We recently wrote two posts about abuses in bogus plaintiff’s actions challenging merger transactions — litigation designed to generate legal fees for plaintiff’s counsel and not benefits to the company or shareholders. See Commentary on Abusive State Law Actions Following M&A Deals, and Hi-Crush Securities Class Action Settlement Benefits Lawyers and No One Else. The first post described a New York state court judge’s willingness to reject a proffered collusive settlement designed to generate unearned benefits to plaintiff’s counsel in return for dismissal of the action and a broad set of releases for the defendants. The second described a federal court judge’s unfortunate willingness to sign off on a settlement that lined the pockets of plaintiff’s lawyers but gave no real benefit to the purportedly defrauded shareholders.
Today we can report on another enlightened action by a New York state court judge in such a case: City Trading Fund v. Nye, No. 651668/2014 (NY Sup. Ct.). The opinion includes a remarkable discussion of the nature of frivolous “merger tax” litigation, and includes an unusually frank discussion of why the filing of such cases renders to plaintiff, and the plaintiff’s law firm, unfit to serve as class representatives or class counsel.
The case involved alleged misleading disclosures in connection with an acquisition of Texas Industries, Inc. by Martin Marietta Materials, Inc. Just before a scheduled hearing on a motion for a preliminary injunction to enjoin the shareholder vote on the proposed transaction, the parties entered into a settlement. As the court describes, it was “disturbed by the settlement, which presents significant public policy concerns.” It ordered defendants to file a memorandum addressing the settlement, which was needed because otherwise the defendants would stand mute, as implicitly required by the settlement.
Following a motion to approve the settlement, and the mandated filing by the defendants, Judge Shirley Kornreich of the New York Supreme Court wrote a scathing opinion describing in detail the cynical and abusive nature of the claims asserted and the practice of the plaintiff’s law firm, the Brualdi Law Firm, of filing such claims on behalf of a supposed investor which, in fact, held a portfolio of stocks for the purpose of being able to file what the judge calls “merger tax lawsuits.” She wrote in detail about why the claims asserted were meritless, and then took the unusual step of describing the sordid practice of the plaintiff’s firm and its “client” as follows:
Plaintiffs allege that CTF is a general partnership and that Bass and Carullo are its partners. CTF, however, is not a business, at least in the sense that it does not engage in commerce. It does not sell or manufacture products nor does it provide services. Rather, CTF is the name of an E*Trade brokerage account belonging to Bass and Carullo. Before the merger, CTF owned 10 shares of MMM, which was worth approximately $1,200 in April 2014.
This is the modus operandi of Bass and the Brualdi Law Firm. They purchase nominal amounts of shares in publicly traded companies. Then, when one of the companies announces a merger, the partnership engages the Brualdi Law Firm to file a merger tax lawsuit. Since 2010, the Brualdi Law Firm has filed at least 13 lawsuits in this court in the name of different partnerships. Aside from this lawsuit, the Brualdi Law Firm has filed lawsuits on behalf of entities called RSD Capital (Index No. 651883/2010), Broadbased Equities (Index No. 652413/2011), Broadbased Fund (Index No. 653236/2011), Special Trading Fund (Index No. 653253/2012), Reliant Equities (Index No. 651230/2012), Sector Grid Trading Company (Index No. 650121/2013), Broadway Capital (Index No. 650143/2013), Gotham Investors (Index No. 651831/2013), Realistic Partners (Index No. 654468/2013), Rational Strategies Fund (Index Nos. 653566/2012 & 651625/2013), and Equity Trading (Index No. 650112/2014). The Brualdi Law Firm resists disclosure of the relationship between these partnerships unless, in the face of an objection, such as GBL § 130, it must disclose who is really behind the curtain.
The Brualdi Law Firm’s recent wave of litigation in this court appears to be a continuation of a business strategy it previously carried out in the Delaware Court of Chancery, which went awry. See In re SS & C Techs., Inc. S’holders Lit., 948 A2d 1140, 1150 (Del Ch 2008) (“those entities and that relationship raise very disturbing questions and may well disqualify those partnerships or the persons associated with them from serving in a representative capacity in the future”). The SS & C court sanctioned the Brualdi Law Firm in a merger lawsuit based on immaterial disclosures, which led to the court rejecting the settlement. See id. at 1142. Vice Chancellor Lamb held that “the record did not support a finding that plaintiffs’ counsel adequately represented the interests of the class or that the settlement terms [were] fair and reasonable.'” Id. After the settlement was rejected, defendants discovered that the Brualdi Law Firm was filing lawsuits on behalf of “a web of small investment partnerships for the sole purpose of bringing stockholder lawsuits”, similar to the CTF-like entities in this court. See id. at 1144. Sanctions were imposed for a pattern of unethical conduct, including making false statements to the court, which were compounded by further false statements made to hide the original inaccuracies. See id. at 1145.
In sum, this litigation is “pernicious” for reasons best articulated by defendants’ counsel:
First, permitting Mr. Brualdi’s clients—fictitious entities with no purpose for existing and no economic interests apart from the generation of attorneys’ fees—to act on behalf of classes of other, real investors with actual money staked on the financial health of public companies poses a stark conflict of interest. Second, that fundamental conflict causes the Brualdi Law Firm to adopt inequitable litigation tactics and to advance meritless claims directed not at vindicating the rights of real shareholders but at maximizing the chance Brualdi Brand litigation will settle, resulting in awards of attorneys’ fees that are wholly out of proportion to any real benefit conferred on shareholders. Making this conflict even worse is the fact that ultimately, the shareholders themselves are (through their ownership of the companies Mr. Brualdi sues) responsible for paying fees awarded to Mr. Brualdi. Allowing the Brualdi Law Firm’s tactics to succeed wastes judicial resources, undermines the public’s faith and confidence in the courts of this State and impairs the State’s reputation as a fair, welcoming place for companies to do business.
Dkt. 87 at 7-8. The court could not agree more.
Slip op. at 14-16 (footnotes omitted).
The court went on to discuss why the supposed “corrective disclosures” agreed to as part of the settlement were not at all meaningful to shareholders because they were “grossly immaterial.” See id. at 16-21. It then says: “Plaintiffs’ counsel wants $500,000 for bringing this lawsuit. This lawsuit has already cost the shareholders tens of (or possibly hundreds of) thousands of dollars to defend. This is a problem.” Id. at 22 (footnote omitted).
The court then proceeds to bemoan “the current state of merger litigation,” and mentions “proposed reforms to corporate by laws” to address these concerns (presumably referring to the current discussion of “loser pays” derivative actions provisions in corporate bylaws), as follows:
It is no secret that when a public company announces a merger, lawsuits follow. There is nothing inherently wrong with this phenomenon. If the merger price is woefully unjustifiable or if shareholders are not given adequate disclosure to cast an informed vote, a lawsuit is very much the proper way to redress these matters. However, the ubiquity and multiplicity of merger lawsuits, colloquially known as a “merger tax”, has caused many to view such lawsuits with a certain degree of skepticism. The lawsuits are filed only a relatively short time before the shareholder vote, and all it takes is a remote threat of injunction or delay to rationally incentivize settlement, even if defendants firmly and rightfully believe the lawsuit has no merit and would be disposed on a motion to dismiss or at the summary judgment stage. Most commonly, the lawsuits are brought on behalf of the company being acquired, and the claim is that the shareholders are not being bought-out at a high enough price. This court is well acquainted with such lawsuits. . . . Likewise, this court, and presumably all counsel in this action, are aware of the proposed reforms to corporate bylaws aimed at addressing the concerns many have with the way in which this litigation occurs. The wisdom of these reforms and their legality are hotly contested issues. Compelling arguments have been made by a variety of stakeholders. Aside from what one thinks of the proposed reforms, that such reforms are such a hot topic suggests a growing frustration with the current realities of merger taxes.
No one, not even plaintiffs, disputes this reality. The defendant corporation’s cost-benefit calculus almost always leads the company to settle. Even a slight change of an adverse outcome will induce a company to rationally settle given the costs. Here, defendants provide countless examples of such costs, none of which are contested by plaintiffs. See Dkt. 87 at 23-24 (discussing impact on information technology, human resources, sales and marketing, finance, accounting, tax, and regulatory matters); see also In re Delphi Fin. Group S’holder Lit., 2012 WL 729232, at *19 (Del Ch 2012) (“if the merger is enjoined, the deal may be lost forever”); In re CheckFree, 2007 WL 3262188, at *4 (“The theoretical harm to plaintiffs here is not particularly substantial” and “the public interest requires an especially strong showing where a plaintiff seeks to enjoin a premium transaction in the absence of a competing bid”). The very nature of this lawsuit incentivizes settlement, regardless of its frivolity.
Slip op. at 22-24 (footnotes omitted).
The court finally determines that it “will not certify the class nor will it approve the settlement because it is not in the best interest of the class.” Judge Kornreich refers to Judge Schweitzer’s “highly persuasive opinion in Gordon v Verizon Communications, Inc., which was the subject of the earlier post Commentary on Abusive State Law Actions Following M&A Deals. A copy of that opinion is available here: Decision and Order in Gordon v. Verizon Communications. She concludes: “Here, had plaintiffs alleged material omissions or settled for material supplemental disclosures, the court would have approved the settlement. Even if the court did not think the supplemental disclosures were worth much, if they were legally material, the court would have withheld any criticism of plaintiffs’ counsel until the final approval stage, when the court, as guardian of the best interests of the class, would have limited the attorneys’ fees award to an amount commensurate with the value of the disclosures. However, in this case, the supplemental disclosures are utterly immaterial for the reasons discussed earlier. The settlement, therefore, should not be approved. . . . Approving the settlement in this case would both undermine the public interest and the interests of MMM’s shareholders. It would incentivize plaintiffs to file frivolous disclosure lawsuits shortly before a merger, knowing they will always procure a settlement and attorneys’ fees under conditions of duress — that is, where it is rational to settle obviously frivolous claims. Without the court serving as a gatekeeper, plaintiffs who file such ligation will continue to unjustifiably extract money from shareholders, who get no benefit from the litigation but nonetheless end up paying two sets of attorneys, both plaintiffs’ and defendants’. This is a perverse result.” Slip op. at 32-33 (footnotes omitted).
Judge Kornreich’s coda is an attack on The Brualdi Firm and the plaintiff “and why they are ill suited to be class counsel and class representative”:
[T]he court does believe they filed this class action because they had a genuine concern for the Company’s corporate governance. Rather, they are simply trying to make money from litigation. They and their counsel have accurately identified a massive inefficiency in the way in which courts adjudicate merger litigation, and have capitalized accordingly. They are, in a word, shrewd investors. Their investment, unfortunately, is in litigation. . . .
In merger litigation — unlike other class action litigation (e.g., securities fraud) where, if the case is frivolous, the court can dispose of it on a motion to dismiss — the time crunch incentivizes a payout to plaintiffs to settle all cases, even frivolous ones. Thus, extra scrutiny is warranted when it appears that the incentives of the purported class representatives diverge from those of the shareholders. Such a divergence of incentives may exist, as is the case here, where it appears that the original plaintiff, CTF — essentially a fictitious entity — seeks to obfuscate what it really is. When a proposed class representative appears to be a fiction, there is the concern that it has no accountability, either to the class or to the court. . . .
Simply put, the secretive nature in which plaintiffs and their counsel choose to litigate, both here and in Delaware, along with the frivolity of their claims, is a strong indication that they are ill suited to represent the class. . . .
Slip op. at 34-37 (footnote omitted).
Bravo Judge Kornreich. May the seeds strewn by you and Judge Schweitzer bear fruit in other judicial orchards.
The full opinion can be found here.
December 9, 2015
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