little chance of success.

Critically, the economic erosion of the M&A strike suit has already begun, even though we have not yet seen a drop in the number of cases filed. Last year, only two strike suits settled for over $5 million, compared to similarly trivial numbers in recent years (three in 2013, six in 2011, and five in 2010). The declining value of these cases is still more obvious from the fees sought by the attorneys who bring them. Plaintiffs' lawyers are now working harder (in relative terms) to justify their unjustifiable fees, and they are quietly discounting their demands. The average fees requested by plaintiffs' counsel in these cases dropped more than 20% last year, to $1.1 million in 2013 from $1.4 million in 2011 and 2012. And for settlements that only involved supplemental disclosure, rather than any monetary pay-out, the average fee requested in 2013 was only $500,000 -- a new nadir for the preceding five-year period. These data may be the best trend indicator yet that plaintiffs' attorneys themselves are acknowledging the falling value of their lawsuits.

There is reason to believe that heightened judicial scrutiny will portend reform that is broader and far more protective of honest dealmakers than just chipping away at the plaintiffs' lawyers' franchise one fee petition at time. In another recent case involving the sale of Theragenics Corp., the Chancery Court thoroughly interrogated the plaintiffs' lawyers on the basis for their fee request before rejecting the proposed settlement altogether. In doing so, the Court asked the very sort of questions that Congress mandated in 1995 to combat the similarly abusive practice of plaintiffs reflexively filing federal securities class actions against any public company that missed earnings, restated financials, or otherwise announced stock-dropping bad news.

Specifically, the Court inquired into (i) the economic stake the plaintiffs had in the company at the time they sued; (ii) how the plaintiffs connected with the lawyers who filed the case; and (iii) how many times those same lawyers had filed similar M&A lawsuits. Such questions are plainly designed to separate the (few) meritorious cases from the (many) invented by lawyers who sue in the name of puppet investors. And those questions are no less relevant in combating frivolous M&A cases today than the lawyer-driven federal securities class actions that required an Act of Congress in the 1990s.

In the final analysis, we are fast approaching the tipping point where many more courts will -- and legislators should -- put a fence around the barnyard. The reforms in federal securities litigation from the mid-1990s, echoed by the Chancery Court in Theragenics, provide a promising road map. But because these are state law cases in state courts, the business community must pick its shots by choosing the best places to press their advantage. The obvious targets reform are in the states that see the most filings (namely Delaware, New York, and California), as well as forums like Virginia where courts and elected officials are less gun-shy about stepping up to protect legitimate enterprise -- as opposed to the plaintiffs' lawyers who claim to speak for shareholders but, by and large, litigate for them- selves. It may be that reform already is inexorable, but the pace of the progress can only be accelerated by organized effort by business leaders.

Originally published by The Deal.

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Jonathan A. Shapiro
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