United States: Seventh Circuit Criticizes Disclosure-Only M&A Litigation Settlements, Holding That Supplemental Proxy Disclosures Must Address And Correct A Plainly Material Misrepresentation Or Omission

In In re Walgreen Co. Stockholder Litigation, No. 14 C 9786, 2016 WL 4207962 (7th Cir. Aug. 10, 2016) (Posner, J.), the United States Court of Appeals for the Seventh Circuit issued a highly charged opinion critical of an unopposed settlement of a stockholder class action "strike suit" which provided "nonexistent" benefits to class members yet "sweet fees for class counsel."  In this case, a putative stockholder class action was filed immediately after Walgreen Co. ("Walgreens") issued a proxy statement seeking approval of its reorganization as a new Delaware corporation to be called Walgreens Boots Alliance, Inc.  (As the Seventh Circuit noted, this was hardly unusual, as an astounding 94.9% of public company strategic transactions involving $100 million or more in recent years have triggered "strike suits" or "deal litigation.")  Echoing criticisms of similar types of disclosure-only settlements by the Delaware Court of Chancery (see In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016); blog article here], the Seventh Circuit reversed the district court's approval of the settlement.  This decision from an influential federal jurist will put additional pressure on plaintiffs in these types of cases to forego or abandon litigation over public company strategic transactions (or, perhaps ironically, to litigate these cases more aggressively).

As noted above, plaintiffs filed suit almost immediately after the Walgreens deal was announced.  Eighteen days later, and less than a week before the scheduled vote of stockholders to consider the transaction, the parties agreed to settle.  The entire benefit to the class consisted of six supplemental disclosures to the voluminous proxy materials already issued.  The settlement agreement also authorized class counsel to request that the district court award it $370,000 in attorneys' fees (for less than a month's work), without opposition from defendants.  After notice and a hearing, the United States District Court for the Northern District of Illinois — somewhat grudgingly — approved the settlement and fee request, overruling an objection to the amount of fees awarded.  The objector appealed.

The Seventh Circuit reversed.  The Court did not mince words:  it characterized the supplemental disclosures as a "trivial addition to the extensive disclosures already made in the proxy statement."  The supplemental information included the following:  (a) the "worthless" disclosure that Walgreens had spent time with a proposed board member learning his views on strategic direction before nominating him to the new board; (b) a disclosure, which "added nothing," that computed the stock allocations of two investment groups which "could be derived by simple arithmetic from data in the proxy statement"; (c) a disclosure that a Walgreens' officer had previously resigned and sued for defamation, which was not "even related to the formation of a new company"; (d) inclusion of four additional risk factors which "provided no new information to shareholders"; (e) the recusal from voting on the transaction of the individual designated to become the new company's CEO which "had been highlighted elsewhere in the proxy statement;" and (f) a more detailed recitation of the new CEO's previous leadership experience which was characterized as "frosting on the cake" of previous public filings.

The Seventh Circuit thus held that the value of the supplemental disclosures "appears to have been nil" and that the $370,000 paid to class counsel "bought nothing of value for the shareholders."  Specifically, the Court held that the supplemental disclosures "contained no new information a reasonable investor would have found significant" in deciding how to vote.  In remarkably strong language (even for Judge Posner), the Court cautioned "[t]he type of class action illustrated by this case — the class action that yields fees for class counsel and nothing for the class — is no better than a racket.  It must end."  The Court further recommended on remand that serious consideration be given to either appointing new class counsel or dismissing the suit.

The Court proceeded to endorse "a clearer standard" for approving the settlement of class action stockholder litigation embraced by the Delaware Court of Chancery in Trulia.  In that case, the Chancery Court advised practitioners of the "continued disfavor" of disclosure settlements by an "increasingly vigilant" judiciary unless the supplemental disclosures "address a plainly material misrepresentation or omission" (emphasis in original).  The Trulia court advised that "plainly material" did not mean a "close call," and if doubts existed the trial court should appoint an amicus curiae to assist in the evaluation of the benefits of the supplemental disclosures.

It is becoming clear that the days when a defendant could quickly buy stockholder peace for a relatively modest amount on a significant transaction, while plaintiffs' class counsel profited from relatively little work, are over.  As in Delaware, to the extent a disclosure-only settlement will be approved by a district court in the Seventh Circuit, an affirmative showing of a plainly material misrepresentation or omission in the proxy statement that will be adequately corrected through a supplemental disclosure will be required to justify a significant attorneys' fee.  As noted above, this development beyond Delaware likely will continue to contribute to the decline in such deal litigation.  See Cornerstone Research, Shareholder Litigation Involving Acquisitions of Public Companies:  Review of 2015 and 1H 2016 M&A Litigation (Aug. 2016) (percentage of large M&A deals hit with deal litigation dropped to 64% in the first half of 2016).

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